Why Dividend Stock Kinder Morgan Is A Buy And 4 Ancillary Stocks to Sell
19 comments | by: Todd Johnson November 1, 2011 | includes: EP, EPB, EPD, KMI, KMP, KMR, MWE
Clearly, KMI will see faster growth in distributions than KMP & KMR ... partially compensated by a lower current yield. I have a good bit in KMR, will probably add KMI in the future.
This article highlights the rationale to own Kinder Morgan, Inc. ( KMI) and sell equities associated with Kinder Morgan. Kinder Morgan's role as General Partner has Incentive Distribution Rights (IDR) which explicitly indicate the shortcomings of not owning Kinder Morgan, the General Partner. Kinder Morgan's incentive distribution rights remove any motive to own Kinder Morgan Energy Partners LP ( KMP). I will opine why other negatively impacted companies are Kinder Morgan Management LLC ( KMR), El Paso Corp. ( EP), and El Paso Pipeline Partners, L.P. ( EPB).
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2011 Kinder Morgan IPO
It has been a busy year for Kinder Morgan, Inc., one of the largest pipeline transportation and energy storage companies in the U.S, and, so far, it has worked out especially well for investors. In February, Kinder Morgan completed its public offering, which actually is a re-IPO after its common stock was originally bought up by private equity firms in 2007. It was the second largest energy deal in recent years, outside of the Conoco IPO completed in 1998. And, as expected, its stock performed well and investors have been rewarded this year with dividend yield of 3.9%. Its stock price has been on a small coaster ride of late, but it has recently closed near its IPO price of $30.
El Paso Acquisition
The second big event for Kinder Morgan was its recent acquisition of El Paso Corporation ( EP) creating the largest midstream and the fourth largest energy company in North America. The combined company will be the largest owner of natural gas pipelines with nearly 70,000 miles transportation pipelines. It is also the largest independent transporter of petroleum products in the U.S. El Paso is also the second largest oil producer in Texas at 50,000 barrels a day. So, at $38 billion, this was no small deal by any measure.
2012 Dividend Yield
As for the acquisition of El Paso, Kinder Morgan expects natural gas to be a core component of energy production in the future. El Paso has a near monopoly on the oily shale production and distribution in the western U.S. which holds an abundant supply of natural gas. Although KMI also acquired a significant amount of debt with the El Paso purchase, it will be unloading many of its less profitable operations and focusing on those that are now generating significant cash flow. KMI has already had a tremendous history of growth and KMP has demonstrated an almost uncommon ability to produce an increasing stream of distributions, both of which are expected to accelerate with the acquisition of El Paso.
KMI management is now forecasting dividend growth of 12% with an expected doubling of its current dividend by 2015. With that kind of growth, investors could also expect significant capital appreciation as well. For high-yield investors, KMI may not be the perfect stock to own. No stock really is, however, it may be the perfect supplement to a high-yield portfolio over the next five years.
2011 Dividend Yield
So what does the re-emergence of KMI as a listed stock and its new dominance of the energy industry mean for yield-seeking investors? Plenty, if you consider its long range prospects for increasing its cash yield from operations and its master limited partnership (MLP), Kinder Morgan Energy Partners ( KMP). For a taste of what’s to come, KMI’s management just announced a 3% dividend increase which brings its yield up to 4.21%.
First, as the general partner of KMP, its highly successful natural gas pipeline company formed as an MLP. Essentially, KMI has increased its stake in KMP and is the largest recipient of its $4.64 dividend yielding 6.1%, which will be distributed to KMI shareholders. KMP has been the chief cash cow for KMI with a solid record. Under this new, more traditional corporate structure, KMP investors who received KMI shares in the IPO will benefit because of the more favorable tax treatment of KMI dividends.
Own Kinder Morgan
Kinder Morgan had its initial public offering (IPO) this year. I address this offering in the article, " Kinder Morgan, Inc.: The Positives and the Negatives". This is the security to buy as it holds financial incentives far outweighing the benefits of Kinder Morgan Energy Partners LP, Kinder Morgan Management LLC, El Paso Corp., and El Paso Pipeline Partners, L.P.
Kinder Morgan operates in the best interests of Kinder Morgan. This operation comes at the expense of associated parties. As discussed in a September 21st investor presentation, page 22, KMI receives a disproportionate amount of distribution income:
Kinder Morgan Energy Partners LP
Kinder Morgan Energy Partners LP is the nation’s largest pipeline master limited partnership. The partnership is suffering due to the high level of Incentive Distribution Rights paid to General Partner Kinder Morgan. The below table highlights the extent in which Kinder Morgan Energy Partners LP is paying Kinder Morgan 45% of its distributions.
This high payout to the General Partner has caused the following problems:
- Kinder Morgan Energy Partners LP is having problems paying its quarterly distributions. The General Partner is extracting 45% at current levels.
- Kinder Morgan Energy Partners LP has a higher cost of equity capital. Companies, without General Partner Incentive Distribution Rights, can operate increasingly more efficient.
Kinder Morgan Management LLC
Kinder Morgan Management LLC shares are legally pari passu with KMP shares. KMP receives distributions in cash. KMR receives distributions in the form of KMR shares.
