The first question that comes to mind when you see yield on a stock that is north of 6% is -- what are the risks? Savvy investors typically don't fall for the lure of high yields, without first evaluating the risks involved. At times, the risks don't justify the high yields, presenting attractive buying opportunities. Let's take a look at three energy stocks -- Enbridge (ENB -1.23%), Phillips 66 (PSX -2.00%), and Williams Companies (WMB -1.54%) -- that offer precisely such an opportunity.
Enbridge
When investors' sentiment for a sector sours, all the stocks in that sector face the heat. That's what happened with Canadian midstream giant Enbridge. Enbridge has raised its dividends consistently for 25 years, at an impressive average annual rate of 11%.
Based on the mid-point of its distributable cash flow guidance range, Enbridge expects to pay roughly 70% of its 2020 DCF as dividends. That is slightly higher than its target of paying out less than 65% of DCF as dividends. Indeed, in the current environment, it is surely as safe as it can get. Still, the stock is trading at a yield of 8% as of this writing.
ENB Dividend Yield data by YCharts
While many energy companies reported losses in the second quarter, Enbridge delivered strong performance with adjusted EBITDA rising to CA$3.3 billion compared to CA$3.2 billion in 2019. The company also reaffirmed its DCF guidance for 2020. Moreover, it expects 5% to 7% annual growth in per share DCF through 2022.
Finally, Enbridge expects its debt-to-EBITDA ratio to remain within its target range of 4.5 to 5 times for 2020. All in all, Enbridge stock's fall this year looks like a perfect example of throwing baby out with the bathwater.
Williams Companies
Like Enbridge, Williams Companies posted strong performance in the second quarter. The company expects its 2020 earnings to be within its guidance range. Williams' regulated gas pipelines and its fee-based contracts provide relative stability to the company's earnings. Moreover, a chunk of its earnings is backed by reserved capacity contracts. That means the customers pay even when volumes fall short of the contracted capacity.
Image source: Getty Images.
According to the U.S. Energy Information Administration, U.S. natural gas production is projected to increase by an average of 1.9% per year through 2025. Williams Companies should benefit from the positive outlook for natural gas. Moreover, its gas gathering operations are strategically located in premium basins including the Marcellus and Utica shales.
With a coverage of 1.7 times, Williams Companies' dividends look reliable. It expects a debt-to-adjusted EBITDA ratio of 4.4 times for 2020. Trading at a yield of 8.1%, Williams Companies stock could be a great addition to your dividend portfolio.
Phillips 66
Another energy stock that got punished along with the sector is refiner Phillips 66. Surely, second quarter was harsh for the company. But demand for gasoline and distillate has improved substantially since then. Though it may take some more time before demand reaches to pre-COVID levels, the refiner can withstand the lower demand a little longer.
US Finished Motor Gasoline Product Supplied data by YCharts
That's because of certain key advantages that Phillips 66 has. Firstly, its refineries have access to low-cost Canadian crude, which helps it minimize its input costs. Secondly, Phillips 66 can leverage its midstream assets by placing them around its refining footprint. Lastly, with a net debt-to-capital ratio of 35%, it has a pretty strong balance sheet.
Phillips 66 recently took a major step towards production of renewable diesel. It plans to transform its San Francisco refinery to produce renewable fuels using cooking oil, soybean oils, fats, and greases. The step will allow Phillips 66 to meet requirements under California's Low Carbon Fuel Standard program, in addition to fulfilling its customers' demand for renewable fuels.
Phillips 66 stock has fallen more than 50% since the beginning of 2020 and is trading at an enticing yield of nearly 7%. Dividend-seeking investors sure wouldn't want to miss this buying opportunity.
