Cabot Dividend Investor Issue: May 10, 2023

Profit From a Sleeping Energy Giant

Energy stocks have been by far the best-performing market sector over the last couple of years. They went from worst to first in dramatic fashion. And the good times may be just beginning.

Prior to 2021, the energy sector was by far the worst-performing of all eleven S&P 500 sectors in every measurable period over the prior 15 years. But everything changed. Since the start of 2021, the Energy Select Sector SPDR Fund (XLE), which tracks energy stocks on the S&P 500, returned 151%, compared to a return of just 7% for the S&P 500 over the same period.

This year has been a different story. The energy sector is lower YTD, with a worst-of-all-sectors negative 8% return so far. That’s because oil prices plunged from over $120 per barrel (WTI) last June to under $70 in early May. But those low prices are unlikely to last.

Global oil and gas supplies remain tight relative to demand. A big reason for the price drop is that the Chinese economy shut down because of covid restrictions. But that’s ending and the Chinese economy is coming back. Supply issues remain a problem as there is a high degree of uncertainty regarding the expansion of oil supply.

The industry has had very low capital spending and expansion in recent years. Crude oil inventories have fallen below the five-year average and are likely headed far lower. OPEC has pledged dramatic production cuts to push prices higher. There is also a high degree of geopolitical risk. In fact, Goldman Sachs analysts are forecasting oil prices to get back to $95 per barrel before the end of this year.

Meanwhile, energy stocks are still cheap, despite the high performance of the past couple years. The average S&P 500 energy stock currently sells at a price-to-earnings ratio of just 6.7 times. That is by far the lowest valuation of any of the eleven market sectors and compares to a current average valuation of over 20 times earnings for the overall market.

Of course, energy prices can be unpredictable in the short term. But the fundamentals are in place for prices to average a lot higher than they are now over the next few years. And that will lift stock prices. Stocks are also cheap, have among the best dividend yields on the market, and tend to perform well during times of inflation.

In this issue, is highlight one of the highest growth energy companies on the market. It has the ability to grow production by double digits for many years to come, and at very low cost.

What to Do Now

The market is grappling with uncertainties regarding inflation and the Fed as well as a possible recession. It is unlikely that stocks can gain sufficient traction to rally into the next bull market until there is more clarity on these issues.

Inflation remains sticky. Sure, it has come down. But historically inflation has never been this high for this long and not taken around 10 years to get rid of. The Fed may be done hiking rates, or close to it. But the Central Bank will likely have to keep those rates high for longer than in previous cycles.

The banking crisis has increased worry about recession later this year. Even if there are no more bank failures, or just a few, these smaller regional banks are likely to cut back on lending. Smaller banks are the backbone of the real economy. Reduced lending by them will surely slow the economy.

Perhaps a recession can be avoided. But we don’t know yet. If there is a recession, the timing, severity, and duration are still unknown. Eventually, the market will rally out of the current funk. When we move past this rate hiking cycle and investors sense an economic bottom, stocks should take off. But that is unlikely to happen until late in the year.

In the meantime, the market is probably in for more choppiness or perhaps another significant selloff. That’s why the current BUY-rated stocks in the portfolio are all more defensive companies that can continue to grow earnings in just about any economy and have the ability to navigate inflation. Those stocks include the midstream energy companies (EPD, OKE, and WMB), the utilities (NEE, XEL, and BIP), and healthcare insurer UnitedHealth Group (UNH).

This month’s Featured Action and addition to the buy list breaks the mold a bit. But it may be a very advantageous time to take advantage of the unusual situation in the energy industry.

Featured Action:

BUY Hess Corporation (HES) Yield: 1.3%

Hess (HES) is a leading independent global energy company primarily engaged in exploration and production of oil and gas. Net production currently averages 72% oil and natural gas liquids and 28% natural gas. Its key assets are in the U.S. Bakken Shale, Guyana, the Gulf of Mexico, and Southeast Asia.

Hess is also involved in the piping and storing of oil and gas through its 41% ownership stake in midstream partnership Hess Midstream LP (HESM). But Hess is overwhelmingly an oil and gas production company. The midstream operation only accounts for around 13% of the total net income. The rest is from selling oil and gas.

The stock has been a strong performer in recent years. In 2022 it returned 87% for the year, after returning 42% the year before. But HES is down around 7% so far this year. That’s because of lower energy prices.

