In a recent article called Oil Stocks Get Devastated By Coronavirus Fears: 5 Stocks To Buy Right Now For The Long Term I argued that the recent coronavirus-inspired oil price decline will likely not last for a very long time and that the low stock prices of many energy stocks result in great buying opportunities for income investors looking for a long-term investment.
Spot prices for crude oil have not recovered over the last couple of days, as the market still worries about the short-term impact that the coronavirus will have on global oil consumption. The great buying opportunities for energy stocks, therefore, continue to exist, and in this article, I will highlight 5 more high-yielding energy stocks that could be big winners over the coming years and decades. Before that, we will take a look at the macro environment for global oil prices, and at a perceived risk that many readers worry about.
Market Irrationality Is A Great Way To Buy Income Stocks While Their Yields Are At A High Level
Source: Seeking Alpha’s image bank
My belief that global oil markets will only see a short-term hit from the coronavirus is explained in more detail here, but in short, the thesis is the following one:
Oil consumption will decline in China in the near term, but once the coronavirus crisis is dealt with, demand for oil should get back in line with pre-crisis levels. Demand growth from expanding economic activity around the globe, and especially demand growth from growing economies such as India, will result in ongoing global oil consumption increases over the coming years and decades.
In general, this is also what many experts believe — there will be an impact on oil demand, but it will not be long-lasting, and oil consumption will ultimately hit new record highs in 2020. The IEA, for example, forecasts that oil consumption will look like this in 2020:
Indeed, there will be a hit to global demand, but in Q2 we will already be at pre-crisis levels again, before demand hits a new record high in Q3. For investors with an investment horizon of several years or even decades, it does not matter whether demand will be temporarily down by 1% in Q1 of 2020. What matters is how oil demand will look 5, 10, or even 20 years from now, and current projections look very supportive for energy investors:
Source: OPEC presentation
OPEC believes that oil consumption in OECD countries will decline to some degree by 2040, due to measures that are aimed at curbing CO2 emissions. Non-OECD countries, however, will increase their oil consumption by a large degree, which will more than offset declining oil consumption by the US, Europe, etc. All in all, OPEC believes that growing demand from countries such as India and China will drive global oil consumption to more than 110 million barrels per day 20 years from now. OPEC is not the only organization predicting an increase in oil consumption, the IEA’s forecast looks quite similar — demand growth from emerging countries will lead to new record highs in global consumption over the coming years and decades:
When we look at the facts, it is relatively unsurprising that China, India, the Middle East, and Africa will be large demand drivers for oil (and other forms of energy) going forward. These countries and regions combine growing populations and steadily rising disposable incomes. This means that an increasing portion of consumers is able to buy cars, travel via aircraft, spend money on larger houses that require more heating (winter) and/or more cooling (summer), while they also can spend more money on consumer goods that need to be (a) produced and (b) transported.
All in all, I thus believe that even though the coronavirus outbreak will have a short-term impact on oil consumption, the long-term trend still looks favorable, and ultimately growing oil consumption should result in significantly higher oil prices. The macro-environment for energy companies is thus not bad, and yet many energy stocks trade at bargain prices.
The Fight Against Global Warming – A Risk For Oil Companies?
In my previous article, I looked at some risks for global oil prices, which included a potential economic slowdown as well as political risks. In order to not repeat myself too much, I will take a closer look at another risk that has been mentioned in the comment section a couple of times, which is the fight against climate change, or the goal of CO2 emission reduction.
It is true that politicians, corporations, and societies around the globe have gotten more serious about curbing CO2 emissions, but this will not necessarily result in declining oil consumption. First, it should be noted that not all oil that is consumed is being burned, as oil is also being turned into plastics and other materials. This portion of oil that will never get burned will, according to the IEA, rise substantially in the future, and it will not lead to CO2 emissions.
Another fact that should be considered is that oil is not the worst energy source by far. In fact, the highest CO2 emissions, relative to the energy output we receive, are caused by coal. In order to be most effective in curbing CO2 emissions, societies should get rid of the worst energy sources first, which would mean replacing coal-fired power plants by less-CO2-intensive technologies, which includes natural gas. Even if politicians would get very serious about lowering CO2 output, getting rid of gasoline-powered cars and replacing them with EVs that are partially fueled by electricity that comes from coal-burning power stations would not be a very smart move. Getting rid of coal-powered plants and replacing them by renewables and natural gas-powered plants would be way more effective, and would not hurt global oil consumption. Oil companies would even benefit from such a move, as many of these companies own natural gas assets as well.
Last but not least, it should be noted that the impact of measures to reduce oil demand (and CO2 output) is already included in current oil demand forecasts, which explains why oil consumption in OECD countries is forecasted to decline somewhat going forward. Additional demand from higher-growth countries will be so strong that these measures will most likely be more than offset, though. This is not surprising: CO2 consumption on a per-capita basis is much lower in India or China, compared to the US or Europe. As consumer wealth in these emerging markets grows, their populations will eventually have living standards that are similar to those from industrial nations, which includes comparable oil consumption levels and CO2 output.
