Last year, the energy sector was the only market sector to post a positive return—and it did a heck of a job! The Energy Select Sector SPDR (XLE) gained 60% last year.
One-year gains like that may make you cautious about committing to energy this year, but I believe your portfolio should continue to hold an above-average energy weight.
Let’s look at some of the fundamentals…
The mega-cap energy companies give a good view of the sector. With a $440 billion market cap, Exxon Mobil Corp (XOM) is one of the ten largest U.S. companies. Exxon is an integrated energy company with operations that include drilling for oil and gas, refining, and even retail. For the 2022 third quarter, the company reported earnings of $19.7 billion—yes, the company made almost $20 billion in one quarter!—and had $24 billion of cash flow from operations. For comparison, Alphabet (GOOG), with twice the market cap, earned $14 billion for the quarter. Despite appreciating by 65% over the past year, XOM trades at a P/E of 8.
Chevron Corp (CVX), with a $340 billion market cap, also operates as a fully integrated energy company. Chevron earned $11 billion in the third quarter, with $12.3 billion of free cash flow. After gaining 43% over the last year, CVX trades at a P/E of 9.
These large-cap energy companies will remain very profitable at current energy commodity prices. If oil and natural gas prices go up during the year (which I think is very probable), the share prices could post similar gains. I think both will beat the Wall Street estimates for fourth-quarter results.
However, I have a better idea for the energy sector for 2023. I predict energy midstream will generate very attractive total returns. Midstream companies operate gathering systems, pipelines, and terminals. The business operates on a fee basis with long-term contracts. Revenues and cash flow to pay dividends are stable and growing.
In the midstream sector, you find corporations and master limited partnerships (MLPs). Currently, I favor MLPs. Both camps have the same growth prospects, but the MLPs start the year with higher current yields.
Midstream companies will grow dividends by high single digits this year. Combine that growth with similar starting yields, and you end up with total returns in the mid teens.
Here are three MLPs with near 10% yields:
MLPs do come with Schedules K-1 for tax reporting. They also pay tax-advantaged distributions. If you don’t want the hassles of K-1 reporting or want to own MLP investments in a qualified retirement account, I recommend the InfraCap MLP ETF (AMZA). AMZA pays stable monthly dividends and yields 8.6%—and there is a good chance of a dividend increase when the fund announces its January dividend.