Energy stocks have increased significantly this year. the S&P Energy Select Sector Index is up 36% so far in 2021. That doesn’t mean, however, that bargains in the industry have completely disappeared. Three pipeline stocks – Enbridge (NYSE: ENB), Enterprise Product Partners (NYSE: EPD), and ONEOK (NYSE: OKE) – seem attractive despite their increase this year. Let’s see what makes these stocks a buy right now.
Stable cash flow
All three companies generate relatively stable cash flow. Because they are in the middle segment of the energy sector, their profits are relatively less affected when oil and gas prices fall compared to the profits of those engaged in oil and gas production. Indeed, the profits of these three companies are supported by long-term fee-based contracts.
Although contract rates can be affected if commodity prices remain suppressed for long periods of time, corporate profits are not greatly affected by short-term commodity price fluctuations.
About 87% of Enterprise Products Partners’ 2020 revenue was paid. Likewise, more than 90% of ONEOK’s 2020 revenues were paid. Likewise, Enbridge’s regulated gas transmission and distribution activities provide it with a fairly stable revenue stream. The tolls for its liquids pipelines are long-term and approved by the Canadian Energy Regulator. Thus, the profits of the three companies are relatively resistant to commodity prices. Because of this, they have been able to steadily increase their income over the years.
As the chart above shows, earnings and operating cash flow for the three companies have largely trended upward over the past 10 years. This included periods of sharp decline in commodity prices, including the years 2014 and 2020.
Growth and strong dividend yields
All three also have a strong track record of dividend growth. Enterprise Products Partners has increased its distribution for 22 consecutive years, while Enbridge has increased its dividend for 26 consecutive years. ONEOK has a history of dividend growth of over 30 years, although it had a small indirect cut through its Master Limited Partnership (MLP) in 2017.
Additionally, despite their share price increases this year, all three stocks are trading for returns above their respective historical average returns. This is because stocks have only recovered part of their losses from last year. Dividend investors will surely find the high yields attractive.
Balance sheet strength
Often times, high returns are associated with high risks. But this is not the case for Enbridge, Enterprise Products or ONEOK. All three stocks have reasonable debt-to-EBITDA ratios, with Enterprise Products being the most conservative of the lot.
In comparison, Enbridge’s higher ratio can be attributed to its slightly aggressive approach to growth. Yet the ratio has improved significantly recently, thanks to the growth in the company’s EBITDA. Strong balance sheets give all three companies the flexibility to raise funds at reasonable rates when needed. It also means that in tough times, if profits fall, companies can rely on their balance sheets rather than being forced to cut payments.
Another parameter that reflects the long-term sustainability of dividend payments is the percentage of distributable cash that companies pay out as a dividend. In the last quarter, Enterprise Products Partners distributable cash flow (DCF) was 1.7 times its distributions for the quarter.
Enbridge aims to pay 60% to 70% of its DCF as dividends while keeping the remainder. Based on its 2021 dividend and DCF forecasts, its ratio would be within its target range. Likewise, ONEOK’s DCF in Q1 was 1.59 times its dividends paid for the quarter.
Main dividend-paying stocks
All three companies have a strong backlog of capital projects. This means that they can not only maintain their payments for years to come, but also grow them. In short, all three stocks are attractive buys, especially for dividend investors.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.