For dividend investors, one of the most important things to know about the energy sector is that it is very volatile. That means that dividend-paying energy stocks should go through a little extra scrutiny before being added to your portfolio.
A great example of the problem income investors face when looking for energy investments is Devon Energy(NYSE: DVN). Meanwhile, Chevron(NYSE: CVX) and Enterprise Products Partners(NYSE: EPD) are solid examples of the gems that you can unearth in the energy sector when you dig in just a little bit.
Devon Energy's dividend history isn't shocking
Devon Energy is what is known as an upstream company, which means that it produces oil and natural gas. In this case, the company operates exclusively in the onshore U.S. space, but that's not the most salient factor here.
What is important to understand is that its top and bottom lines are driven almost entirely by energy prices. Oil and natural gas prices are highly volatile, and so Devon's financial results are also highly variable.
This isn't a bad thing, per se. It is pretty much par for the course when you are looking at an upstream company. For dividend investors, however, there's an added wrinkle. Devon's dividend is variable, with the final payment tied to the company's financial results.
Even though the dividend yield is listed at 4.4% on major online quote services, investors should expect the actual income received to vary greatly over time. In some ways, the variable dividend policy is a good way to ensure that shareholders are rewarded when energy prices are high, but the downside is that dividend cuts are inevitable.
For most income investors Devon Energy isn't going to be a good stock to own.
Chevron is a reliable dividend payer
If you are looking for a reliable dividend payer with a long history of annual increases behind it, you'll probably be better off with Chevron. For starters, it is much more diversified. Its business encompasses the upstream, the midstream (pipelines), and all the way to the downstream (chemicals and refining).
The company's energy portfolio is also globally diversified. And it happens to be one of the largest energy companies on the planet with a $260 billion market cap. Chevron's dividend yield is also around 4.4%.
The energy company has increased its dividend annually for 37 consecutive years despite the inherent volatility of the sector. A big part of the story here is its rock-solid balance sheet, with a debt-to-equity ratio of just 0.14 times.
That would be strong for any company, but it gives Chevron the leeway to take on debt during industry downturns so it can support its business and dividend. When energy prices recover, as they always have historically, it pays down the debt in preparation for the next energy sell-off.
If you are looking for an energy producer with a reliable dividend, Chevron is one of the best options you'll find.
Enterprise is a boring high yielder
If Chevron's exposure to oil and natural gas production is a bit too troubling for you, there are still some energy options out there. One of the most reliable is Enterprise Products Partners, a master limited partnership (MLP) that operates a large portfolio of midstream infrastructure assets.
Generally speaking, it charges fees for the use of these assets so the price of the oil and natural gas that flows through its system isn't really that important to its financial results.
This is highlighted by the fact that the company has increased its distribution annually for 26 consecutive years. And there's more to like here. Specifically, the balance sheet is investment-grade, and cash flow covers the distribution by a strong 1.7 times. There is a lot of room for adversity before a distribution cut would be on the table.
That said, Enterprise's hefty 7% or so distribution yield is likely to make up the lion's share of returns over time. This is because there are limited growth prospects in the midstream sector.
But bolt-on acquisitions, expansions of existing assets, small ground-up capital projects, and regular rate increases within its existing portfolio will likely lead to slow and steady growth over time. And that, in turn, should support ongoing distribution growth.
The best options for income in energy
Dividend investors need to understand the impact that the energy sector's high volatility will have on their investments. Both Chevron and Enterprise have proved they know how to handle the industry's ups and downs while continuing to reward investors well over time.
That said, Devon Energy isn't a bad company, but it has chosen a very different dividend approach that inherently means shareholders will see dividend cuts. If you are looking for a reliable income stream in the energy sector, Chevron and Enterprise will be much better choices.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
