Energy investors are in a rough spot with oil and gas stocks being decimated due to the unprecedented demand destruction associated with the ongoing coronavirus pandemic.
Ripple Effects of the Pandemic Continue to Frustrate Energy Investor
From upstream (exploration and production) to downstream (refining and distribution), no subset of the energy space has been immune to the coronavirus-induced downturn. While the price slump has greatly impacted the results of E&P companies for obvious reasons, refiners’ numbers are being dragged down by lower utilization due to a collapse in consumption for jet fuel and gasoline. Further, the trough in prices and demand has pushed drilling activity lower. This automatically translates into lesser work for the oilfield service firms — companies that make it possible for upstream players to drill for oil and gas.
Energy investors have been running for cover as the demand erosion caused by efforts to stem the spread of the coronavirus whipsawed stocks and futures. While oil prices have rebounded from the coronavirus-induced lows in late April to more than $40 per barrel now, they are still around 30% below pre-COVID-19 levels. Moreover, a surge in fresh coronavirus cases threatens to derail the commodity’s recovery.
Pipeline Stocks Provide a Safer, Less Volatile Option
Considering the uncertainty in oil right now, a safer way of playing the sector would be to utilize Master Limited Partnerships (MLPs), which offer considerable returns at significantly lower risk.
The assets that these partnerships own — oil and natural gas pipelines and storage facilities — typically bring in stable fee-based revenues under long-term contracts and have limited, if any, direct commodity-price exposure. In the longer term, these agreements result in steady cash flow through the boom and bust cycle. Even within fee-based contracts, a significant portion is of a take-or-pay type, meaning that the MLPs get paid irrespective of the volume of commodities that get transported.
Moreover, the space has benefited from some constructive developments over the past few years. These include major project completions, elimination of incentive distribution rights (“IDR”) leading to a reduction in cost of capital, merger agreements between general partners and limited partners aiding unitholder interests, and the switch to a self-funding business model.
They Also Offer Generous Yields
As the coronavirus crisis crushed fuel demand, even Big Oil companies like Royal Dutch Shell RDS.A and BP plc BP were forced to reduce their payouts in a bid to preserve liquidity. Meanwhile, the MLPs represent an attractive investment option for income-focused investors in the current environment. In addition to high yields, MLPs are structured as pass-through entities.
This means that they typically distribute nearly all of their cash flows back to their unitholders. The MLPs are not required to pay a corporate income tax as the tax liability of the entity is passed on to its owners (or unitholders) in the form of a cash dividend (distribution). This allows the MLPs to offer very attractive yields to their investors.
3 High-Quality MLPs to Invest in
Although the benefits of dividend investing cannot be stressed enough, one should keep in mind that not every company can keep up with its dividend-paying momentum. Hence, a cautious strategy needs to be followed in order to select the best dividend stocks with the potential for steady returns.
To guide investors to the right picks, we highlight three pipeline operators that carry a Zacks Rank of #1 (Strong Buy) or 2 (Buy). The Zacks Rank is a reliable tool that helps you to trade with confidence regardless of your trading style and risk tolerance. To learn more about how you can use this proven system for market-beating gains, visit Zacks Rank Education.
Finally, the stocks that we shall cherrypick offer current distribution yield of more than 10% and carry a coverage ratio above 1.0X. This reflects the partnerships’ ability to continue paying or growing its quarterly distribution.
Global Partners LP GLP is a vertically integrated energy partnership focused on the distribution of gasoline, distillates, residual oil and renewable fuels, apart from owning several refined-petroleum-product terminals. Unlike most energy operators, which have maintained their payouts, Global Partners is among a minority that has continued to increase its distributions in 2020. The #1 Ranked stock’s estimated distribution yield (at 45.875 cents per quarter) is around 14%. Global Partners registered a distribution coverage ratio of 2.4X last quarter, implying a sufficiently covered payout with room for growth.
Holly Energy Partners, L.P. HEP owns and operates a system of pipelines and distribution terminals in the western United States. The partnership currently pays out 35 cents quarterly distribution ($1.40 per unit annually), which gives it a 11.5% yield at the current stock price. For the second quarter, distribution coverage for Holly Energy Partners was 1.5X, implying a 90% cushion for future payouts. The partnership carries a Zacks Rank #1.
CrossAmerica Partners LP CAPL is a wholesale distributor of motor fuels. It carries a Zacks Rank #2 and pays out a quarterly distribution of 52.50 cents per unit. At the current price of $14.87, this gives the partnership an annualized distribution yield of 14.1%. Finally, CrossAmerica Partners’ distribution coverage, at 1.31X, remains healthy.
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BP p.l.c. (BP): Free Stock Analysis Report
Royal Dutch Shell PLC (RDS.A): Free Stock Analysis Report
Global Partners LP (GLP): Free Stock Analysis Report
Holly Energy Partners, L.P. (HEP): Free Stock Analysis Report
CrossAmerica Partners LP (CAPL): Free Stock Analysis Report
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