Thanks to the strong recovery of global oil consumption from the pandemic, energy stocks are the top performing market sector of the S&P 500 this year. The commodity price rally has been fueled by the recovery from the pandemic, as well as the limited oil production from OPEC and Russia.
These two factors have led the price of oil to rally to a fresh 7-year high lately.
In this article, we will analyze the prospects of three energy stocks which are offering attractive dividend yields. These income stocks are:
BP, one of the largest oil and gas corporations in the world, is first on this list of energy stocks for income investors.
The company operates in two segments: upstream and downstream (mostly refining). The worst appears to be behind BP. Thanks to the massive distribution of vaccines worldwide, the pandemic has begun to subside and as a result, the global demand for oil has returned to its long-term growth trajectory.
According to the latest report of the Energy Information Administration (EIA), global oil consumption is expected to surge from 92.4 million barrels per day in 2020 to 97.4 million barrels per day in 2021 and its pre-pandemic level of 101.0 million barrels per day in 2022.
In addition, OPEC and Russia implemented unprecedented production cuts last year to provide a support to the price of oil. Although global demand for oil is recovering strongly, OPEC and Russia will not boost their production quotas to pre-pandemic levels until the end of 2022. This aggressive stance has resulted in a remarkably tight oil market, which has led the oil price to rally to a 7-year high.
Moreover, the price of natural gas has rallied to multi-year highs, as global production has hardly caught up with the rising demand. The steep rally of oil and gas prices is a strong tailwind for all the oil majors, particularly for BP, given its material debt load.
In the second quarter, BP reduced its production by 4% sequentially, primarily due to maintenance, but it enjoyed a 13% increase in the average price of Brent and improved refining margins thanks to strong pent-up demand for refined products. As a result, the company grew its earnings per share from 78 cents in the first quarter to 83 cents.
The earnings per share of BP in each of the first two quarters were among the highest of the company in the last seven years. Both results exceeded the analysts’ expectations by an impressive margin (81% in the first quarter and 38% in the second quarter).
BP slashed its dividend by 50% last year due to the pandemic, but it is still offering an attractive 4.4% dividend yield. The oil major has a payout ratio of only 40%, which provides a wide margin of safety to the dividend.
BP raised its dividend by 4% in the second quarter and stated that it can continue raising its dividend by 4% per year until 2025 as long as the price of oil hovers around $60. At that level of oil prices, BP also expects to be able to repurchase approximately $1 billion of shares per quarter. As this buyback rate corresponds to a 4% annual reduction of the share count, it is certainly significant.
Overall, as long as oil prices remain above $60, BP will continue offering excessive shareholder distributions, namely a 4.4% dividend that will grow by 4% per year, and meaningful share repurchases.
Valero Energy (VLO)
Valero Energy is the largest petroleum refiner in the U.S. It owns 15 refineries in the U.S., Canada and the U.K. and has a total capacity of approximately 3.2 million barrels per day. It also has a midstream segment, Valero Energy Partners LP, but its contribution to the total earnings is under 10%. Valero should thus be viewed as a nearly pure refiner.
All the U.S. refiners came under great pressure last year due to the coronavirus crisis, which caused an unprecedented collapse in the demand for refined products. Due to a steep decrease in volumes and a plunge in refining margins, all the U.S. refiners incurred hefty losses last year.
Fortunately, global demand for oil products is recovering strongly this year, which means refiners are in recovery mode. But while oil producers are on track to post multi-year high profits this year thanks to the rally of oil and gas prices to multi-year highs, refiners are poised to achieve marginal profits, as refining margins have improved only modestly.
Valero is not an exception, as it is poised to achieve earnings per share of about 50 cents this year. However, thanks to the sustained recovery of global consumption of refined products, the company is likely to achieve much higher earnings per share from next year.
Moreover, Valero is heavily investing in the expansion of the capacity of its renewable diesel production in order to adjust to the environmentally friendly government policies, which have gained ground in recent years.
Therefore, the focus of Valero on renewable diesel makes great sense. In addition, thanks to its high-return growth projects, Valero expects to grow its annual EBITDA by $1.2 to $1.6 billion in the upcoming years.
Valero has raised its dividend for 10 consecutive years and is now offering a 4.9% dividend yield, which places it on this list of energy stocks for dividend seekers. Given its strong recovery expected next year and the repeated commitment of its management to a growing dividend, Valero could announce a small dividend hike at the end of October, in order to extend its dividend-growth streak.
National Fuel Gas (NFG)
National Fuel Gas is a diversified energy company that operates in five business segments: exploration ands production, pipeline and storage, gathering, utility, and energy marketing. The largest segment is exploration and production, which generates approximately half of the earnings of the company.
The natural gas market proved much more resilient to the pandemic than the oil market last year. Even better, the natural gas market has become exceptionally tight this year and thus the price of natural gas has rallied to a 7-year high. This is a strong tailwind for National Fuel Gas, which generates approximately half of its earnings from its upstream segment.
In the third quarter of its fiscal year, National Fuel Gas grew its production by an impressive 48% over last year’s quarter, primarily thanks to the acquisition of Appalachian assets from Royal Dutch Shell (NYSE:RDS.B). In addition, the average price of natural gas rose 15%, from $1.92 in last year’s quarter to $2.20. As a result, adjusted earnings per share grew 63%, from 57 cents to 93 cents, and exceeded the analysts’ consensus by 11 cents.
National Fuel Gas raised its guidance for a fourth consecutive quarter thanks to the uptrend of the price of natural gas. Management now expects earnings per share of $4.05 to $4.15 (versus previous guidance of $3.85 to $4.05), for 40% growth at the mid-point. It also initiated guidance for earnings per share of $4.40 to $4.80 in fiscal 2022, implying 12% growth at the mid-point, primarily thanks to an improved outlook for natural gas prices.
National Fuel Gas has paid uninterrupted dividends for 118 consecutive years. It has also grown its dividend for 51 consecutive years and thus it has become the first energy company that belongs to the group of dividend kings. This achievement is admirable, particularly given the high cyclicality of the energy sector.
National Fuel Gas is currently offering a 3.2% dividend yield. Given its solid payout ratio of 44% and its promising growth prospects, investors should rest assured that the dividend is safe.
We analyzed the prospects of three high-yield energy stocks, which have different yield and safety characteristics. Among the above three stocks, National Fuel Gas is the most resilient to the pandemic and is offering the lowest but safest dividend yield.
Valero is offering the highest yield but it is the most vulnerable stock to the pandemic, as it has yet to recover from that crisis.
Lastly, BP is thriving in the current environment but it is vulnerable to the downturns of the energy sector.
Overall, all three energy stocks offer high yields, and growth potential from exposure to rising commodity prices.
On the date of publication, Bob Ciura did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura has worked at Sure Dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a bachelor’s degree in Finance from DePaul University and an MBA with a concentration in investments from the University of Notre Dame.