Cabot Dividend Investor Issue: November 8, 2023

An Overlooked Energy Juggernaut

Last week was extremely positive for stocks. The S&P rallied nearly 6% for the week, which was the strongest weekly rally of the year so far.

The events of last week strongly indicate that interest rates have peaked. The Fed indicated it is done raising the Fed Funds rates and a weak jobs report confirmed less upward pressure on all rates. The benchmark 10-year Treasury yield, which had touched the crucial 5% level in late October, fell back to about 4.5%. And stocks exploded higher.

Rising interest rates had driven the market lower since the end of July. Now, rising rates are over and they continue falling. The main impediment to a rally has been removed. It looks the a “soft landing” is likely, as the rate hiking cycle is likely over and the economy is still solid.

Things look good for now. But we’ll see if that rosy scenario holds up next year. Things could change. Inflation could reignite. The recession that it seems like we avoided could be just a little further down the road. Anything is possible. In six months, we could be in a raging bull market or bounding toward recession.

The market has been highly unpredictable over the last several years. Things are too uncertain to make bets on the current outlook. Timing the market and betting on sector rotation is a riverboat gamble. I’d rather bank on prevailing trends that will transcend short-term market gyrations, sporadic growth projections, or the impact of unpredictable headlines.

There is a strong prevailing positive trend in the energy industry, particularly American energy. The world blew it over the last decade or so. Investors lost their appetite for seemingly anachronistic fossil fuel companies. Many Western nations adopted ambitious plans to move away from fossil fuels and develop clean energy, only to realize that these alternative energy sources are not yet viable.

Clean energy is the future, but not the near future. The world will continue to rely overwhelmingly on fossil fuels for at least the rest of this decade and probably much longer. But the world has underinvested in oil and gas exploration and production over the last decade and a half. Global supplies of oil and gas are straining to meet growing demand. The dynamic will last for some time.

Recent world events underscore the crucial importance of energy for the economy. And investors are realizing the value of companies and stocks in a sector that had been neglected for many years until recently. While commodity prices will go up and down based on several circumstances, energy companies should benefit over time going forward.

In this issue, I highlight the largest American oil refiner. The stock has been a stellar performer, even in tough markets for other energy stocks. And the company will continue to benefit from cheaper American oil and a reduced number of refineries.

What to Do Now

Last week appears to have been a game-changer for the market in the near term.

The market was at a crossroads with the benchmark 10-year Treasury teetering near the crucial 5% level. Uncertainty crippled the market over the question of whether 5% would be a peak or if rates would blow past 5% and rise into territory uncharted over the past couple of decades.

Last week determined that 5% would probably be the peak. Stocks exploded higher on the news and the S&P soared nearly 6%. A combination of a more dovish Fed indicating that they are likely done hiking rates and a weak jobs report indicating that the Fed probably won’t change their minds convinced investors that interest rates have peaked. The 10-year Treasury rate fell back to about 4.5%.

The central question for the market has been resolved in a very positive way (at least for now). Defensive portfolio stocks that had been clobbered this year rallied strongly off the lows and may now have more lasting momentum. And the last two months of the year are historically very positive for the market.

Rates are done rising and the economy is still strong. It looks very much like the “soft landing” scenario is indeed unfolding, as we get through this rate hiking cycle without much economic pain.

We’ll see if the positive prognosis holds up next year or if things discombobulate down the road. But the situation is likely to be positive for stocks for the rest of the year at least. I’ll take it.

I am changing the allocations from cash to stocks by half a position for every currently “BUY” rated stock. The allocation will also change from cash to fixed income by half for the two current fixed-income positions, USB Depository Shares (USB-PS) and Vanguard Long-Term Corp. Bd. Index Fund (VCLT). In other words: add 50% to each of those positions.

Featured Action

Refining companies are flush with cash from recent boom times as much refining capacity was shut down during the pandemic and slow to return. Although margins have come down from last year, they are still quite high compared to historical averages. There are also strong reasons why profitability will remain on the high side for years to come.

