Morgan Stanley recommends buying these two high-yielding dividend stocks — including one with an 11% yield

Markets move in cycles, experiencing ups and downs influenced by various conditions ranging from inflation rates to consumer sentiment. The key to successful investing is tracking these changes, avoiding black swans, and building a portfolio that can consistently generate returns. With their steady stream of passive income, dividend stocks are a useful addition to such an investment strategy.

Morgan Stanley's outlook calls for a recession this year, making dividend stocks more attractive than ever. They are a classic defensive play that ensures a return even when markets are falling. That downtrend seems more likely, according to Morgan Stanley strategist Mike Wilson.

“If this new inflation regime reflects the post-WWII era, it will be volatile with significant cyclical ups and downs that should be dealt with if one is to take full advantage of excess returns in this new regime.” In short, the boom /Bust phase that began in 2020 is currently at the bottom of the earnings cycle – a momentum that we believe is not yet priced in,” said Wilson.

With that in mind, Morgan Stanley analysts have identified two dividend payers with impressive yields of up to 11% that could potentially provide a solid source of passive income for investors. Let's take a closer look.

Equitrans Midstream (ETRN)

We start with Equitrans, an energy company that operates in the midstream segment. This segment is an important part of the energy industry as midstream companies are responsible for transporting hydrocarbon products from wells to storage facilities, refineries and distribution points. Equitrans, which spun off from EQT in 2018, is one of the largest natural gas gathering companies in North America. The Company's network includes natural gas collection and transmission facilities and water transportation pipelines in the Appalachian gas reserves, particularly in the region where Pennsylvania, West Virginia and Ohio meet.

In number, Equitrans operates more than 1,180 miles of high pressure headers, 950 miles of interstate transmission lines and 200 miles of water lines; In total, Equitrans has 4.4 billion cubic feet of natural gas transmission capacity.

The company received a dose of good news earlier this month when the debt ceiling bill was signed into law. The final draft of the bill included permitting and federal funding for Equitrans' Mountain Valley Pipeline (MVP) project. This pipeline is scheduled to be completed by the end of the year. The total cost is $6.6 billion.

In the company's Q1 2023 results released last month, Equitrans reported revenue of $376.34 million. That was a 10% increase year over year and topped expectations at $15.6 million. Bottom line, the company reported non-GAAP earnings per share of 22 cents, overall results that compared favorably to EPS of 14 cents in the year-ago quarter and 10 cents per share above guidance.

What's interesting for dividend investors is that Equitrans has managed to generate cash. The company's cash flow from operations was $224.7 million, up from $185.9 million in the first quarter of 22, and free cash flow of $94.2 million increased from the same quarter last year 300% from $23.5 million in the same quarter last year. The strong cash flows support the company's dividend payments.

Equitrans paid its last declared dividend on May 15th. This payment was made at 15 cents per common share, or 60 cents annualized. The annual interest yields a return of 6.3%.

5-star analyst Devin McDermott, who covers this stock for Morgan Stanley, sees a lot of potential for investors to take advantage of.

“ETRN continues to trade below its fair value in our view. Fair value realization is likely to depend on (1) the completion of the project to fully address investor risk concerns, (2) progress on deleveraging and communication of capital allocation priorities by management, and (3) formulation of a strategy and drivers for creation of shareholder value following an extended period of focus on MVP outcomes,” McDermott wrote.

McDermott adds an Overweight (ie, Buy) rating to his comment and completes his stance with a price target of $14, expressing confidence in ~49% upside potential over the next 12 months. The stock has a potential total return profile of ~55% based on its current dividend yield and expected share price increase. (To view McDermott's track record, click here)

While McDermott takes the bullish view, Wall Street is somewhat divided on the stock, as revealed by the nine most recent analyst ratings. These break down into 3 buy, 5 hold and 1 sell, resulting in a consensus rating of hold. ETRN's shares trade at $9.42, and its average price target of $9.66 suggests a 2.55% nominal gain over the year. (See ETRN Stock Forecast)

Petroleo Brasileiro (PBR)

For the second high-yield dividend stock, we turn our attention south of the border — down to Brazil, the largest country in South America and home to Petróleo Brasileiro, or Petrobras, one of the world's largest oil majors. Petrobras started out as a state-owned company, and today the Brazilian government still owns just over 50% of the company's publicly traded shares.

If we look at some raw numbers, we find that Petrobras has more than 5,000 oil and gas production wells and proven hydrocarbon reserves of 9.878 billion oil equivalent barrels and that the company's daily production rate is approximately 2.77 million oil equivalent barrels per day. In addition to producing oil and gas, Petrobras also operates 12 refineries with a production of more than 1.85 million barrels per day of oil products.

Petrobras has a strong position in both midstream and production. The company controls more than 7,700 kilometers of oil pipelines and another 9,100 kilometers of natural gas pipelines. In addition, the company owns or charters over 120 tankers.

All of this makes Petrobras one of the world's leading oil companies. In US currency terms, Petrobras generated total revenues of $26.77 billion in the first quarter of 23, resulting in gross profit of $14.11 billion. Those numbers represented declines of 1.5% and 2.5%, respectively, year over year, with revenue numbers falling $1.08 billion short of guidance. Bottom line, Petrobras reported GAAP EPS of $1.12, beating expectations by 23 cents.

The company saw a slight year-over-year increase in net cash flow from operations, which rose to $10.35 billion from $10.31 billion. Free cash flow fell a tenth of a percent year over year to $7.92 billion.

As a dividend, Petrobras currently pays out about 38.16 cents per American Depositary Share quarterly. This works out to be just under $1.53 per ADS on an annualized basis and a yield of 11.55%.

Morgan Stanley's Bruno Montanari sees great potential for this company to add to that return, stating, “So far, policy changes have been far less disruptive than initially anticipated, and lower oil prices and a stronger BRL have contributed to the stock's defensive nature.” . Our new estimates, using lower oil prices from the current futures curve, see PBR still generating $23 billion in FCF in 2023, a 30% return. And our new dividend expectation of 40% of FCF (before interest) generates a compelling 16% yield.”

To that end, Montanari has an Overweight (ie, Buy) rating on Petroleo stock and its price target of $16.50 implies a potential one-year upside of 25% in the coming year. (To view Montanari's track record, click here)

Now turning to the rest of the road where this stock receives a consensus Moderate Buy rating based on another 2 Buy and 3 Hold. Shares are selling for $13.15 and the median price target of $13.94 suggests a 6% one-year gain. (See Petrobras Stock Forecast)

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

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