In the first quarter, Hess earned $1.13 per share, down from $1.30 in last year’s first quarter. The average realized price per barrel of crude oil fell to $74.23 from $86.75 in last year’s quarter. Natural gas liquid prices fell to $24.25 from $39.79 and natural gas prices fell to $4.39 from $5.28 per unit. The lower prices were partially offset by increased volumes.

Hess produced 374,000 boepd (barrels of oil equivalent per day) versus 267,000 boepd last year, an increase of 40%. All four major segments had higher production than last year. But most of the growth came from Guyana with 112,000 boepd versus 30,000 boepd last year. Growth in Guyana is the main reason to buy this stock.

The Guyana property is the largest new oil province in the last decade. Hess has a 30% interest, and the rest is owned by the operator ExxonMobil (XOM). The find is a massive underground reservoir with 11 billion boe already discovered and recoverable and many billions more likely from exploration.

Hess will have the ability to continually increase production for many years. But there’s another part that might be even better. Extraction of oil and gas from this site is dirt cheap. The shallow producing horizons provide less than ½ the drilling time and costs of typical offshore deepwater exploration. The four developments already producing for Hess have average breakeven levels of $35 to $25 per barrel of Brent Crude Oil.

Guyana is positioned to be one of the highest-margin, lowest-carbon-intensity, and highest-growth production sites in the world. And growth isn’t too shabby at the other sites in Bakken Shale, GOM, and Asia.

Hess estimates average annual production growth of over 10% through 2027. But that may prove to be very conservative. It also estimates cash flows from operations (CFFO) to increase at a compound annual growth rate (CAGR) of 25% through 2027. That’s huge growth for an energy company. The average S&P 500 energy company is expected to post CFFO growth of negative 5% from 2022 through 2025.

The company says it intends to use 75% of free cash flow to pay dividends and buy back shares. The current dividend is rather lame at $0.438 per quarter for a current yield of 1.34%. But the dividend was just raised by 17% and the company has stated clearly that it intends to keep raising the payout. Stocks with growing dividends tend to perform well over time.

Hess is an oil and gas exploration and production company. Earnings are highly levered to commodity prices. As I mentioned in the sections above, there are powerful reasons to believe oil and gas prices will average higher than they are now over the next year and beyond. But prices can always fall in the short run, especially if there is a recession.

It is certainly possible that energy prices and HES will go down in the months ahead. The near-term timing is somewhat risky. But consider this. Prices have already fallen a lot. WTI crude oil prices peaked at over $120 per barrel last June and have fallen to under $70 per barrel. That is a more than 40% plunge. Since the day oil prices peaked, HES has returned a positive 5.67% (as of May 3^rd).

The stock can be volatile. But it has shown some of the best resilience to falling energy prices among its peers. And the longer-term situation is hugely promising.

Hess Corporation (HES)

Security type: Common stock
Sector: Energy
Price: $130.94
52-week range: $90.34 - $160.52
Yield: 1.3%
Profile: Hess is a leading oil and gas exploration and production company with key assets in Bakken Shale, Guyana, the Gulf of Mexico, and Southeast Asia.

Positives

• Hess has strongly growing production volumes and cash flow.
• The track record of the stock and the projected growth are tops in the industry.
• The Guyana property is a massive find that will increase production at low cost for years.

Risks

• The company is highly levered to energy prices which can fall further, especially in a recession.
• The stock is far from the 52-week low and can fall from here in the near term.

Hess Corporation (HES)
Next ex-div date: June 10, 2023, est.

Recent Activity

April 12^th
Purchased UnitedHealth Group Incorporated (UNH) - $521.19

April 19^th
Eli Lilly and Company (LLY) – Rating change BUY to HOLD
Visa Inc. (V) – Rating change BUY to HOLD

April 25^th
BUY ½ position in NextEra Energy (NEE)

May 10^th
BUY Hess Corporation (HES)

Current Allocation

Stocks 34.2%
Fixed Income 20%
Cash 45.8%

Portfolio Recap

Enterprise Product Partners (EPD – yield 7.7%) – Enterprise reported another solid earnings quarter last week. Earnings per unit grew at 6.9% while distributable cash flow increased 5.5% over last year’s quarter. The partnership also increased the quarterly distribution by 5.4%. Business is solid while most company earnings are shrinking.