I thus believe that societies will, in order to battle climate change, engage in measures that are aimed at reducing CO2 output, but that will likely not prevent oil demand from growing on a global scale, as rising living standards in large parts of the world are too much of a demand driver, while oil is also not what politicians should focus on when trying to battle CO2 emissions in the most effective way.
The First Oil Stock That Looks Attractive Right Here: Royal Dutch Shell
Royal Dutch Shell (RDS.A) (RDS.B) is one of the supermajors, and an oil stock that has been mentioned often in comments to my recent article. I think that the stock is highly attractive, and the only reason I did not include it in my first article is that its share price has not been bombed out as much as that of Exxon Mobil (XOM), for example.
Its share price is not at 10-year lows, as shares traded much lower during the oil-price crash in 2016. Nevertheless, Shell’s share price has also suffered a lot in the recent past, and shares are currently offering a very attractive dividend yield of 7.5%. Unlike peers Exxon Mobil and Chevron (CVX), Shell has not raised its dividend very consistently, but the dividend track record is still strong, as Shell has not cut its payout since World War 2.
Shell’s dividend ($14.8 billion a year) is easily covered by its strong cash generation, as its free cash flows totaled more than $19 billion during the last four quarters, which includes a headwind from working capital increases. As we see in the above chart, free cash flows were even higher in the recent past, and the company has a goal of hitting annual free cash flows of ~$35 billion by 2025, which would result in a free cash flow payout ratio of just ~40% for its very juicy dividend.
Based on a current market capitalization of $195 billion, Shell’s shares also have huge upside potential as long as the company comes anywhere close to generating free cash flows of $35 billion by 2025. Even if the free cash flow multiple was just 8 five years from now, shares could still rise to $72, not including the impact of future buybacks. The combination of share price upside potential of 40% or even more over the next five years, combined with an initial dividend yield of well above 7%, makes Shell look highly attractive at current prices. I believe that there is a high chance that Shell will deliver double-digit annual returns over the next couple of years.
The Second Oil Stock That Looks Attractive Right Here: Total
Total (TOT) may be the least-known of the supermajors, but like its peers, it looks like an attractive long-term investment right here. The French company is valued at $127 billion, and offers an attractive dividend yield to its shareholders:
Its dividend yield is almost 6%, and the company has increased its dividend meaningfully in the recent past. The small temporary decline in the dividend chart can be explained by currency rate movements, as Total declares its dividends in Euro, not US Dollars.
Source: Total’s investor relations website
When we back out forex movements, we see that the dividend has been hiked by % in 2019, while management aims to increase its payout by at least 5% a year in the future, too. The combination of a dividend yield of almost 6%, and 5%+ annual dividend increases makes Total an attractive dividend growth investment. If dividends are reinvested, the total annual payout would rise at a double-digit pace.
Like Shell, Total easily covers its dividends with free cash flows, as its dividend payments of $6.6 billion during the last four quarters were just half as high as its free cash flows of $13 billion during that time frame (data from YCharts).
Total has a large oil and gas portfolio which the company seeks to grow through a range of growth projects, this has resulted in highly attractive production growth of 8% during the most recent quarter. On top of that, the company has also been investing in other businesses, including renewables and batteries. For investors that want to hold the stock for 20 years or even longer, it could be a plus to see that the company is already positioning itself for a future when oil demand is no longer growing.
Due to the fact that its share price is at multi-year lows, upside potential to the analyst consensus price target is quite large right now, at almost 40%. Coupled with production growth, a growing renewables portfolio, and its attractive dividend growth properties, the large upside potential makes Total look like a compelling investment right here.
The Third Oil Stock That Looks Attractive Right Here: Enterprise Products Partners
Enterprise Products Partners LP (EPD) is, unlike Shell and Total, not an oil producer, but a midstream company. It has nevertheless seen its share price decline substantially in the recent past:
The recent share price decline from $29 to $26 has lifted its dividend yield to a quite high level of 6.7%, which is close to the highest level throughout the last year, and which is more than three times the broad market’s dividend yield.
Enterprise Products is not the highest-yielding midstream stock, but it is a high-quality company with a healthy balance sheet, compelling underlying growth, and a large growth backlog.
Source: Enterprise Products Partners presentation
Due to the fact that 86% of Enterprise Products’ gross profits are derived through fee-based contracts, whereas just 4% of gross profits are dependent on commodity prices, the company generates very secure cash flows that are not volatile. The oil price decline in the recent past should not impact its cash flows.
During the most recent quarter, the company managed to grow its distributable cash flows by 12% year over year, which is a highly attractive growth rate for a high-yielding stock like Enterprise Products.
