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3 Embarrassingly Cheap Dividend Stocks

Matthew DiLallo, The Motley Fool

The oil industry has had its share of ups and downs in recent years. That volatility has spooked investors, leading many to flee the sector. Now most energy stocks trade at cheap prices.

Some, however, are so cheap that it's embarrassing. Three that stand out are midstream companies Kinder Morgan (NYSE: KMI), Tallgrass Energy (NYSE: TGE), and Energy Transfer (NYSE: ET).

A jar of coins with the word dividends written on the front.

Image source: Getty Images.

Rock-solid income for a low price

Kinder Morgan currently pays its investors an attractive 4.9%-yielding dividend after boosting the payout by 25% earlier this year. That above-average income stream looks sustainable over the long term. For starters, Kinder Morgan only pays out about 45% of its cash flow to support its dividend, which is a conservative level for a pipeline company. On top of that, the company has a strong balance sheet and produces predictable cash flow backed by fee-based contracts.

Typically, a solid income stock like that would sell for a premium price. However, that's not the case with Kinder Morgan. A quick look at the numbers shows that Kinder Morgan is on track to generate about $5 billion, or $2.20 per share, of cash flow this year. With its stock currently selling for around $20.50 per share, it's trading at about nine times cash flow. That's an embarrassingly cheap level for a pipeline company since the sector historically trades at a mid-teens multiple of cash flow.

Cheap cash flow with tremendous upside

Tallgrass Energy currently offers an even more attractive dividend yield of 8.7%. One reason Tallgrass has a higher yield is that it pays out a larger percentage of its cash flow. During the first quarter of 2019, for example, it paid out 75% of its cash flow, which is still a conservative level in the pipeline sector.

The other reason Tallgrass Energy's has such a high yield is that it trades at a low valuation. The pipeline company is currently on pace to generate about $2.84 per share in cash flow this year. With shares selling for around $24.25 apiece, Tallgrass' stock trades at a ridiculously low valuation of 8.5 times cash flow.

That cheap price doesn't make much sense. First of all, Tallgrass Energy has a relatively low leverage ratio. Thus, it doesn't have any balance-sheet issues weighing it down. On top of that, the company isn't lacking growth prospects. Not only does it have an oil pipeline expansion joint venture with Kinder Morgan in development, but it's also working on needle-moving oil pipeline and export terminal projects. Those expansion opportunities provide it with tremendous upside potential, which investors aren't giving it any credit for in the stock price.

Scraping the bottom of the barrel

Energy Transfer pays an eye-catching yield that's currently up to 8.2%. That payout looks rock solid, since it consumes less than half of the company's cash flow. Because of that, Energy Transfer is on track to produce as much as $3 billion in free cash this year after paying its distribution to investors, which it can use to fund its large slate of expansion projects.

The other reason Energy Transfer has such a high yield is that it trades at the lowest valuation in its peer group. That bottom-of-the-barrel price doesn't make any sense. That's because Energy Transfer has a strong balance sheet after undertaking several actions in the past year to shore up its financial profile. On top of that, the company has ample growth coming down the pipeline, given that it expects to invest $5 billion in expansion projects this year.

Energy Transfer should command a premium valuation on its growth potential alone. Instead, it trades at a ridiculously low one. That makes it an incredibly compelling opportunity for investors.

Excellent income streams for crazy cheap prices

Income-seeking investors should take a close look at this trio of pipeline companies. Not only do they offer above-average payouts, but each also trades at ridiculously low valuations, especially when considering their growth prospects. This trio could potentially produce market-crushing total returns in the coming years, which is why they stand out as some of the most compelling dividend-paying stocks around.

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Matthew DiLallo owns shares of Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.