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Motley Fool Issues Rare “All In” Buy Alert
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Kinder Morgan (KMI -0.03%) and Devon Energy (DVN 0.09%) are among the two most popular oil and gas dividend stocks out there. While Kinder Morgan has a long, proven history of dividend growth, Devon Energy emerged as the dark horse of the year after it doled out monster dividends quarter after quarter under its offbeat fixed-plus-variable dividend policy that was launched only last year.
Both stocks, though, have lost steam in recent weeks as crude oil prices slid. The U.S. crude oil benchmark West Texas Intermediate (WTI), in fact, has declined to almost half off its high for the year.
For investors in energy, this could be a perfect opportunity to take a closer look at top-notch stocks like Devon and Kinder Morgan and add some shares to their portfolios. Which among the two high-yield stocks is a better buy, though? It depends much on how much risk you are willing to take.
Daniel Foelber (Kinder Morgan): Kinder Morgan is a leading North American pipeline and infrastructure company. The objective for Kinder Morgan is simple — invest in projects that can produce decades of cash flows. These cash flows can then support future projects by reinvesting in the business. That cash can also pay dividends, buy back stock, acquire other companies, and even pay down debt.
For Kinder Morgan to succeed, it must choose investments with a high chance of working out. It’s a tall order, as interstate pipelines can cost a fortune and take a long time to pay off.
After the oil and gas crash of 2014 to 2015, Kinder Morgan reeled in its spending and focused on restoring order to its balance sheet. It also slashed its dividend. The last seven years have been transformative. Total net long-term debt has been reduced by 27%, trailing-12-month capital expenditures are down over 60%, and the company is generating plenty of free cash flow (FCF) to support its dividend — which yields 6%.
Although domestic demand for natural gas may stagnate over time, there’s plenty of growth potential for Kinder Morgan to tailor its infrastructure toward the U.S. export of natural gas, either via pipelines to our neighbors or to ship it as liquefied natural gas (LNG). With surging glboal demand and the U.S. being awash in crude and natural gas, it’s up to companies like Kinder Morgan to build the pipelines, storage, and terminals necessary to make that production useful.
The beauty of Kinder Morgan’s business is that it contracts its assets through long-term take-or-pay and fixed-fee contracts that give it steady cash flows no matter the market cycle. For example, Kinder Morgan suffered only minor hits to its performance during the oil and gas crash of 2020, while many companies in the upstream sector had their worst years in decades. On the flip side, Kinder Morgan is unlikely to outperform producers during a bull market in oil and gas because its upside is limited by its long-term contracts.
In sum, Kinder Morgan is an excellent stodgy company with low to moderate growth prospects, and a great business model and balance sheet to support its high yield.
Neha Chamaria (Devon Energy): As an oil exploration and production company, Devon Energy’s fortunes are tied closely to oil prices. That is why the company has performed so well this year, what with oil prices skyrocketing. That also means it becomes tougher for Devon to grow its cash flows when oil prices fall. During such times, only a financially strong company can withstand the volatility and continue to reward shareholders.
Devon Energy has that quality, having judiciously used this year’s incremental cash flows to balance growth and stability. It repaid debt, made some bolt-on acquisitions, repurchased shares, and rewarded its shareholders handsomely through big dividends. Acquisitions included that of Eagle Ford operator Validus Energy and some assets in the Williston basin.
As for dividends, every quarter Devon pays a fixed base dividend as well as a variable dividend of up to 50% of the excess cash flows left after funding capital expenditures and the fixed base dividend. That variable component — and therefore Devon’s total per-share dividend payout — grew exponentially this year as Devon’s cash flows zoomed amid high oil prices.
DVN data by YCharts
Investors are becoming increasingly worried about Devon’s dividend safety now that crude prices are cooling off, but the company’s recent acquisitions should help boost its cash flows and support a high yield even if oil prices fall. The oil stock currently yields a hefty 7.9%.
Devon is, in fact, on track to generate record free cash flow in 2022, and while it’s hard to predict what 2023 could bring, all of that money puts the company on solid footing. In the longer run, Devon’s fixed-plus-variable dividend policy backed by cash-flow growth could prove richly rewarding for patient shareholders.
As a midstream company, Kinder Morgan is a steadfast stock that can generate steady cash flows, pay out regular dividends, and even grow them slowly but steadily over time. The stock’s yield, therefore, is safer and well suited for risk-averse income investors. However, if you can stomach the oil market’s volatility, Devon Energy’s dividends, though not bankable for steady growth, could fetch you a lot of money should the oil market boom.
Daniel Foelber has no position in any of the stocks mentioned. Neha Chamaria has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Kinder Morgan. The Motley Fool has a disclosure policy.
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