by Aaron Levitt | March 13, 2013 7:00 am
Finding reliable sources of income continues to be the name of the game for many investors, which has sent them to various sectors and assets classes in the search for yield. Most of that interest and money has gone to traditional dividend-paying sectors such as healthcare and utilities, but even technology stocks have caught the income fever.
The energy sector, on the other hand, is generally thought of as a place for growth. Still, some overlooked picks could be a real gusher for those investors looking for dividends … and can provide income opportunities as well.
We’re not just talking about pipeline limited partnerships or royalty trusts, either. Instead, the long-term growth in advanced drilling techniques and rising global demand for oil and natural gas has created a unique dividend environment.
See, the long-term demand for fossil fuels remains intact. Driven by new sources of demand in the emerging world, the Energy Information Administration estimates that total worldwide energy consumption will increase by about 49% by 2035. That demand — along with higher CAPEX budgets devoted to unconventional resources — has continued to push up prices for various energy commodities.
Those sustained higher prices have helped create some very robust cash flows at a variety of the firms that are drilling or providing equipment needed to do so … and those steadily rising cash flows are being returned to investors in spades. According to FACTSET, the energy on average increased their dividends by 21% in 2012.
The trick is finding just who is paying out those hefty cash flows. The broad-based Energy SPDR (NYSE:XLE), for example, currently only yields a paltry 1.67%, and many E&P firms don’t pay dividends at all. Still, there are several ways to get your hands on some energy dividends … and because investors generally focus on the growth prospects for the sector, many of these income opportunities are overlooked and thus trade at discounts.
Here are three of the top picks:
While Transocean (NYSE:RIG) may get all the credit in the offshore drilling space, second-place firm Ensco (NYSE:ESV) could be the better value. Since its $7 billion purchase back Pride Drilling back in 2011, Ensco has quickly become a leader in the deep and ultra-deep water drilling space. The company owns 70 rigs and currently receives over half of its revenue from deep-water drilling.
Those drill-ships, jack-ups and deep-water platforms — which are newer than rival RIG’s — command premium day rates thanks to their technological sophistication, which helps effectively and safely access reserves in harder-to-get-to reservoirs. Two years ago, Ensco was only receiving about $400,000 a day for it services. Today, that number is well above $600,000 and has boosted cash flows over $200 million.
That cash flow has helped Ensco pay down debt and show shareholders the love. ESV recently hiked its dividend 33%, bringing the company’s quarterly payout from 37.5 cents to 50 cents per share — a juicy 3.5% yield. That sweetened payout is also more than 16 times the 3-cent quarterly dividend Ensco had in 2010.
Adding those dividends to the company’s growth prospects could make for a total return of more than 15% in 2013.
When Canadian natural gas-focused firm EnCana Corp. (NYSE:ECA) decided to spin-off it oil sands and heavy oil assets as Cenovus Energy (NYSE:CVE), the general idea was that the natural gas operations would be the growth element, while the liquids production would the steady-eddy play.
Things haven’t gone exactly according to plan. Cenovus is steady, but it’s still providing much more “oomph” for shareholders than its former parent.
That growth is coming from its oil sands production. With a number of large number bitumen projects in the works, Cenovus expects these assets to be fully brought online by 2020 — which will grow production from around 100,000 barrels per day to 400,000. The key for the firm — like rival Suncor (NYSE:SU) — is the firm’s own refineries that can tackle much of that heavy oil production.
Those refineries also help produce ample cash flow (the latest earnings release showed a 29% increase in operating cash flow from refining) and support CVE’s dividend. The company recently approved a 10% increase for the first quarter of 2013, giving the stock a yield just under 3%.
The refining or downstream sector has historically has paid paltry dividends, if any, due to its volatile earnings and high capital spending … but the unconventional drilling revolution and lower priced Bakken-based crude oil is changing that. Crack-spreads and refining margins are currently the biggest they have been in years, so many of the top independent refining firms — including Valero (NYSE:VLO) — can now afford to pay ample dividends.
VLO’s shares have more than doubled over the last 52 weeks, and its dividend has been on the way up as well. The downstream firm recently increased its payout 14%, making for a 1.8% yield.
Sure, that’s nothing to write home about, but consider this: In a presentation on its website, Valero states that its goal is to have “one of the highest cash yields among peers via dividends and buybacks.” That means more increases could be on the horizon … and many analysts think they’ll happen sooner than later.
Analysts at Morgan Stanley, for example, think Valero will significantly raise its dividend over the next 12 months, possibly doubling its dividend this year to $1.60 per share annually. Plus, the company’s increasing cash flows can support a payout in the $2 range. At current prices, that’s a very nice 4.5% yield.
As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.
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