That massive payout is rock solid and growing. The company has just a 55% payout ratio and the distribution is covered 1.8 times by cash flow. That’s among the very best coverage in the industry. And the distribution has grown for 25 straight years. A high yield and earnings that are resilient in inflation and/or recession should continue to be a winning formula for the rest of this uncertain year. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: July 27, 2023, est.

ONEOK Inc. (OKE – yield 5.8%) – The midstream energy company also reported another stellar earnings quarter last week. Recent acquisitions are boosting the top and bottom lines and natural gas processing volumes were solidly higher across the board. Adjusted EBITDA rose 98% over last year’s quarter and earnings per share grew to 2.34 from 0.87. The company also received a credit rating upgrade. OKE continues to post strong results and is well-suited to endure inflation and/or recession. Also, OKE has trended higher recently, but the stock price is still below the pre-pandemic high despite much higher earnings. BUY

ONEOK Inc. (OKE)
Next ex-div date: July 28, 2023, est.

Realty Income (O – yield 4.9%) – In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. The returns haven’t been inspiring so far. But this stock has held its own in a bear market. As the economy slows and moves towards recession, investors will continue to demand safety and O is a highly desirable safe income stock.

Although Realty Income is a retail REIT, it is far less volatile than most because of the diversification and remarkably stable clients that offer essential services that are recession resistant. Its largest clients include Walgreens, 7-eleven, Dollar General, FedEx, Walmart and CVS. Tenants have a historic median 98.2% occupancy rate. HOLD

Realty Income (O)
Next ex-div date: May 30, 2023, est.

The Williams Companies, Inc. (WMB – yield 6.1%) – The midstream energy company once again delivered on earnings and beat expectations for the fourth straight quarter. Earnings per share grew a whopping 36% over last year’s quarter as natural gas volumes remained strong and growing. After returning over 30% in 2022, WMB is down YTD and more than 40% below the all-time high despite having higher earnings now.

WMB has been a struggling stock this year because of natural gas prices, which have crashed. Although the company is not highly levered to energy prices, it is affected by turbulence in its industry. Prices have fallen largely because of the unusually warm winter temperatures throughout the country and the world. But it is a temporary problem for a fuel source that should own the next decade. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: June 9, 2023

Dividend Growth Tier

AbbVie (ABBV – yield 4.0%) – This is a tricky year for AbbVie as its U.S. Humira patent expires. Humira has been the world’s best-selling drug with $20 billion in annual sales. This expiration has been anticipated for a long time and the stock valuation reflects the concern. The stock had been navigating this year well until recent earnings.

Humira sales fell sharply but less than expected. Its new autoimmune drugs, which are expected to pick up the slack in the years ahead, had sales below expectations. The market was disappointed and ABBV has fallen more than 10% since the report. Big pharma companies often have issues like this along the way. But AbbVie still has an amazing pipeline that will serve it well. The stock should do quite well once investors look past the Humira expiration. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: July 13, 2023, est.

Broadcom Inc. (AVGO – yield 2.9%) – AVGO is a highly resilient technology company that is mostly involved in technology infrastructure, and earnings are not highly dependent on product sales. In the ugly technology market, AVGO returns have been even since the sector began to sell off at the beginning of last year. It’s also up over 40% since the low of last October. Although it is still somewhat tied to the fortunes of the technology sector in the short run, it’s a great stock that has shown resilience in a tough market and should take off when the sector recovers. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: June 21, 2023, est.

Brookfield Infrastructure Partners (BIP – yield 4.3%) – The infrastructure company reported a solid earnings quarter last week with funds from operations (FFOs) per share growth of 12.5% over last year’s quarter. The company benefited from recent expansions and acquisitions but also showed solid organic growth. The stock got a solid bump from the report. The stock is now right around the midpoint of its 52-week price range and should be a solid holding amid inflation and/or recession. (This security generates a K1 form at tax time). BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: May 30, 2023

Eli Lilly and Company (LLY – yield 1.1%) – WOW! LLY continues to kill it. It’s up over 38% since being upgraded to a buy in early March and just made another new all-time high. The stock got a huge bump after the earnings report when it reported very promising results from its obesity drug tirzepatide. Obesity is a massive problem, and this seemingly superior drug has mega-blockbuster potential. The following week, Lilly reported promising trial results for its Alzheimer’s drug, another potential blockbuster that could be approved within the year. HOLD

Eli Lilly and Company (LLY)
Next ex-div date: May 12, 2023

Intel Corporation (INTC – yield 1.6%) – Intel posted two quarters of negative earnings and guided for more of the same for the rest of the year. The company also slashed the dividend by 80% to save cash for its ambitious turnaround program. Yet, INTC is up 20% YTD. That indicates that the stock has likely bottomed out already. Also, the early release of its CPU chip for data centers indicated that production problems have been solved and bodes well for an earlier-than-expected turnaround. HOLD

Intel Corporation (INTC)
Next ex-div date: August 4, 2023, est.

