The financial press obsesses about the Fed every day. Everybody is talking about artificial intelligence. Meanwhile, it’s an energy bull market. It’s been the hottest sector of the market while nobody’s looking.
Energy has been the best-performing market sector of the past one- and three-month periods, and it is the second-best-performing of the 11 S&P stock sectors YTD, with a 17% return. The main reason is oil prices, which have risen over 20% YTD to $86.39 per barrel. And there are reasons that prices are likely to remain elevated.
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.
[text_ad]
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, after an extended period of underinvestment, global supplies of oil and gas are straining to meet growing demand. The dynamic will last for some time.
The energy sector was the market dog for most of the decade before 2022. The American energy renaissance increased world supplies of oil and gas and prices crashed. But that dynamic is over as was evident after the pandemic. Energy prices spiked again as limited supplies couldn’t catch up to the lockdown recovery. Prices abated for a while but are on the move again.
Look at the performance over the last three years. The Energy Select Sector SPDR Fund (XLE) has vastly outperformed the S&P 500.
Then there’s inflation. Sure, CPI has fallen all the way down to 3.5%. You might remember the double-digit inflation of the 1970s and think 3.5% is no big deal. But inflation isn’t measured the same today as it was then. Using the ‘70s inflation calculation, today’s inflation would be around 8% by most estimates. And it is proving to be very sticky. Energy stocks are one of the only industries that thrive with inflation. The stocks are a great hedge.
There are also two wars going on. Any escalation or disruption in the oil supply will send prices soaring. Until those wars go away, there is a high level of upward potential in energy prices.
Energy looks solid in both the long and short terms. It is also true that you can find some of the highest dividend yields on the market in the sector. Here are two great stocks in the industry. One is more about price appreciation and the other is more about income.
2 Energy Bull Market Stocks
Marathon Petroleum Corporation (MPC)
Yield: 1.7%
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.
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 the fortunes of the U.S. oil refinery business. But MPC is several cuts above other refiner stocks and has consistently outperformed its peers. MPC has blown away the performance of its peers and the overall market in every measurable period over the last five years. Over the past three years, MPC has returned a whopping 341%, more than ten times the S&P 500 return of 32% over the same period.
Refining margins have shrunk since the sizzling market of 2022 as crack spreads have narrowed throughout the industry. Marathon’s earnings were actually lower on a year-over-year basis this past year. But it was nevertheless still one of the profitable periods in the company’s history and crack spreads remain elevated with no end in sight. That’s why MPC is already up 40% YTD.
You would think that after the recent stock performance, MPC is overvalued and almost out of gas. But it isn’t. It still sells at a price/earnings ratio of just nine, less than half that of the overall market.
Enterprise Product Partners (EPD)
Yield: 7.0%
(This security generates a K1 form at tax time)
Enterprise Products Partners (EPD) is one of the largest midstream energy companies in the country, with a vast portfolio of service assets connected to the heart of American energy production. It is connected to every major U.S. shale basin and 90% of American refiners east of the Rockies and offers export facilities in the Gulf of Mexico as well.
The thing that jumps out about this master limited partnership (MLP) is the distribution. It currently yields 7%. MLPs tend to have higher yields because they are required to pay out most of their earnings to unitholders in the form of distributions, but I’ve never seen a yield that high that is this safe. Distributable cash flow covered the distribution by 1.6 and 1.7 times in the two worst quarters of the pandemic. A ratio of 1.2 is considered conservative. The most recent quarter showed 1.9 times coverage.
The high-paying midstream goliath keeps quietly delivering. In the 2022 bear market, when the S&P 500 was down 19.5% for the year, EPD returned 15% for the year. Last year, EPD returned 17.21%. It’s up 12% YTD. Enterprise is benefiting from a strong energy market but also has properties that should enable superior relative performance even if the economy turns south. It should be good to go in just about any market.
As a midstream energy company, Enterprise is not levered to commodity prices but rather collects fees for the services of transporting and storing crude oil, natural gas, natural gas liquids, and various refined products. Roughly three-quarters of the partnership’s operating margins are tied to highly predictable long-term, fixed-fee contracts with inflation adjustments built in. That’s why the distribution has been secure in any kind of market and Enterprise has been able to raise the distribution for 25 consecutive years.
Although EPD is near the 52-week high, the stock is still cheap at just 10 times Wall Street’s forward-year consensus earnings. The price is also more than 30% below the all-time high with significantly higher earnings. The partnership has also been historically less volatile than the overall market.
[author_ad]