5 Dividend Stocks to Buy on Energy's Weakness

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The prices of oil and energy shares have been under pressure recently. I'm joined today by Josh Peters. He is the editor of Morningstar DividendInvestor newsletter and also our director of equity income strategy. We're going to talk about if any opportunities have opened up.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start with that fall in the price of crude oil. Can you talk a little bit about some of the factors that are driving that?

Peters: Well, this is really just good old-fashioned supply and demand at work. We've had a lot of supply growth for crude oil globally. Companies have been investing all over the world in countries to develop more production because of high prices over the last few years. That's what you expect high prices to do--provide that signal to produce more. We've had a lot of growth, especially here in North America. Our shale-oil boom is putting a lot of additional barrels into the global market. Now, we don't export really from the United States, but we're certainly importing a lot less. And it's a global commodity with a globally set price, so that's having an effect.

At the same time, the demand growth is just not there. Emerging markets have slowed a lot. Europe is just stuck in a funk. So, you're not getting a steady uptake of that incremental supply, and that means the price is coming lower.

Glaser: What impact do these lower prices have on some of the energy firms that own, then?

Peters: It depends, first, on how long it might last. If you think oil is going to go down and keep going down and then stay down, then you've got some challenging economics. But that is really not what we think of as the most likely case because oil isn't getting cheaper or easier to find. And that high cost of discovering a marginal barrel of oil and extracting it and selling it is what we think will continue to support fairly high oil prices for many years into the future.

And in that context, you look at what Saudi Arabia has done, deciding not to curtail production in order to support the price but rather letting the price fall and trying to maintain its market share, that has the effect of curtailing investment and squeezing some of the higher-cost OPEC producers so that they can't invest. And it means you might wind up actually with higher average oil prices over the long run. But in any event, it's that price over the next five, 10, 20, or 50 years that I think you have to be thinking about when you're looking at these companies.

For the big players like Chevron (CVX) and Shell (RDS.A) and Exxon (XOM), they are definitely thinking long term; they are managing their businesses to deliver and pay big dividends and grow dividends over very long periods of time. They have lived through periods of oil-price volatility before. Frankly, oil has been more volatile historically than it's been over the last couple of years. So, people maybe are unfamiliar with the idea that you can have big moves, but certainly these big grownup companies are used to that.

They were able to continue paying and even raising their dividends through the last big downturn in oil prices during the Great Recession. I think that's pretty much what you're going to see through this bump in the road here again. And with that, especially Chevron, which I think of as being a very well-run company with a good production-growth story that will start here in a year or two and extend for maybe five years or longer. To be able to pick up this stock with a yield in the mid to high 3% range, I think that's pretty attractive.

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Glaser: How about some of the midstream limited partnerships you own?

Peters: With these, I think, in general, there is a sense that you don't have a lot of direct commodity-price sensitivity, and for the most part, that's true. Now, you very often will see midstream MLPs go up and down with energy stocks, in general, just because they fit into the same sector categories. And in some cases, you have a lot of the same investors in the hedge fund world. That's led to some really unusual volatility for some MLPs here recently, where you see these big intraday drops.

Somebody was running a levered trade and got hit with the margin call and had to liquidate in a hurry. Those types of events don't affect the value of the partnership's assets at all. You don't really have to worry so much about that. But when you think about the longer-term effect of where the oil price is going to go--how much is it going to affect a midstream partnership that I own? Well, remember some of them that are out there are oil and gas producers and they could run into trouble fairly quickly.

At the other end of the spectrum, you have Magellan Midstream Partners (MMP), one of my favorites--actually my top holding of any sector in our portfolios--most of that business is a refined-petroleum products delivery system that runs up and down the middle of the country, connects refineries to the terminals that then load the trucks that carry gasoline to gas stations.

The price of crude oil going down and dragging the gas price down might actually be a net positive if it spurs additional consumption, because they are paid based on throughput--how many barrels of refined products they are carrying. And then you've got a lot of varying degrees of sensitivity in between.

But here's a good way to think about it: If the partnership is close to the wellhead--they are really involved in a lot of gathering and processing activity and perhaps putting a lot of capital in and growing their business very quickly with the growth of output from these different shale formations--then you have to be a little bit worried, maybe not about this price drop. But if prices stay low over the next couple of years, drying activity could slacken quite a bit. You expect producers to cut back on investment if the oil price is low and those projects are no longer economical. With that, you could see growth within a couple of years--again, if the oil price does stay low--start to disappoint.

And for that reason and for many other reasons, I tend to prefer those partnerships that are more driven by energy consumption--what you might think of as consumers pulling as opposed to producers pushing energy into these logistic systems. So, that's Magellan and it's Spectra Energy Partners (SEP), which is a name I actually recently added to our position in the Harvest portfolio. And I like AmeriGas Partners (APU), a propane distributor that kind of sits out--sees some of the volatility of the MLPs, in general, but doesn't have a real close link to the oil price or even the natural gas price. Year to year, its results are driven more by the weather than anything, but it really functions more like a natural gas utility than a play on oil or gas production, per se.

Glaser: So, Chevron, Magellan, Spectra Energy Partners, and AmeriGas would be your top picks for investors looking to maybe buy on some of this energy weakness?

Peters: Yeah, and I'd add Shell, too. But Shell is a position we have a little bit lower weight in, not quite as much conviction. You've got sensitivity there to oil prices, and the stock has come down here recently. Now, it yields around 5%, which is very attractive. I think the yield is still secure at this level, but you've also got a restructuring story going on here after quite an extended period of poor management.

We'd like to see new management at the helm at Shell improve their returns on capital. There are some signs that they, at least, at Shell understand the nature of the problem, but this could be some heavy lifting. I think with Chevron you have a lower yield, but you have better long-term dividend-growth prospects and I think just a higher-quality business. So, you could own some Shell. We own some Shell. It's in buy territory right now, but Chevron would be my pick of the two.

Glaser: Josh, thanks for the update.

Peters: Thank you, too, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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