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No Need to Bet on Oil Prices for More Dividend Income

July 18, 2019

US crude oil is up almost 22% year to date. The Organization of Petroleum Exporting Countries, plus non-members including Russia, recently conducted one of its regular meetings and has committed to extending its production cutbacks of 1.2 million barrels per day.

These output cuts—and compliance with them—have been unprecedented in recent history.

Those cuts and various conflicts in the Middle East make US production that much more important to global oil supplies. WTI is also moving in sync with Brent Crude spot prices, as shown in the graph below.

WTI Spot (CL1, White) vs. Brent Spot (CO1, Green)—Source: Bloomberg Finance, L.P.

However, both WTI and Brent prices are down from April’s highs due to a lack of clarity on global supply and demand calculations outside the US, including whether sanctions on Iran will have more of a measured impact.

And the US crude surplus is bringing down the number of actual active rigs to a 17-month low. This means exploration and production (E&P) companies aren’t booming. Take a look at drilling in the Permian Basin, the bellwether of the US E&P industry.

Permian Basin Rig Count—Source: Bloomberg Finance, L.P.

It could be an indicator of improved E&P efficiencies, since it points to rising productivity for rig operations. Regardless, it’s also part of the continuing challenge of pipeline capacity.

With the unsettled oil market, don’t take on risk from upstream E&P companies. Look to the midstream pipelines for more secure dividend income.

Pipelines have less exposure to the ups and downs in the price of oil. However, they do need to manage their customer risk to make sure that contracts to pipe crude will continue to work.

The Pipes are Calling for More Dividends

Pipelines are great cash cows. And investors are figuring that out, so the demand for pipeline stocks has been climbing briskly since last December. The Alerian Infrastructure Total Return Index (AMZIX) is the best midstream indicator, and it has generated a return of 19% year to date.

Alerian Infrastructure Total Return Index—Source: Bloomberg Finance, L.P.

If you want to focus solely on pipes, buy Plains GP Holdings (PAGP).

Plains owns general partnership (GP) interests in Plains All American Pipelines, which is an operating company with oil gathering and storage facilities as well as pipeline and other transportation structures around North America.

The transportation unit moves nearly five million barrels per day of crude and natural gas liquids.

Its customers are a who’s who in the oil market, including Marathon Petroleum (MPC), ExxonMobil (XOM), Phillips 66 (PSX) and others.

Revenues are up over the past year by some 30%, and while operating margins are a little thin, the company moves a lot of petroleum.

Plains GP Holdings (PAGP) Total Return—Source: Bloomberg Finance, L.P.

And Plains has little debt compared to its vast assets and pays out the majority of its profits to unit-holders. The dividend yield of 5.80% goes along with a solid return to date of 25%.

Magellan Midstream Partners (MMP) runs a massive network of assets to store, transport and distribute petroleum and related products. It has a network of 12,000 miles of pipe and 50 terminals to gather and transport its contracted liquids. And it has the ability to store 85 million barrels of petroleum liquids.

The company’s upstream and downstream customers include Shell (RDS/A), Kinder Morgan (KMI) and MPC.

It transports domestic products and provides marine transport access for imported and exported petroleum—ever more important with the US now being the largest-producing nation on the planet.

Revenues are up over the trailing year by nearly 13%. And its crude oil revenues are up 14% over the past three years alone. Operating margins are very high—particularly for a midstream company, which has driven an impressive return on shareholder equity of 56%.

It has ample cash on hand, although debts are a bit more than some of its peers. But with ample cashflows and margins, its debt isn’t a big issue. The dividend distribution is projected to be raised again this year, which has been happening for the past five years at an average annual rate of 11.47%.

Magellan Midstream Partners (MMP) Total Return—Source: Bloomberg Finance, L.P.

It’s a bit more expensive than its peers, but the underlying actual book value is up nicely from last year. So far in 2019, the stock is up 18%, with a dividend yield of 6.16%.

All My Best,

Neil George

PS—If you’d like to see more of my market research and recommendations for safe growth and big, reliable income, check out my Profitable Investing advisory.

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