Qualcomm Inc. (QCOM – yield 2.9%) – The chipmaker posted mixed earnings results that the market hated last week. The stock fell 6% on the day of the report. Because of slower smartphone sales as the global economy slows and the market gets more saturated, revenue declined 17% and earnings fell 33% in the quarter.

That wasn’t a surprise and Qualcomm beat expectations. But it was pessimistic about the rest of the year and indicated the handset chip market may not have bottomed out. That’s a problem because handset chips accounted for 77% of revenue. The stock is already down more than 40% from the high on expected lower smartphone sales. There probably isn’t much downside in the stock from here. But we’ll see if it can recover somewhat in the next week. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: May 31, 2023

UnitedHealth Group Inc. (UNH – yield 1.3%) – This recent portfolio addition has strong predictable revenues in a very defensive business ahead of a possible recession down the road. UNH has been a terrific stock to own in any market, as its three-, five- and ten-year returns attest. But it is also the epitome of a stock to own during an economic downturn. It pulled back since being added to the portfolio, but I expect the stock to be solidly higher in the months ahead. BUY

UnitedHealth Group Inc. (UNH)
Next ex-div date: June 10, 2023, est.

Visa Inc. (V – yield 0.8%) – V has been hanging very tough near the high point of the recent range. The payments processing company once again exceeded expectations on earnings. Visa grew earnings per share by 17% and revenues grew double digits versus last year’s quarter. And this is what the company does in a bear market with the economy slowing. It can really take off when the market recovers for good. V should be higher by the end of the year but there is a chance it pulls back somewhat after moving to recent highs. HOLD

Visa Inc. (V)
Next ex-div date: May 11, 2023

NextEra Energy (NEE – yield 2.4%) – This combination regulated and clean energy utility stock has bounced around over the past two years and is currently at the lower end of that range. It has been trending higher since the beginning of March as the risk of recession has grown and defensive stocks have outperformed. NEE is still well positioned as a defensive stock with growth in a highly uncertain market where a recession is becoming more likely. The utility also has growth from the clean energy side and can rally with the rest of the market when it eventually recovers. BUY

NextEra Energy Inc. (NEE)
Next ex-div date: May 23, 2023, est.

Xcel Energy (XEL – yield 3.0%) – This clean energy utility delivered strong earnings this quarter that beat expectations with earnings per share growth of 8.5% in the quarter. That’s a higher level of growth than most utilities as the clean energy business delivers higher margins. Defensive stocks are springing back as a recession later this year or early next becomes more likely. Utilities and healthcare have been among the top-performing sectors over the past month. And with a recession possibly looming, XEL should remain a good place to be. BUY

Xcel Energy Inc. (XEL)
Next ed-div date: June 14, 2023, est.

USB Depository Shares (USB-PS – yield 6.4%) – This preferred stock took a big hit over the past few weeks. It’s down about 18% from the recent high about a month ago. It didn’t fall because of rising interest rates. It was the banking crisis. Bank stocks have been under some pressure across the board. Although this is a preferred stock of one of the country’s largest banks, that has actually increased deposits, it has taken a hit along with everything else. The bank is rock solid, and this security tends to rally back when panic fades. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: July 15, 2023, est.

Invesco Preferred ETF (PGX – yield 6.2%) – Longer-term rates are bouncing around again with a bias toward lower since the bank failures increased the risk of recession later this year. This fund is also vulnerable to fluctuations resulting from banking troubles and many preferred issues are those of banks. The fund is well-diversified and should be fine, although it can sell off during periods when banking crisis fears take center stage. BUY

Invesco Preferred ETF (PGX)
Next ex-div date: May 24, 2023, est.

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.4%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The increased risk of a recession this year bodes well for the near-term total return of this fund. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: June 1, 2023, est.

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates are estimated.

The next Cabot Dividend Investor issue will be published on June 14, 2023.