American refiners have a huge advantage because of the WTI/Brent Crude spread that should last many more years. And there are a very limited number of refineries in the U.S. A big part of that is because a new refinery has not been built in this country since 1976. In addition, the CEO of Chevron recently said that he did not believe that there will ever be a new refinery built in this country.

Therefore, established American refiners and refineries are in a fantastic position to reap a huge American advantage and likely earn historically high margins for many years to come. The short term should be strong as well. A huge amount of U.S. refining capacity will be shut down in the fall of this year for scheduled maintenance. And the shutdown schedule for 2024 is the highest since the pandemic.

Buy Marathon Petroleum Corporation (MPC)

Marathon is the largest energy refiner in the U.S. with 16 refineries across the country and 3.1 million barrels a day in throughput capacity. The company also markets finished products to 7,100 locations throughout the country and gathers and processes oil and gas through its Midstream subsidiary MPLX (MPLX).

Marathon became the country’s largest refiner after its 2018 acquisition of independent refiner Andeavor. The purchase greatly enhanced the geographical reach and the company’s ability to take advantage of price spreads between producers and end users. The acquisition increased earnings and resilience during tough markets. Marathon also did a very good job in reducing its per-barrel operating costs and increasing the complexity and quality of its refineries.

The increased complexity enhances Marathon’s ability to process lower-quality, lower-cost heavy and sour crude into high-value clean product such as gasoline and diesel. U.S. refiners have a big advantage over other countries. They can refine lower-cost crude oil and gas and charge higher overseas rates. Marathon’s increasing ability to press that advantage has led to stellar results.

Although Marathon is primarily a refiner, a significant amount of business comes from its midstream subsidiary MPLX. In the third quarter, MPLX accounted for about a quarter of the company profits. In tough times for refining the midstream segment provides a larger share of profits and serves to make overall earnings steadier than most refiners. MPLX also provides a cost advantage as Marathon can pipe and store oil themselves.

To a large extent, fortunes of Marathon are directly tied to fortunes of the U.S. oil refinery business. But MPC is several cuts above other refiner stocks and has consistently outperformed its peers. Below is the recent total return performance of MPC versus the VanEck Oil Refiners ETF (CRAK), an index of oil refiners throughout the world, as well as its main U.S. competitors, Valero Energy Corporation (VLO) and Phillips 66 (PSX).

Over the past three years, MPC has returned a whopping 424% compared to a 32% return for the S&P 500 over the same period (as of November 4). While the past three years have been unusually good for energy companies and refiners in particular, MPC also blew away the performance of its industry peers. It also vastly outperformed its sector and the overall market in the last five- and 10-year periods.

Refining margins have shrunk since the sizzling market of last year as crack spreads have narrowed throughout the industry. Marathon’s earnings were actually down 12% on a year-over-year basis in the third quarter. But it was nevertheless still one of the all-time best quarters in company history and the stock is still up over 30% YTD.

The recent good times have made the company flush with cash. And much of that cash is being spent on shareholders. Aggressive share buybacks have reduced the outstanding share count by more than 25% in the last year alone. And they’re not done. Management has already approved an even more aggressive share buyback program for the next year.

Marathon announced another 10% dividend hike, making it a better than 42% payout increase in the last year and a quarter. The dividend yield is currently about 2.2%. But the dividend payout ratio is under 20% with room to grow. The dividend yield is low but Marathon is playing it right. Profits can be erratic, and they want to make sure they can at least maintain the current dividend in any environment. Extra cash in the good times is used primarily for stock buybacks that enhance the value of shares.

The economy remains strong and that should support solid refined product demand in the quarters ahead. Although the stock price has leveled off since August, MPC remains in a strong uptrend that began about three years ago. Although MPC returns have been spectacular over the past several years, it currently sells at earnings and cash flow valuations well below the five-year averages.

Marathon Petroleum Corporation (MPC)

Security type: Common stock
Sector: Energy (refining)
Price: $147
52-week range: $104.32 - $159.50
Yield: 2.2%
Profile: Marathon is the largest oil refiner in the U.S.

