Stock Analysis & Ideas

Seeking at Least 7% Dividend Yield? Morgan Stanley Suggests 2 Dividend Stocks to Buy

The conventional wisdom outlook for 2023 is mixed – most market watchers and economists would say that a recession is likely during the first half of the year, with disagreements centered more on the duration and depth of a downturn than its likelihood, and a rebound will come in the second half, leading to stock markets finishing this year about where they began.

Weighing in from Morgan Stanley, chief Us equity strategist Mike Wilson notes the conventional wisdom, saying: “Both the sell and buy side are now closely aligned with the view of a tough first half due to the high risk of a mild recession, followed by a nice recovery in 2H… Our concern is that most are assuming ‘everyone is bearish’ and, therefore, the price downside in a recession is also likely to be mild (SPX 3,500-3,600). On this score, the surprise might be how much lower stocks could trade (3,000) if a recession arrives.”

If Wilson is right, then investors should start looking for the defensive plays that will protect them when the markets shift downward again.

It’s a mindset that naturally turns us toward dividend stocks. These are the traditional defensive investment plays, offering steady payouts to shareholders that guarantee an income stream whether markets go up or down. The best dividend stocks will combine a high regular payout with a solid share appreciation potential, giving investors the best of both worlds when it comes to returns.

Morgan Stanley analyst Robert Kad has found two such names that deserve a second look. According to the latest TipRanks data, these are Strong Buy stocks with dividend yields of 7% or better. Both are also showing high upside potential, on the order of 20% or better. So, let’s take a closer look at these two dividend champs.

Energy Transfer LP (ET)

We’ll start with one of North America’s largest hydrocarbon-sector midstream companies, Energy Transfer. This company boasts an impressive network of assets and energy infrastructure, totaling some 120,000 miles and able to move approximately 30% of the US’ total output in crude oil and natural gas products. Energy Transfer’s network is centered in the rich hydrocarbon producing areas of Texas-Oklahoma-Louisiana, and branches out to the Great Lakes, Pennsylvania, the mid-Atlantic, and Florida.

Midstream, moving oil and gas products from the wellheads to the terminal points, storage farms, and refineries, is a profitable business, providing strong cash flows – and Energy Transfer shows both. In its last reported quarter, 3Q22, the company had a top line of $22.9 billion. This total was up 37% year-over-year.

Furthermore, ET’s earnings, measured as income attributable to partners, grew by $371 million y/y, to $1.01 billion. The company’s distributable cash flow, which is the direct support for the dividend, came in for 3Q22 at $1.58 billion, up 30% from the $1.31 billion reported in 3Q21.

Turning to the dividend, Energy Transfer made its last declaration this past November, and paid out the common share dividend on November 21. The payment, of 26 cents per common share, was up 13% from the prior quarter; the increase was the fourth consecutive quarterly dividend increase. At the current rate, the payment annualizes to $1.04 and yields 8.2%. That yield is more than 4x the average found among S&P-listed companies, and beats the last annualized inflation numbers (the 6.5% reported for December) by 1.7 points.

Analyst Kad describes ET stock as Morgan Stanley’s ‘top pick.’ In his coverage, Kad points out the dividend as the key to making this a top pick, and writes: “We see arguably the most significant mispricing within our coverage, with 20.2% 2023 FCF yield supportive of an additional 15% distribution increase in 4Q22 (early February) and prioritization of leverage reduction this year (ET expects to reach its target leverage range of 4.0-4.5x by 2022-end, with a focus on further reducing leverage down to 4x). We see incremental return of capital helping drive significant re-rate off of sector-low valuation.”

To this end, Kad gives ET an Overweight (i.e. Buy) rating to go along with this bullish outlook, and quantifies it with an $18 price target to indicate potential for 42% upside in the year head. (To watch Kad’s track record, click here)

Overall, this stock has picked up 5 recent reviews from the Street’s analysts, and they all in agreement that it’s a buy – making for a unanimous Strong Buy consensus rating. The shares are trading for $12.75 and their $17.20 average price target implies a gain of ~35% by the end of this year. (See ET stock forecast)

Western Midstream Partners (WES)

Next up is Western Midstream Partners, another player in the US energy midstream sector. Western Midstream, as its name suggests, operates in the West – specifically in Texas and the Rocky Mountain regions. The company has assets in Delaware Basin of Texas-New Mexico and the DJ Basin of Colorado, as well as operations in Wyoming, Montana, Nebraska, and Oklahoma. Overall, Western Midstream can boast of 15 pipelines for crude oil and natural gas liquids, and 6 for natural gas; the pipelines total some 15,389 miles altogether. In addition, the company has 23 gathering systems and 72 processing and treating facilities.

In the third quarter of last year – the last quarter for which financial results have been reported – Western Midstream showed top line revenues of $837.6 million. This was a 9.6% increase from the $736.8 million reported in the prior-year quarter. For the first nine months of calendar year 2022, Western’s top line totaled $2.47 billion.

Net income attributable to partners came in at $259.5 million for the quarter (a 3.7% y/y gain), or 67 cents per common share (a 9.8% y/y increase). Cash from operations in the quarter was reported at $468.8 million, a $2 million y/y increase, and included $330.4 million in free cash flow. This was a $42 million y/y decrease in free cash flow.

At the same time, Western Midstream maintained its dividend at 50 cents per common share, or $2 annualized, for the third quarter in a row. The dividend was raised to this level in April of 2022, marking an increase from a pandemic-era pullback. The 50-cent payment went out this past November, and gives a yield of 7.05%. At 3.5x the market average, a full half-point better than inflation, and fully covered by the net income EPS, Western’s dividend is definitely worth a second look for return-conscious investors.

The stock also caught a second look from Morgan Stanley’s Robert Kad, who wrote: “WES has an attractive set of gathering and processing assets, particularly in the Permian Basin, complemented by a high-quality portfolio of equity investments, and distribution and capex/opex reductions support a robust FCF yield… Management has also outlined a financial trajectory through 2025 that — based on current producer activity levels remaining consistent — would generate sufficient excess cash flow to repay all debt maturities and achieve 5% annual distribution growth… We see an attractive set-up for WES going forward given thematic exposure to improving commodity fundamentals and strong FCF generation…”

In Kad’s view, this justifies an Overweight (i.e. Buy) rating on the shares, and a price target which, at $37, implies a 30% one-year upside potential.

All in all, we’re looking at a stock with a unanimous Strong Buy consensus rating based on 4 recent positive analyst reviews. The shares are trading for $28.42 and their $34.50 average price target suggests 21% gain from that level. (See WES stock forecast)

To find good ideas for dividend stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a tool that unites all of TipRanks’ equity insights.

Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.

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