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Running for Great Dividends

February 28, 2019

Investing for dividends isn’t a quick sprint, but rather a steady distance run. You need to find and invest in stocks of companies that are dependable, in industries that can reliably provide for ample and rising revenues to support consistent to improving dividend distributions.

One of my favorite industries for dividends is the US petroleum market. The energy patch remains a lucrative market, as the US has emerged as the world’s leading producer of petrol. Global demand remains robust for crude oil, refined products and natural gas. And easily transportable liquified natural gas (LNG) is a relatively new profit-driver for US companies.

In addition, the soft pricing for crude oil, particularly prior to last year, provided the incentives for producers to increase their field exploration and production (E&P) efficiencies. This is providing for profitability even at lower crude oil and natural gas prices.

One of the limitations for US companies has been the lack of additional capacities in pipeline and marine terminal facilities for both oil and gas. But thanks to the energy policies of the current administration, approvals have spurred additional and expanded lines and facilities, providing for more deliverable petrol and more cash flows for US companies.

Then we have the Organization of the Petroleum Exporting Countries, plus Russia (OPEC+). OPEC+ has come through with production limits, which are also aiding petrol prices and operating margins for US petroleum companies.

There are various segments inside the US petroleum market. For one, there is a segment of upstream producers that can provide bigger profits with higher oil and gas prices, as well as improved production efficiencies. Another would be the midstream segment, which includes pipelines and related facilities that act as toll-takers for transporting petroleum. And then you have the downstream segment of the petroleum market that focuses on refineries and wholesale and retail distribution.

Refineries provide reliable dividend flows, as they manage to control costs of their feedstock—crude oil—while efficiently turning it into gasoline, jet fuel and other distillates.

The key for refineries is to make sure that they make the most of the “crack spread,” which is the difference in the cost of a barrel of crude oil and the revenue from the refined products produced.

Among the reliable refiners, my favorite is Marathon Petroleum (MPC)—one of the best in the downstream segment. It continues to efficiently manage its feedstock costs and its effective crack spreads for steady revenues and profits.

This company completed its acquisition of Andeavor last October to become a major national refinery. It is now pulling crude from around the US and Canada for its refinery operations, increasing its discounted feedstock crude input with the lower-priced North American crude.

Chart of Marathon Petroleum (MPC)—Source: Bloomberg Finance, L.P.

Marathon’s operating margins are quite good at 5.90% and are up significantly from last year for the comparable calendar quarter. This shows how it runs itself efficiently for better profit margins.

This is driving an impressive return on its expensive capital at 14.50%. And for shareholders, the return on their equity is running at 27.40%.

Revenue is climbing over the trailing 12 months by 44.10%, which is piping in profits to fund dividends that are up this past year by 17.90% to a current payout of 53 cents, or a yield of 3.32%.

Yet, despite the great underlying fundamentals, Marathon’s stock has been deeply discounted. The stock is valued at a discount of 70.00% to its trailing sales. Also, the stock’s price-to-book value has gone from 2.62 times in late September to a bargain buy at only 1.90 times. And remember, refineries are very hard to get permitted, so its assets are truly valuable and hard to replicate.

Marathon has less to fear from OPEC+ price supports and more of an opportunity to capitalize on increasingly productive US petroleum fields, making it a good dividend-paying stock for income and growth over the long run.