The energy sector can be a great place for income-seeking investors to lock in an above-average yield because the industry offers several investment types geared toward returning cash to shareholders. Two of those income-focused entities are midstream master limited partnerships (MLPs) and renewable yieldcos. Companies operating in these areas tend to sign long-term contracts to transport oil and gas or sell renewable energy, thereby enabling them to generate steady cash flow and pay high-yielding dividends.
Three top options in these income-focused subsectors of the energy market are Magellan Midstream Partners (NYSE: MMP), Pattern Energy (NASDAQ: PEGI), and NextEra Energy Partners (NYSE: NEP). Here's why these Motley Fool contributors think they're the best energy stocks to buy in March.
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A top-tier MLP for a good value
Matt DiLallo (Magellan Midstream Partners): Last year was another solid one for Magellan Midstream Partners. The oil and refined products transportation and storage MLP was able to grow its cash flow by 9% despite selling a stake in a large oil pipeline, which enabled it to increase its high-yielding distribution to investors by 8% so that it's now up to 6.7%. That payout is on rock-solid ground since Magellan covered it with cash flow by a comfortable 1.26 times. This conservative payout ratio also allowed it to retain some excess cash to help fund growth projects. With the addition of the proceeds from the pipeline sale, Magellan was able to finance a large slate of expansions while maintaining one of the lowest leverage ratios in its peer group.
However, despite its financial and operationally successes last year, units of Magellan Midstream Partners tumbled in 2018. As a result, the company currently offers investors a much more attractive valuation and yield, especially after factoring in not only last year's growth but what it has coming down the pipeline.
While the pipeline sale will cause Magellan's growth engine to slow down this year -- with the company anticipating a 3% increase in cash flow -- a large backlog of capital projects should start service in 2020 and reaccelerate growth. Consequently, the company is forecasting an increase in its distribution to investors by 5% in 2019 and 5%-8% in 2020.
Magellan Midstream currently offers investors a compelling combination of features since it trades at an attractive valuation, offers a high yield, and has visible growth prospects and a top-notch financial profile. Those factors should give the company the fuel to generate strong total returns in the coming years, making it a top energy stock to buy this March.
The headwinds are turning
Jason Hall (Pattern Energy Group): While this renewable energy's stock is on the riskier end of the risk-reward spectrum -- since it has had to pay out essentially all of its cash flows over the past year simply to maintain its dividend -- its recent results and management's track record of executing pretty well on capital allocation have me convinced that it's worth taking on the risk of owning.
Here's the short version: Pattern Energy makes a living by selling the power it produces from its wind and solar energy plants to utility and industrial customers, and a combination of changes in the tax law and rising interest rates has made it harder to come by financing for new projects while also increasing the cost of capital. This has necessitated Pattern's management to be more flexible with how they deliver cash flow growth.
Simply put, CEO Mike Garland and his team have done an admirable job of taking some short-term pain for long-term gain. Last year, the company raised about $230 million by selling off certain assets, flipping that cash into newer assets that will generate higher returns. This hurt cash flows in the fourth quarter, but as management said, it will pay off with per-share cash flow growth going forward and get the company to its long-term goal of an 80% payout ratio.
The reward for accepting the risk that Pattern's plans will be blown off course is the best dividend yield in the yieldco space, over 7.7% at recent prices and almost 21% better than the next-highest payout. Sure, there's risk, but I think this management team and Pattern's asset base make that risk worth taking.
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Renewable energy's best dividend
Travis Hoium (NextEra Energy Partners): As the utility industry changes from being powered primarily by coal to one increasingly powered by renewable energy, there are a lot of opportunities for investors to find growth stocks. One way is to buy yieldcos like NextEra Energy Partners, a company that owns 5.3 gigawatts of renewable energy assets.
What makes yieldcos great is that they're backed by long-term contracts to sell electricity to utilities. These contracts provide cash flow that ultimately drives a dividend, which for NextEra Energy Partners currently stands at a 4.1% yield. To grow, companies can use debt, cash flow, or even stock sales to acquire projects that keep the dividend growing. In NextEra Energy Partner's case, the company already has enough visibility to project acquisitions that management says will grow the dividend 12% to 15% annually through the end of 2023.
On top of great operations, NextEra Energy Partners has a lot of tax advantages as well. The company doesn't expect to pay significant federal taxes for the next 15 years and distributions, or dividends, to shareholders won't be subject to taxes for more than eight years because they're classified as a return of original capital.
If you're looking for ways to play the growth in the energy industry without betting on commodities, NextEra Energy Partners is a great stock with a great dividend to go with it.
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Jason Hall owns shares of Pattern Energy Group. Matthew DiLallo has no position in any of the stocks mentioned. Travis Hoium owns shares of NextEra Energy Partners and Pattern Energy Group. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.