Looking to profit from oil-powered dividends? Look no further than this discounted payer dishing 9.6%.
Oil prices had plunged in recent months on recession fears. However, there’s still no recession. Oops. One point for the energy bulls.
Meanwhile, OPEC said enough “cheap” oil. On Sunday the cartel announced production cuts. Oil prices popped.
Will OPEC’s move prompt the Federal Reserve to raise higher rates to cool oil demand? I don’t think so because the Fed has a problem. It broke the banks! Higher rates could do more damage.
High oil is painful, but a banking crisis is worse. Given the choice between financial stability and controlling inflation, the Fed will choose stability.
Which means oil is free to rip higher once again. Because, hey, there was easy money for the 14 years prior to this tightening cycle. The Fed was trying to sober up the crowd. But it is now learning it needs to keep the punch bowl spiked just a bit, with the key rate still below the rate of inflation.
Silicon Valley Bank’s deposit vomiting was a wake-up call for Jay Powell. Now, he must keep rates at 5% and hope the inflation headache fades.
With respect to oil, it ain’t gonna happen. Not yet, anyway. Oil was coiled, ready to spring. OPEC set it off.
The black goo is in the midst of a multi-year “Crash ‘n Rally” pattern. Prices last topped in 2014. The shale boom then worked wonders and brought lots of supply online.
Oil prices sank for six years, culminating in the spring of 2020 when crude traded at negative prices. That’s right, you got paid to accept crude oil deliveries!
But a funny thing happened. It sure felt like the world was ending, but it wasn’t. The world has a stubborn way of continuing; when it does, it uses lots of crude.
Producers had been punished by a six-year bear market. They had cut and cut and cut production.
So when resurging demand overtook supply, prices rebounded. They topped last spring when Russia invaded Ukraine, have pulled back on recession fears, and now appear ready to bounce again as OPEC pouts.
Let’s talk about the perfect dividend plays to profit from that move. Bonus: these payers will do just fine even if crude merely trades flat for a while!
At $80 per barrel, this is a dividend deal we’ll take all day.
To make money when crude is merely “flat to higher” we’re going to focus on toll bridges like Plains All American Pipeline LP (NASDAQ:PAA). PAA is the leading pipeline in the Permian Basin. It yields 8.2% and is fresh off a 28% dividend raise earlier this year.
(If the Permian were its own country, it’d be the number four producer of energy in the world. It’s that important. My Texan buddy Tom gives Permian ground zero cities Midland and Odessa a wide berth because of 24-hour traffic jams.)
As profits grow and PAA pays down debt accrued during the 2014-20 energy bear market, its leverage ratio will drop, fueling the next dividend hike.
A toll bridge for the most important energy region in the world today, PAA checks all the boxes for an energy darling dividend.
But, sadly, PAA will kick you a K-1 come tax time. Master limited partnerships (MLPs) must issue you a K-1 package at the end of the tax year. If you owned PAA last year, you probably received this recently. And you’re probably getting a dirty look from the person who does your taxes. (Hint: I’ll tell you how to avoid this.)
Fifteen years ago, I bought two MLPs: Enterprise Products Partners (NYSE:EPD) and, well, I can’t recall the other. But I can vividly remember the annoyed look on my accountant’s face.
He calmly but sternly asked me to stop buying MLPs in my personal portfolio. I agreed. And I’m paying my lesson forward with a K-1-free way to buy PAA.
PAA is a top holding in Alerian MLP ETF (NYSE:AMLP), which owns 13 more pipeline firms, including my old friend EPD.
These are all infrastructure companies—middlepersons that take their own tolls. They are generally less sensitive to energy prices than producers like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX).
As long as energy prices merely grind sideways, these toll bridges keep collecting. Which means their dividends continue to flow.
Given the supply constraints in the energy market and the strong US economy, these pipelines really are perfect—except for their tax headaches. Fortunately, Alerian saves us the hassle and pays us a sweet 7.8%.
“But Brett,” I can hear thoughtful readers now. “You told us to always demand a discount. As an ETF, Alerian usually trades for fair value. We want cheaper than fair!”
Fair enough. For those of you who demand a discount, Kayne Anderson MLP Investment Closed Fund (NYSE:KYN) is a CEF on sale at 14% off its net asset value (NAV). Since KYN’s NAV is comprised of publicly traded stocks, it’s particularly attractive.
KYN yields 9.6% and holds Contrarian Income Report favorites like ONEOK (NYSE:OKE) and The Williams Companies (NYSE:WMB). If you enjoyed our 167% and 71% total returns respectively on them, KYN gets you both for just 86 cents on the dollar.
KYN should be trading closer to its net asset value. Heck, the fund traded at a premium as recently as 2018 and energy was in a bear market then. Now, it’s making a multi-year run higher. But when there is fear in the broader stock market, we can buy KYN for less than the value of the stocks it holds.
This is about as cheap as we ever see it. And yes, KYN avoids the K-1 hassle by issuing one neat 1099, as does AMLP.
KYN gives us three ways to win. First, we enjoy a 9.6% current yield. Second, the discount! That’s 14% in free money. And third, NAV gains. When stocks owned by KYN rally, its NAV directly benefits.
AMLP and KYN are perfect income investments.
That said, oil is pretty hot this week. I’m not sure I’d chase it right here. I prefer other perfect dividend stocks and funds that are likely to pop next week.
Disclosure: Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. Click here to learn how to profit from their strategies in the latest report, "7 Great Dividend Growth Stocks for a Secure Retirement."