Although bonds lack the liquidity of equities and require more up-front capital to purchase, income-seeking investors shouldn’t overlook the opportunities in this corner of the energy market.
Because bonds have a higher position in the capital structure than stock, a company usually privileges its interest payments over dividends or distributions to investors who own common shares or units.
Kinder Morgan (NYSE: KMI) underscored this point when the company slashed its dividend by 75 percent, opting to fund its growth plans internally and pay down debt to placate Moody’s Investor Service, which had threatened to cut the pipeline owner’s credit rating to junk.
Whereas this painful dividend cut sent the common stock plummeting, Kinder Morgan’s bonds rallied. The yield to maturity on Kinder Morgan’s 3.05% Notes of 12/01/19 tumbled from their peak of 7.5 percent on Dec. 2, 2015, to about 5 percent a week after the company announced its dividend cut.
Given the uncertainty surrounding the likes of Energy Transfer Partners LP (NYSE: ETP), Williams Partners LP (NYSE: WPZ) and Plains All-American Pipeline LP (NYSE: PAA), investors should regard sharp downward spikes in their bonds as a potential buying opportunity. We’ll keep our eyes peeled.
Investors can also expect highly leveraged oil and gas producers, especially those with marginal assets, to take advantage of any rally to issue equity and raise capital to pay down debt and help fund capital expenditures.
With most exploration and production companies in survival mode, investors shouldn’t hang their hat on the dividend as the primary source of their return.
For example, Anadarko Petroleum’s shares yielded about 3.4 percent when we added the stock to the Model Portfolio on Jan. 15, 2016. However, the dividend yield did not figure into our investment thesis one iota; much of the stock’s upside will come from the company’s high-quality asset base and strong balance sheet–advantages that will enable the firm to win market share in a lower-for-longer environment. We also focused on identifying an ideal entry point that would limit our downside risk.
When Anadarko Petroleum announced a dividend cut, the stock barely moved–if anything, the market (and credit raters) viewed the decision to retain more cash flow as a positive.
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In October 2012, renowned energy expert Elliott Gue launched the Energy & Income Advisor, a twice-monthly investment advisory that's dedicated to unearthing the most profitable opportunities in the sector, from growth stocks to high-yielding utilities, royalty trusts and master limited partnerships.
Elliott and Roger on Feb. 27, 2020
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