Positives

• Demand for gasoline and diesel remains strong in the still-solid economy.
• U.S. refiners have a big advantage in lower feedstock prices from cheaper oil.
• The longer-term structural supply/demand dynamic should make refiners profitable and stocks perform well for many years.

Risks

• A recession will curtail demand and have a negative effect on the stock price.
• Margins are dependent on erratic and unpredictable commodity prices.
  

  

Recent Activity

October 11
Purchased McKesson Corporation (MCK) - $456.66
ONEOK, Inc. – Rating change “HOLD” to “BUY”

October 25
Hess Corporation – Rating change “BUY” to “HOLD”

November 8
Buy Marathon Petroleum Corporation (MPC)
USB Depository Shares (USB-PS) – Rating change “HOLD” to “BUY”
Vanguard Long-Term Corp. Bd. Index Fund (VCLT) – Rating change “HOLD” to “BUY”

Portfolio Recap

Enterprise Product Partners (EPD – yield 7.6%) – This midstream energy partnership has done quite well in the past two challenging years for the market. In last year’s bear market EPD managed a total return of positive 15%. It’s also returned more than 17% so far this year. It has consistent earnings that can hold up to inflation and a slowing economy and that huge yield and extremely well supported with 1.7 times cash flow coverage. In fact, Enterprise just increased the distribution 5.3% in the last quarter. The growth in profits and distributions is likely to continue as the partnership is expanding operations in the high-growth Permian basin. (This security generates a K-1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: January 30, 2024, est.

ONEOK Inc. (OKE – yield 5.8%) – This midstream energy company reported solid earnings with adjusted EBITDA growth of 11% over last year’s quarter as natural gas volumes were up 12%. The company also completed the acquisition of Magellan Midstream Partners and raised the guidance on projected consolidated earnings going forward. The stock performance has leveled off since July and pulled back from the recent high made last month. The dividend is safe, and earnings should continue to be solid and growing in just about any environment. BUY

ONEOK Inc. (OKE)
Next ex-div date: January 31, 2024, est.

Realty Income (O – yield 6.1%) – The REIT was already having a bad year when it announced the purchase of Spirit Realty Capital (SRC) for $9.3 billion. It is slated to be an all-stock transaction and Realty estimates the acquisition will increase its annual adjusted funds from operations (AFFO) by 2.5%. The stock fell on the day of the announcement, as is usual for stocks of acquiring companies. But O has since recovered the losses plus more. The deal should be a longer-term positive and this REIT is selling at historically dirt cheap valuations. BUY

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

The Williams Companies, Inc. (WMB – yield 5.0%) – The midstream energy company made a new 52-week high on Friday. The stock had been trending sharply higher until the rally sputtered in early August. But it got hot again in October and, after pulling back in a turbulent market, has soared back to a new high after the market had its best week so far this year. Hopefully the momentum will last. Williams also operates in an inflation-resistant business and revenues should remain solid even in a slow economy. Williams also reports earnings on Wednesday. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: December 7, 2023

AbbVie (ABBV – yield 4.4%) – The drug maker has shrinking revenue and earnings this year because its blockbuster Humira drug is facing biosimilar competition in the U.S. But this has long been expected and the company’s new drugs and pipeline are well on pace to make the company a solid earnings grower in the years ahead. Its two new biosimilar drugs Rinvoq and Skyrizi grew sales by more than 50% in the last quarter and the company expects these drugs alone to eventually surpass Humira’s peak sales. The stock sells at a low valuation and investors sense that it might turn the Humira corner sooner ahead of a very bright future. BUY

AbbVie Inc. (ABBV)
Next ex-div date: January 12, 2024, est.

