How are your finances keeping up? Inflation has eased, but many Canadian households still worry about their upcoming mortgage renewal, which could significantly increase their monthly payments. Your household finances pretty much depict the scenario of the economy and stock market. Are you cutting down unnecessary expenses to save up for the loan repayment? Are you stressed about your high energy bills and have decided to reduce travel?
Where do energy stocks stand today?
Do you see where we are heading? In the second quarter, Canada’s real GDP contracted due to a slowdown in household spending, declines in house sales, smaller inventory accumulation, and slower exports. The Israel war has once again shaken the oil supply chain. Remember what happened during the Russia-Ukraine war? Oil stocks made their multi-year high in July 2022 and fell steeply after the interest rate hike pulled down demand.
This time, the Western world is already at its 16-year high interest rate. Another oil price hike is too much to take for an average household already stressed with expensive mortgages. Oil stocks may not replicate the 2022 rally as they have reached their cyclical peak. Oil stocks are cyclical because the oil price cannot go beyond a certain point. If it goes beyond a point, that will cripple its demand and reduce oil prices.
Hence, you see stocks like Suncor Energy (TSX:SU) and Crescent Point Energy unable to reach their July 2022 peak. Why is that so? For this, you need to understand that the oil price is not something these companies determine. It is determined by demand and supply forces. While there is no supply crunch in North America, you are feeling the heat of rising fuel prices as global oil prices have surged.
Why you might want to sell those energy stocks soon?
Suncor produces a barrel of oil at an average cost of $27–$30, which is way above Saudi Arabia’s and Russia’s below US$15. As Suncor doesn’t have a cost advantage, its profits can only grow to a certain point. And Suncor distributes a portion of these profits as dividends to shareholders. Moreover, it is not developing new oil fields due to environmental concerns.
As the energy industry transitions to cleaner sources, the International Energy Agency believes oil could see its lifetime peak this decade. It is not just a cyclical trend but a structural shift in demand that will have a long-lasting impact. With not much scope for growth, selling energy stocks while they are still trading at their peak makes more investment sense.
Instead, buy this stock for the next market cycle
With the macro indicators showing signs of a recession, the current cyclical uptrend could end as early as 2023. Next year could wipe out your cyclical energy gains. It is time to book profits in oil stocks and buy this income stock at its low.
Some passive income stocks sustain all market cycles, and Telus Corporation (TSX:T) is among them. The company has invested heavily in building 5G infrastructure and restructuring its business. The accelerated capital spending increased its net debt faster than its earnings before interest, taxes, depreciation, and amortization (EBITDA). The EBITDA took a hit due to restructuring. Moreover, its free cash flow growth slowed due to higher interest payments.
All this increased its second-quarter dividend payout ratio to 87%, way beyond its targeted 60–75% range. However, this ratio falls to 70% when adjusted for accelerated capital expenditures. Telus has adequate liquidity and free cash flow to fund its dividend payment even in a recession. In the worst-case scenario, it might slow its dividend growth rate below 7% and pause its capex until the economy recovers.
The falling profit margins pulled Telus stock to its pandemic low of $22. The worst seems to be over for Telus. Now is the time to buy the stock and lock in a 6.6% yield. You can invest small amounts and keep accumulating more shares of Telus throughout the market downturn. You can also opt for a dividend reinvestment plan (DRIP) and compound your future passive income.
