Extracting Solid Income From the 'New Oil' Names

 | Sep 18, 2013 | 12:00 PM EDT
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There are some big changes sweeping oil-and-gas right now. National oil companies and supermajors are shifting production into deepwater. All over the U.S., technology has finally opened up the shale "source rock," bringing old oilfields back to life and creating new ones.

While most players in these two spaces need all the capital they can get their hands on, there are some players that pay you to own them. This article will focus on three of my favorite income-bearing names in "new oil."

Of all the shales in the U.S., the Marcellus is the most prolific -- though note that it produces only natural gas. MarkWest Energy Partners (MWE) is the dominant midstream player here. The company is taking advantage of production growth in the Marcellus, and in the neighboring liquids-rich Utica, by nearly doubling its already vast gas-processing capacity by 2014. The partnership is also working with Kinder Morgan (KMP) to pipe Marcellus natural gas liquids down to the Gulf Coast refining complex. Markwest is building at full speed, and it expects distributions to eventually follow. Its current dividend yield is 5%, and the stock trades at 18.8x distributable cash flow.

Proppant sand is an important component in unconventional shale drilling. Without it, producers would be unable to force oil and gas out of the source rock. Hi-Crush (HCLP) is a new partnership in this field, mining and delivering "Northern White" rock used for proppant. The stock yields at a sustainable 7.6%, as well. Yes, Hi-Crush is a master limited partnership, but it has valid GAAP earnings.

Hi-Crush's balance sheet is clean, as well, with minimal debt (it raises capital through equity offerings). Management expects double-digit distribution growth in 2014. As sand use per well grows, earnings will be propelled forward over the long run. Hi-Crush will reward its unitholders with a high and growing yield -- and the stock is cheap at 8.35x earnings.

It's not just the shale, either. Oil activity is increasingly going offshore. Profitable deepwater drilling requires high oil prices, generally above $90 per barrel, so this is something of a wager. Those who are comfortable with this and want income should go with Seadrill (SDRL), which owns, operates and leases offshore rigs.

Seadrill's fleet is big, with 59 ships in total and an additional six under construction. All of the new ones are deepwater or ultra deepwater. Seadrill views the long-term contract and high cash flow visibility of this field as reason to pay a high dividend. Yes, the company's debt is growing, but that's only to build all those new ships that the world will need. Seadrill is at a very reasonable 10x earnings. It is a secular growth story, but does rely on high oil prices.

All three of these names are part of the "new oil" landscape, and therefore they have plenty of growth ahead. Hi-Crush and MarkWest are in the lower-cost shale space, so they are insulated from a big price drop. MarkWest has the least risk, but its yield is a bit low. Hi-Crush is cheap, growing and has a high yield, but dilutes its unitholders. Seadrill is cheap, pays a great yield and hasn't offered equity in a while. However, deepwater drilling requires more capital, so oil prices must remain high for Seadrill to be worthwhile.

While there are pros and cons for each name, all three should grow nicely and provide good income at current levels.

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