Broadcom Inc. (AVGO – yield 2.1%) – Performance for the chip maker and software infrastructure giant has leveled off since the end of July. But the stock has found a home in the new higher range since the massive surge in the spring and summer. AVGO is up 51% YTD, and it doesn’t look like the stock is going to give anything back. The longer-term prognosis remains excellent as the company is getting a huge growth catalyst from artificial intelligence. Broadcom doesn’t report earnings until early next month and the stock is unlikely to do much before then. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: December 20, 2023, est.

Brookfield Infrastructure Partners (BIP – yield 5.7%) – This infrastructure partnership has come roaring back in a hurry after being absolutely clobbered before last week. The market overdid it in an environment where safe dividend stocks were out of favor. BIP had fallen 34% in a three-month period, and the performance wasn’t very good this year before that. The selling was grossly overdone for a company with a high distribution and highly secure and predictable earnings.

Since hitting a three-and-a-half-year low on October 30, BIP has skyrocketed more than 28%. The catalyst was a strong earnings report with 7% funds from operations (FFOs) growth over last year’s quarter. The partnership also reported several acquisitions of higher-return data center properties that will benefit from increasing AI spending. The company said they are the highest-return assets the company has acquired in a decade. The report is positive for the future but the upward move in price was exaggerated because the selloff was way overdone. Hopefully the momentum lasts. (This security generates a K-1 form at tax time). BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: November 29, 2023

Digital Realty Trust, Inc. (DLR – yield 3.8%) – This data center REIT had been in a funk but has turned around and moved 15% higher in the last couple of weeks and closed on Friday not far from the 52-week high. First, Digital reported impressive earnings that pleased investors. Then the market got a lot better, and technology and interest rate-sensitive stocks rallied. The long-term prognosis is solid because voracious AI spending upgrades should provide another growth catalyst. DLR could potentially launch a breakout from here. BUY

Digital Realty Trust, Inc. (DLR)
Next ex-div date: December 15, 2023, est.

Eli Lilly and Company (LLY – yield 0.8%) – The superstar healthcare stock has pulled back just a little bit since making another new high last month. But the stock looks like it will remain in this higher range until something prompts it to resume moving higher. Investors are unlikely to sour on LLY because it has two potential mega-blockbuster drugs up for FDA approval this year as well as stellar earnings growth for the next several years. HOLD

Eli Lilly and Company (LLY)
Next ex-div date: November 14, 2023

Hess Corporation (HES – yield 1.2%) – Chevron Corporation (CVX) is buying Hess for 1.025 shares of CVX for every HES share, to close sometime early next year. Because of the purchase, HES shares trade just like CVX shares. Last week, Hess reported better-than-expected earnings on higher volumes. But Chevron earnings disappointed. As a result, HES shares fell. The portfolio will continue to HOLD the HES shares for now. The current Middle East turmoil could cause a significant rise in oil prices and CVX stock if the conflict spreads. HOLD

Hess Corporation (HES)
Next ex-div date: December 15, 2023, est.

Intel Corporation (INTC – yield 1.3%) – A strong earnings report and a much better market environment have turned INTC around in recent weeks. The stock is up about 20% in a little over a week. Earnings indicate that Intel’s turnaround is well on track. It has promising new chips coming out in high-growth areas and its foundry business could be huge. The company also expressed confidence that the other chip makers could not significantly compete for Intel’s PC chip dominance anytime soon. The future still looks bright and the stock seems to want to move higher when technology stock are not under pressure. BUY

Intel Corporation (INTC)
Next ex-div date: February 6, 2024, est.

McKesson Corporation (MCK – yield 0.5%) – The market will bounce around in the near term. Sector performance rotates. In six months, we could have a solid economy or a recession. But McKesson’s business will continue to hum along regardless of what happens. It caters to a market that is growing all by itself and demand is unaffected by inflation, the Fed, GDP, or whoever is President. I don’t know what the next month holds for MCK, but the longer term should be stellar. That’s why MCK is near the high while the healthcare sector is lower YTD. BUY

