Are These the Safest Dividends in Energy?

Matthew Carr By Matthew Carr
Emerging Trends Strategist

Dividend Investing

A lot of investors want to focus on value… And that’s what the current market offers to those looking to build long-term holdings.

Back on February 17, the S&P 500 went above 2,100 for the first time ever. Today is August 17, and the index hasn’t gained much ground since.

On top of that, dividend stocks – in particular aristocrats – are holding their own, but not knocking the pants off investors at the moment…

Year-to-date, the ProShares S&P 500 Dividend Aristocrats ETF (NYSE: NOBL) is slightly underperforming the S&P 500, though doubling the performance of the Guggenheim S&P 500 Equal-Weight ETF (NYSE: RSP).

YTD Performance of ProShares Dividend Aristocrats, Guggeheim Equal-Weight and S&P 500

This is a surprising turn of events, as the Guggenheim Equal-Weight ETF has outperformed the S&P 500 for much of the last decade, especially over the last five years.

Of course, no sector is getting hit as hard as energy, as shown by the Energy Select Sector SPDR ETF (NYSE: XLE), down nearly 13% year-to-date.

There’s a lot of speculation over where the price of crude will go from here.

Some analysts have called for a tumble in West Texas Intermediate (WTI) crude to as low as $10 per barrel. The market is still oversupplied, with global production outpacing demand. Plus, OPEC doesn’t want to take its foot off the gas and will have to add Iran’s production into the mix.

As the price of crude has cascaded lower, revenue and earnings per share (EPS) for much of the sector have fallen as well. This is particularly important with so many energy companies paying dividends…

Lower Crude’s Safety Net

Falling oil prices have created a boon for one particular industry…

I’m talking about refiners.

Here’s the year-to-date performance of a small sample of refining stocks…

YTD Performance of Marathon Petroleum, Phillips 66 and Valero

Obviously, refining stocks are having a tremendous year.

As the price of crude collapses, refiners enjoy much lower input costs. Now, finished products will dip down as well, but margins for refiners get better and better as oil slips lower and lower.

Looking at the chart, our best performer is Valero (NYSE: VLO), up nearly 39%… followed by Marathon Petroleum (NYSE: MPC), up over 23%.

Phillips 66 (NYSE: PSX) has also done well, closing in on a 13% gain.

Refiners are having a record year in terms of production, seeing inputs of 17 million barrels per day. Total refining capacity in the U.S. is 18 million barrels per day. So, they’re operating at nearly 95% utilization efficiency.

Maintaining Momentum in a Falling Market

Now, given my brief outline above, you probably aren’t too surprised to learn that Valero’s operating income from its refining segment in the second quarter doubled from $1.1 billion to $2.2 billion. Total revenue was down 28%, but income soared as operating income per barrel grew from $4.36 to $8.46 and EPS increased 140.5%.

This increased profitability is what’s driving the shares of refiners higher.

And at the same time, these refiners are able to increase their dividends. For example, Valero’s dividend is now $0.40 per share per quarter, up from $0.25 per quarter in 2014.

That represents a current yield of 2.3%.

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And it probably wouldn’t surprise you that Marathon and Phillips 66 are also seeing better profit margins as oil slides lower.

Now, the dividend yields aren’t insanely high, with Marathon’s at 2.3% and Phillips 66’s at 2.7%. But Marathon did just raise its dividend by 30%.

It’s also important to note that Marathon’s current payout ratio is just 22%. Phillips 66’s current dividend payout ratio is 34.6%. And Valero’s current payout ratio is the lowest at a mere 20.2%.

So, that’s a lot of room for growth.

For comparison, if we look at the large vertically integrated oil companies, Exxon Mobil’s (NYSE: XOM) payout ratio is 70% with a dividend yield of 3.74%… Chevron (NYSE: CVX) has a payout ratio of 111.5% on a 5.1% yield… and ConocoPhillips (NYSE: COP) has a payout ratio of 3,700% on a 5.98% yield.

Clearly, when we look at the 2.3%-plus yields of the refiners versus the 5%-plus yields of the major integrated companies, there’s a lot more safety with the refiners… especially in a long-term lower-priced environment

P.S. Want to know the safety grade of dividend stocks from other industries? Then check out SafetyNet Pro, the brand-new interactive database that will give you the safety grade of stocks from over 600 companies in the S&P 1500.