Source: Enterprise Products Partners presentation
Thanks to $7.7 billion worth of projects under construction, Enterprise Products’ cash flows will continue to grow meaningfully for years. Due to the fact that Enterprise Products’ dividend is easily covered by distributable cash flows (coverage ratio of 1.7), investors don’t have to fear about a dividend cut at all, and it is very likely that the company will continue to increase its payout going forward. The combination of sizeable cash flow growth and a payout ratio that is not high at all, leaves a lot of room for future dividend increases for this high-yielding quality midstream company. Enterprise Products Partners has upside potential of more than 30% to the average price target of $34 (per YCharts).
The Fourth Oil Stock That Looks Attractive Right Here: MPLX
MPLX LP (MPLX) is another pipeline company that has seen its share price drop massively over the last year, which has, in turn, lifted its dividend yield to a very attractive level:
With its shares being down more than 30% over the last year, its dividend yield has risen to more than 11%. With a dividend yield this high, the company’s stock would not have to offer any share price gains at all to be an attractive investment, the dividend alone is sufficient to generate compelling returns.
MPLX, which is the midstream LP of Marathon Petroleum (MPC), is currently outspending its operating cash flows, but this is due to an ambitious growth program that will slow down going forward:
Source: MPLX presentation
With $2.6 billion (equal to more than 10% of its market capitalization) in growth capital spending during 2019, MPLX has been investing heavily in building out its asset base during the last year. Growth spending will not decline to zero, but the company forecasts a more moderate pace of growth investments, with a 2021 growth capital target of $1 billion.
Even if distributable cash flows do not grow at all between 2019 and 2021, distributable cash flows would be high enough to fully cover MPLX’s massive dividend and its growth investments at the same time. Due to the fact that new projects are being placed into service during 2020 and 2021, distributable cash flows in 2021 will, in all likelihood, be meaningfully higher compared to 2019. This means that MPLX should be in a position where the company can fully cover its dividend and its growth spending, while still having surplus cash flows that can be used for buybacks, debt reduction, or acquisitions on top of that.
The company plans to spend $2.5 billion on growth projects during 2020 and 2021, assuming it generates mid-teens returns on these investments (per management’s guidance), cash flows should see a boost by another ~$400 million over the next two years, not including any growth from existing assets. All in all, MPLX should be easily able to keep its dividend at the current level for the future, which will result in compelling returns all by itself. Any share price increases (30% upside to the average price target per YCharts) would be an added bonus on top of that.
The Fifth Oil Stock That Looks Attractive Right Here: Euronav
Euronav NV (EURN), the fifth oil-related stock in this list, will be somewhat of a surprising pick for many readers, as it is a shipping company. Belgium-based Euronav is one of the leading crude tanker companies in the world, employing around 70 ships, with around 75% of those (by tonnage) being VLCCs, with Suezmax tankers making up the remainder.
In the recent past, Euronav has seen its share price decline by roughly one-fourth, despite the fact that the company released very strong earnings results 2 weeks ago:
– Revenues were up 50% year over year during the fourth quarter
– Net profits totaled $0.75 per share during one single quarter, versus a share price of just $10
– Management announced the adoption of a new dividend policy that will lead to substantially higher payouts in the future
The analyst community currently forecasts $2.22 in earnings-per-share for the current year, which equates to an earnings multiple of just 4.5 with shares trading at $10 right now.
Due to Euronav’s new policy of paying out 80% of net profits as dividends, investors could be looking at total dividend payments of $1.78 for the current year, with a final $0.35 per share dividend for 2019 coming on top of that. Combined, this would result in dividend payments of around $2.10 during 2020, which would mean that investors would get a dividend yield of more than 20% during the current year.
The market anticipates that tanker rates will go down in the future, which is why the earnings-per-share forecast for 2021 is only $1.56 (which would still lead to a dividend yield of 12% with shares trading at $10, using management’s guidance for an 80% payout ratio). Due to the fact that tanker supply will remain constrained for the foreseeable future, current earnings estimates for 2021 and beyond could be too low, though. In that case, investors would see even bigger payouts than what the current base case estimate by the analyst community suggests.
Euronav is somewhat of a higher-volatility, higher-risk pick compared to the supermajors and pipeline companies mentioned in this list, but based on the fact that shares are trading at a very low valuation of just 4.5 times this year’s earnings, and accounting for a forecasted dividend yield of 20%+ during the current year, Euronav is an investment with high potential rewards. For those that do not shy away from some volatility in their portfolios, Euronav could be a great addition at its current price, following the 25% share price decline we have seen in 2020.
Buying when others are running for the exit allows for picking up shares at low valuations and with high initial dividend yields, which can positively impact future returns to a large degree. I believe that right here, the market worries too much about the coronavirus and its impact on oil prices, and discounts the fact that oil consumption will, in all likelihood, continue to rise for decades.
This is why I believe that many oil-related stocks are attractive right here, with the ones being listed in this article being prime examples of undervalued stocks that could deliver strong returns over the coming years.
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Disclosure: I am/we are long RDS.A, MPLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.