McKesson Corporation (MCK)
Next ex-div date: November 30, 2023

Qualcomm Inc. (QCOM – yield 2.7%) – The struggling chipmaker stock got a big 14% boost in the last week and a half. While the overall tech sector rallied on falling interest rates, Qualcomm was also helped by the earnings report. While results for the quarter still showed lower earnings and revenue, the future is looking increasingly bright, and investors took notice. Qualcomm is introducing new AI chips for PCs and smartphones that could be big sellers next year. Also, strong smartphone sales in China are indicating that phone sales have already bottomed. It’s looking like 2024 could be a very profitable year. BUY

Qualcomm Inc. (QCOM)
Next ex-div date: November 29, 2023

Tractor Supply Company (TSCO – yield 2.1%) – The rural retail company stock had been trending lower since the beginning of August. But it moved sharply higher last week. Earnings increased 11% over last year’s quarter and net sales were up 4.3%. But the company also slightly lowered guidance for the full year, citing lower demand for seasonal products due to a weaker consumer. But the strong economic numbers and falling interest rates could reignite the stock. BUY

Tractor Supply Company (TSCO)
Next ex-div date: November 25, 2023, est.

UnitedHealth Group Inc. (UNH – yield 1.3%) – Last month’s earnings report missed EPS estimates slightly, due to temporary factors, and revenue grew 8.3% over last year’s quarter. The company also reiterated guidance for 7.5% earnings growth for the full year in 2023. The stock is higher since the report, and everything looks solid going forward. UNH is well-positioned as a defensive company with highly reliable and predictable revenue in an uncertain environment. Its market grows all by itself because of the aging population. Hopefully the positive momentum will continue. BUY

UnitedHealth Group Inc. (UNH)
Next ex-div date: December 8, 2023, est.

Visa Inc. (V – yield 0.8%) – It’s all good news for Visa lately and the stock is surging right back to the recent high. Visa reported earnings last week that beat expectations because of a resilient consumer. Earnings soared 21% and revenue increased 10.6% over last year’s quarter. The company also announced a large share buyback and a dividend increase. News of the strong economy and falling interest rates may continue to rally the market and V could break out. HOLD

Visa Inc. (V)
Next ex-div date: November 8, 2023

NextEra Energy (NEE – yield 3.2%) – Better times have finally arrived for this previously beleaguered clean energy utility stock. NextEra reported earnings last month that beat estimates and grew 10.6% from last year’s quarter. NEE spiked over 8% in the week following the report. NEE has also made a very convincing move off the low. It’s now up 26% from the low made last month. It is welcome news for a stock that had been down 35% YTD. Management also reiterated previous growth projections and said the company expects to deliver earnings near the top of the expected range through 2026. The selling was way overdone. And it sure looks like the low is in and hopefully the momentum continues. HOLD

NextEra Energy Inc. (NEE)
Next ex-div date: November 22, 2023

Rating change – “HOLD” to “BUY”

USB Depository Shares (USB-PS – yield 6.1%) – Last week was great news for this and other fixed-rate investments. Interest rates appear to have peaked which means the selling is over and fixed-income prices are likely to rise as rates fall. The price has soared more than 12% since the beginning of last week. And USB-PS has now returned over 5% since being added to the portfolio a little over a year ago despite the rising interest rate environment. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: January 15, 2024

Rating change – “HOLD” to “BUY”

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 5.3%) – Peaking interest rates are also a huge positive for VCLT, as evidenced by the 6% price surge since last week. This long-term bond fund is very sensitive to interest rates. It held up relatively well in the rising rate environment and now it looks like rates are trending lower. BUY

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

Xcel Energy (XEL – yield 3.5%) – Like other defensive, dividend-paying stocks, XEL had a great week last week as interest rates tumbled lower. But this stock has been trending higher since the beginning of last month. The low may be in. XEL had a convincing 13% move off the low. This is one of the best utility stocks to own and the recent debauchery may prove to be very temporary. XEL still sells near the lowest levels of the past several years and now has some positive momentum. BUY

Xcel Energy Inc. (XEL)
Next ed-div date: December 15, 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 December 13, 2023.