A high-yielding gas energy pipeline ETF and two oil companies gushing cash make up a list of three great stocks to buy for future dividends.
These three stocks offer investors huge dividend potential for many years. The Global X MLP ETF (MLPA 0.62%) invests in master limited partnerships (MLPs) in midstream pipelines and storage. Meanwhile, Devon Energy (DVN -2.31%) and Diamondback Energy (FANG -3.19%) are oil and gas exploration and production companies set to gush cash in 2025 and use it to enhance dividends for long-term investors.
The Global X MLP ETF is well-placed for the new administration
Whether you voted for President Trump or not, he will take office in January. That’s good news for gas pipelines and storage companies, not least because the Trump administration has promised to end the moratorium on new LNG export terminal licenses imposed by the Biden administration.
While investors may enjoy picking winners in the sector, the Global X MLP ETF offers an alternative option. Currently holding 20 MLPs with Energy Transfer, Enterprise Product Partners, and MPLX each representing more than 10% of assets, the ETF offers a relatively stress-free way to get broad-based exposure to midstream pipelines and storage companies.
In addition to the new administration’s approach to LNG terminals, an increase in energy exploration and production is good news for energy infrastructure companies because it increases the likelihood of output increases in the fields they serve. That helps de-risk MLPs and improves their bargaining position when negotiating long-term contracts.
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This ETF, with an 8.3% dividend yield and an expense ratio of 0.45%, is a buy for investors who are optimistic about the long-term future of energy production in the U.S.
Devon Energy’s long-term capital returns
I know what you are thinking: Devon Energy didn’t pay a variable dividend in the third quarter, and its quarterly fixed dividend of $0.22 equates to an annual dividend of $0.88. That figure would put Devon on a dividend yield of just 2.3%, so how is Devon Energy a high-yield stock?
The answer lies in understanding how capital is best returned to shareholders over time. In a nutshell, Devon Energy’s management is currently using its substantive cash flow to reduce its debt and make share buybacks after it pays its quarterly fixed dividend. It’s a strategy that makes sense when it’s gushing cash flow from good production and a relatively high price of oil. The debt reduction will improve future cash flow as it won’t have to pay the interest on the retirement debt, and the share buybacks will lower the share count, so existing shareholders will have a more significant claim on future cash flow.
Putting some numbers to this argument, management believes it will have a free cash flow (FCF) yield of 9% in 2025 based on a price of oil of $70 a barrel and the stock price on Nov. 1 of around $38.32. Interpolating for the current stock price suggests an FCF yield of 8.9%. In theory, Devon could pay all of that in dividends. However, management tends to return 70% of FCF to investors, with 30% earmarked to improve its balance sheet (debt reduction).
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As such, if 70% of returns are in the form of dividends, this implies a 6.2% dividend yield. That would be fine, but given that the stock trades on such an attractive FCF yield, it makes more sense to use investors’ money to buy back stock yielding 8.9% in FCF.
As such, provided FCF stays high, Devon will have plenty of potential to increase its dividend significantly, not least as FCF per share will drop given the share count reduction.
Diamondback Energy is following a similar strategy
In common with Devon, Diamondback Energy didn’t pay a variable dividend in the third quarter. Also in common with Devon, which acquired Bakken-focused Grayson Mill, Diamondback is expanding its production through a merger with Permian-focused Endeavor Energy (expected to close in the fourth quarter).
The parallels don’t stop there. Diamondback also expects to gush cash flow in 2024, with management forecasting $3.4 billion at commodity currency prices. It’s an FCF representing 6.4% of the current market cap. The market is likely valuing Diamondback over Devon due to the Endeavor deal.
Indeed, there’s good news on that front, with management recently lowering its post-dividend breakeven price of oil to $37 a barrel from an initial estimate of $40 a barrel.
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In plain English, provided the price of oil stays above $37 a barrel, Diamondback will be able to pay its base quarterly dividend of $0.90, or $3.60 a year. That equates to a 2% dividend yield. However, given that the price of oil is currently around $70 a barrel, and management takes an opportunistic approach (just as Devon does) in making share buybacks when its valuation is low or increasing its variable dividend where possible, the stock has plenty of potential to grow its dividend in the coming years.
All told, the Global X MLP ETF offers excellent dividend yields now. If you believe energy prices will hold up, then Devon and Diamondback are likely to return to increasing their variable dividends in the future.