Many investors wrongly believe that the dividends and equity returns of oil and gas stocks are risk-free. This is not true. In fact, energy industry companies have been assaulted by commodity price swings in the past and may do so from time to time in the future. They also suffer firm-specific risks, just like the companies of any industry do. They are not risk free.
As it turns out, many top dividend oil and gas industry stocks, including Enbridge Energy Partners (EEP), El Paso Pipeline Partners (EPB), Energy Transfer Partners (ETP) and Kinder Morgan Energy Partners (KMB) have precariously high dividend payout ratios and weak Altman Z-scores.* Do dividend investors have better alternatives for income generating stocks?
As it turns out, investors have many more dividend-paying stocks to choose from. As alternatives to these utilities, stocks across sectors were screened based on the following criteria:
Dividend yield. Each stock pays a dividend yield of at least 2.5%, which is in excess of the 10-year treasury bond and the dividend yield of the S&P 500.
Long term historical return on equity. Each of these stocks has positive average ROE over the past 10 years. This criterion filters for stocks which were able to endure and prosper over the economic downturn. Furthermore, this long-term history filters out firms that are experiencing a short burst of good fortune.
Reasonable valuations. Stocks with lower price-to-earnings ratios than the aforementioned utilities were found to help dividend investors consider them as alternatives. Price-to-book ratios were capped at two.
A payout ratio under 0.60. These firms have more earnings from which to reinvest in the firm or increase dividend payments.
A "safe" Altman Z-score. None of these alternative firms are alarming bankruptcy risks.
The resulting dividend paying stocks are listed below:
Ticker | Company | Industry | 10-Year Avg. ROE | Altman Z-score | Payout Ratio |
(ALV) | Autoliv, Inc. | Auto Parts | 21.7% | 3.33 | 0.25 |
(BBY) | Best Buy Co. Inc. | Electronics Stores | 21.3% | 3.27 | 0.21 |
(CRWS) | Crown Crafts Inc. | Textile - Apparel Clothing | 5.7% | 5.55 | 0.26 |
(CVX) | Chevron Corporation | Major Integrated Oil & Gas | 20.2% | 4.56 | 0.23 |
(FRD) | Friedman Industries Inc. | Steel & Iron | 11.9% | 7.82 | 0.37 |
(JCS) | Communications Systems | Communication Equipment | 6.1% | 7.44 | 0.41 |
(LXK) | Lexmark International Inc. | Computer Based Systems | 26.6% | 3.15 | 0.06 |
(NAFC) | Nash Finch Co. | Food Wholesale | 8.5% | 5.59 | 0.20 |
(NHC) | National Healthcare Corp. | Long-Term Care Facilities | 13.8% | 3.47 | 0.29 |
(SPAN) | Span-America Medical Systems | Medical Appliances & Equipment | 15.9% | 8.55 | 0.29 |
(SPLS) | Staples, Inc. | Specialty Retail, Other | 16.4% | 4.12 | 0.28 |
(SWY) | Safeway Inc. | Grocery Stores | 5.5% | 4.20 | 0.36 |
(UVV) | Universal Corp. | Tobacco Products, Other | 13.2% | 3.17 | 0.57 |
(EEP) | Enbridge Energy Partners LP | Oil & Gas Pipelines | 8.2% | 1.76 | 1.64 |
(EPB) | El Paso Pipeline Partners | Oil & Gas Pipelines | 18.4% | 1.71 | 1.11 |
(ETP) | Energy Transfer Partners LP | Oil & Gas Pipelines | 17.1% | 1.34 | 3.27 |
(KMP) | Kinder Morgan Energy Partners | Oil & Gas Pipelines | 15.8% | 1.58 | 12.71 |
Unlike EEP, EPB, ETP, and KMP, these alternative stocks are all categorized as "safe" according to the Altman Z-score, indicating that they are not considered bankruptcy risks. Moreover, the average 10-year return on equity (from the last ten reported fiscal years) demonstrates that these stocks a track record of growing shareholder wealth. It is clear from these two metrics that each of these four alternative stocks is a "high" quality stock capable of weathering bad times and delivering positive long-term results.
Our screen discovered alternative stocks are trading at cheaper price ratios than their utility sector counterparts:
Ticker | Div Yield | P/E | P/S | P/B | P/FCF |
ALV | 2.8% | 9.9 | 0.7 | 1.8 | 25.0 |
BBY | 2.6% | 8.7 | 0.2 | 1.5 | 3.9 |
CRWS | 3.6% | 9.0 | 0.5 | 1.3 | 5.3 |
CVX | 3.0% | 8.2 | 0.9 | 1.8 | 25.6 |
FRD | 5.0% | 7.8 | 0.5 | 1.2 | 22.9 |
JCS | 4.2% | 9.8 | 0.8 | 1.2 | 21.0 |
LXK | 2.8% | 8.7 | 0.6 | 1.8 | 10.8 |
NAFC | 2.6% | 8.2 | 0.1 | 0.9 | 11.7 |
NHC | 2.6% | 11.4 | 0.8 | 1.0 | 19.7 |
SPAN | 2.6% | 11.7 | 0.8 | 1.8 | 13.6 |
SPLS | 2.6% | 11.0 | 0.4 | 1.5 | 11.7 |
SWY | 2.7% | 14.2 | 0.1 | 1.8 | 7.9 |
UVV | 4.2% | 15.4 | 0.4 | 0.9 | 10.2 |
EEP | 6.7% | 30.7 | 1.0 | 2.3 | 0.0 |
EPB | 5.6% | 17.5 | 5.2 | 4.3 | 120.5 |
ETP | 7.6% | 42.0 | 1.6 | 1.9 | 0.0 |
KMP | 5.3% | 349.8 | 3.6 | 3.9 | 0.0 |
Just because a stock is in the oil and gas industry does not mean it is a great buy with reliable dividends. Investors who dare to screen other stocks might find security based on financial stability and low payout ratios rather than the perception of a stable industry.
Better yet, these firms are trading at cheaper price multiples. Income investors ought to consider these alternative stocks as additions to their income portfolios. Moreover, they ought to carefully consider the safety of the four oil and gas companies challenged in this article and their distributions. Don't assume they are guaranteed.
*The Altman Z-Score is a measure of bankruptcy risk that is not based on stock price volatility. This score places companies into three groups: "safe" (Z-score > 2.99), "grey" (Z-score between 2.99 and 1.81), and "distressed" (Z-score < 1.81), and is surprisingly useful for identifying bankruptcy risk in the coming year. This method of segmenting companies uses of fundamental (financial statement) data and market capitalization only, not on price volatility. Beyond credit risk prediction, companies with higher Z-scores have historically outperformed companies with lower Z-scores, in aggregate. One sector has not been accurately modeled: Altman's Z-score has not accurately predicted the bankruptcy risk of financial companies.
"Distressed" was a label coined by researchers, and should not be taken to mean that any company is bankrupt or in default on the basis of this calculation alone. Credit scoring is not fate, only prediction based on relative past performance of companies grouped by key variables. Time will tell.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.
How useful was this article?
Did you find this article useful?
Yes No
Sending feedback...
Thank you! Your feedback will help us better serve you and other readers.