On Thursday, the US Bureau of Labor Statistics announced that the consumer price index rose 7.5% over the past 12 months, putting inflation at its highest level in 40 years. To fight inflation, the Federal Reserve could start raising interest rates in March, with a total of three or four rate hikes expected this year.
Higher cost of goods, higher cost of capital and supply chain constraints are weighing on business results. However, some companies have shown that they have the power to set prices to pass on some of these costs to their customers.
here’s why Chevron (NYSE: CVX) and Kinder Morgan (NYSE: KMI) are two sure dividend stocks worth buying now.
Chevron’s capital discipline ensures the longevity of its business
One way to invest in companies that can perform well in times of inflation is to find the industries causing inflation and avoid those that are most vulnerable to it. Rising oil and gas prices are contributing to inflation right now. West Texas Intermediate crude oil prices, the US benchmark, and Henry Hub natural gas spot prices are at their highest levels since 2014 as demand outstrips supply.
Chevron has spent the past few years cutting production and maintenance costs and making a timely acquisition during the 2020 downturn so it can break even at lower oil and gas prices. When the COVID-19 pandemic crippled demand for fossil fuels, Chevron’s low cost of production allowed it to perform better than many of its peers. But it still posted a net loss of $5.5 billion.
2021 was a game-changer as many oil majors had some of their best years since 2014. The chart below is a great illustration of Chevron’s lean business model.
Note that 2021 revenue grew only 15.5% in five years, but net income grew 70% and free cash flow increased more than 200%, a sign that Chevron is converting more sales into actual profits.
A lean business operating in the midst of an industry-wide boom should set Chevron off to another strong year in 2022. On its fourth quarter 2021 conference call, management indicated it would remain disciplined and keep capital spending in check so it doesn’t grow too much and leave the business vulnerable in a downturn.
In the meantime, Chevron will continue to deliver value to shareholders through the dividend and by repurchasing its own shares. Chevron is yielding 4.1% at the time of this writing.
Kinder Morgan is a cash cow with a high dividend yield
Like Chevron, Kinder Morgan’s business is relatively insulted by inflation. As one of the largest transportation and energy storage companies in the United States, Kinder Morgan provides the infrastructure needed to move products from major oil and gas plays to end markets.
Although Kinder Morgan and Chevron belong to the same industry, their businesses are quite different. Kinder Morgan does not produce oil and gas or sell it to consumers at gas stations. Its activities focus instead on investing in pipelines, terminals, liquefied natural gas facilities and other projects. To justify building these multi-year, capital-intensive projects, Kinder Morgan secures long-term take-or-pay and priced contracts that make its revenues predictable.
This quality was on display in 2020 when Kinder Morgan adjusted its full year guidance in April as the pandemic became a reality. Kinder Morgan’s Distributable Cash Flow (DCF) and Adjusted Earnings Before Interest, Taxes, Depreciation, Amortization (EBITDA) forecasts were found to be 99% accurate. Many income investors seek accurate forecasts because they allow a company to generate stable cash flow that supports the dividend.
Kinder Morgan forecasts net income of $2.5 billion in 2022, DCF of $4.7 billion, adjusted EBITDA of $7.2 billion and dividend of $1.11 per share, vs. 1, $08 per share in 2021. Kinder Morgan’s dividend obligation in 2022 is expected to cost the company about $2.6. billion, indicating that Kinder Morgan can support its dividend with cash, not debt.
Kinder Morgan’s forecast for 2022 gives the stock a forward price-to-earnings ratio of 15.9 and a forward dividend yield of 6.3%.
Offset inflation with passive income
Buying equal shares of Chevron and Kinder Morgan stock would give an investor an average dividend yield of 5.2% while exposing their portfolio to many aspects of the oil and gas industry. The dividend yield alone is almost high enough to offset the impact of inflation. And because Chevron and Kinder Morgan are in an industry that causes inflation, both companies stand to benefit.
However, investors should keep in mind that if oil and prices stabilize or start falling as costs continue to rise in other parts of the economy, then we could see a scenario where the oil and gas industry is not as good as an inflation hedge. Oil and gas companies are in a commoditized industry where companies with the lowest operating costs tend to win out. Chevron can get positive free cash even when oil is in the $40s. And long-term contractual arrangements make Kinder Morgan’s business resilient to short-term swings in oil and gas prices (as we saw in 2020). So even if production costs rise or profit margins start to fall, Chevron and Kinder Morgan should still generate plenty of FCF to pay and increase their dividends.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.