Why middle stocks will thrive during a recession

Oil prices exploded in 2020 on the back of declining demand for fuel, actually pushing the leading US benchmark West Texas Intermediate (WTI) briefly below zero at one point. But the giants of the middle industry Enterprise Product Partners (NYSE: EPD), Enbridge (NYSE: ENB), and Kinder Morgan (NYSE: KMI) increased their dividends all the same. That’s why dividend investors should be comfortable staying in the mid-market through a recession.

The energy sector is huge

When we first think of energy, it is likely that integrated oil giants like ExxonMobil and Chevron come to mind. This makes sense, given their importance to the industry. But it’s their basic business model that really deserves to be understood. They have assets across the industry, from drilling (upstream) to processing (downstream), and everything in between. The goal is to create a diversified portfolio that can overcome the ups and downs inherent in the commodity-driven industry.

A person in protective gear working on an energy pipeline.

Image source: Getty Images.

But there is a niche in the industry that is a little different from the others: the midstream. It is pipelines, storage, transportation and processing facilities that help move oil and natural gas from where it is extracted from the ground to where it is ultimately used. Most of these activities are paid, so the demand is more important than the prices of raw materials. In 2020, for example, despite the massive impact of the pandemic, the US Energy Information Administration estimates that global demand for oil fell only 8.5%.

That’s a fairly modest drop considering the global economic shutdowns used to slow the spread of the coronavirus. But even so, emotional investors gave up on everything to do with oil, including oil itself.

The evidence was clearly displayed

A few comparisons will help illustrate the difference here. In 2019, diversified energy giant Exxon earned $ 2.25 per share – but thanks to the pandemic, it lost $ 0.33 per share in 2020. Drilling focused ConocoPhillipsAdjusted earnings fell from $ 3.59 per share in 2019 to a loss of $ 0.97 per share last year. Meanwhile, mid-level leader Kinder Morgan had adjusted earnings of $ 0.95 per share in 2019 and still managed to deliver significant profit in 2020, with adjusted earnings of $ 0.88 per share. Its toll business model has simply held up better than companies more dependent on commodity prices. And it wasn’t the only one by any stretch of the imagination, with fellow industry giants Enterprise and Enbridge also holding up very well.

That said, investors shouldn’t just burn out and buy middle stock. There are nuances that are important. The trio mentioned above are all large and diverse, which adds resilience to their businesses. Some middle names focus narrowly on specific niches (such as connecting wells to larger pipelines) or are highly exposed to commodity volatility (Plains All American, for example, cut its distribution in half last year). It is important to make sure that fees are a significant part of a company’s revenue if you are looking for intermediary names for added security.

EPD financial debt / EBITDA (TTM) chart

EPD financial debt on EBITDA (TTM) data by YCharts

On this front, you’ll also want to make sure you stick with intermediate players who have strong track records. Even the best company will struggle if its financial base is weak. Enterprise enjoys prudent funding, but both Kinder Morgan and Enbridge have significantly improved their balance sheets in recent years. This probably makes Enterprise the best bet for risk averse investors, but it shouldn’t scare you off Kinder Morgan or Enbridge if you have a stronger stomach.

Huge returns

The point is that investors are really gloomy about mid-market securities right now, despite the inherent resilience of the paying players. For example, the Enterprise Master LP has a payout yield of 7.5%, Kinder Morgan’s dividend yield is 6.1%, and Canadian giant Enbridge offers a yield of around 7%. All are at the top of their historical range. And yet their companies have shown incredible strength in the face of not just a recession, but a massive global health alert.

If you’re a dividend investor and worried about the next economic downturn, it’s probably time to dive into the biggest and most diverse names in the mid-sector.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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