I believe Kinder Morgan will, upon acquisition completion, engulf El Paso Corp. and El Paso Pipeline Partners, L.P. assets in a business-as-usual manner. This opinion is based upon Kinder Morgan's actions with other non General Partner financial interests. The bottom line is -- own Kinder Morgan shares.
Selected Pipeline and Terminal Cost Structures
This chart shows Kinder Morgan's extraction of Kinder Morgan Energy Partners' current distributions. KMI, as the General Partner, is receiving 45% of KMP's distribution income. This reference can be found on an Enterprise Products Partners LP presentation, page 8:
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Enterprise Products Partners LP
Enterprise Products Partners is an integrated provider of natural gas and natural gas liquids processing, fractionation, and storage services transportation. The company has zero General Partner fees. This allows the company to have a lower cost of equity capital. Dividends have increased for the past 28 quarters.
Markwest Energy Partners ( MWE)
Markwest Energy Partners is engaged in the gathering, processing and transportation of natural gas; the transportation, fractionation, storage and marketing of natural gas liquids; and the gathering and transportation of crude oil. The enterprise also benefits by the lack of General Partner Incentive Distribution Rights. The equity offers a 5.8% dividend yield. Markwest is recognized as a growing and efficiently run enterprise focused upon shareholder returns.
Summary
I recommend that investors consider buying Kinder Morgan. My opinion is to avoid the affiliated Kinder Morgan Partnership equities. The Kinder Morgan General Partner legal structure provides incentives to benefit the General Partner. My advice is to avoid Kinder Morgan Management LLC, El Paso Corp., and El Paso Pipeline Partners, L.P., and Kinder Morgan Energy Partners LP.
Disclosure: I am long KMI, MWE, EPD.
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 Bruce, awesome info. Thanks for sharing. I agree. You hit the issues head on.
KMP has 2 of past 4 quarters where the GP IDR was so excessive to mitigate any KMP growth. KMP was to the point (prior to EP) where dividends would have to stop growing; or KMI would need to reduce IDR take.
Thanks for the comments. Good stuff.
Todd
1 Nov, 09:28 AM! Report Abuse1
kwm3 Comments (477)
good point: KMI can, and will, reduce its IDRs as necessary, so watch out. There were many Form 4s filed a few months ago reflecting large open market purchases of KMR--something that's worthile to note.
1 Nov, 11:35 AM! Report Abuse3
Todd Johnson Comments (2469)
Kwm3 - excellent point. I agree with you. I believe KMI's recent IPO may put some type of covenant on selling the IDR's -- but in time the IDR's will be removed if KMI is expected to compete against other entities with zero IDR's. Investors are not stupid.
1 Nov, 11:59 AM! Report Abuse1
Would have been better if the financial comparison chart had used DCF (distributable cash flow) instead of EPS. EPS not a very good metric for comparing MLPs. That said, the MLPs without GPs have a significantly lower cost of capital, while the others (especially Kinder) has a higher cost. Would it not make sense that ALL the Kinder family would have slower growth than those that have lower costs? Would not the high cost of capital slow growth in KMP/KMR et. al. and thus slow the growth in KMI even if it is leveraged?
1 Nov, 10:44 AM! Report Abuse3
Todd Johnson Comments (2469)
Todd Johnson
I invest in stocks to earn, as a goal - not as a promise, positive absolute returns. I buy stocks, MLPs, closed end funds, options, inverse funds, special situation stocks, spin offs, bonds, metals, oil. My methods are nothing fancy. The only investing aspect that matters is risk-tolerance and... More
arbtrdr - very, very true on a graph with d-cash flow.
Your conclusion is accurate. I believe, however, Kinder Morgan owns the premium pipeline assets in the country. I could ignore Kinder Morgan entirely but I still want exposure to the assets.
In time, I truly believe the IDR's will be bought back & KMI will operate like EPD. Richard Kinder, GS will benefit - in the IDR buyback -- but in time it only makes sense.
1 Nov, 11:57 AM! Report Abuse1
Benzz Comments (30)
Todd, I agree with you 100% but perhaps for a different reason. It was said above that "kinder morgan is for kinder morgan". I would modify that slightly to say that "kinder morgan is for Richard Kinder". His treatment of the EPB unitholders shows that KMI is the only safe place to be.
1 Nov, 11:30 AM! Report Abuse2
Todd Johnson bennzz - excellent point.
1 Nov, 11:54 AM! Report Abuse0
HaroldL Comments (14)
"I believe that Kinder Morgan will, upon acquisition completion, engulf El Paso Corp. and El Paso Pipeline Partners, L.P. assets in a business-as-usual manner."
Can anyone say what it would mean in this case to "engulf" EP and EPB? Its no suprise that EP will no longer trade as a stock, so being engulfed is a given for that company. Now what would happen to EPB? Would KMI really have the incentive to harm the value of EPB's limited partner units? It will own 42% of them if it does no more EPB unit offerings.
1 Nov, 12:05 PM! Report Abuse0
Todd Johnson Comments (2469)
HaroldL,
The KMI GP IDR fee structure will leech income on associated parties. An acquisition, or a GP IDR change, or a KMP dividend cut or 'zero increase' in distribution, were the only options. KMP wasn't quarter by quarter (2 of 4 if memory serves) earning adequate income for distributions - due to IDR.
EP & EPB will be impacted to the extent KMI can make money. the outcome is either negative or at best neutral (for EP/EPB). KMI's involvement can't be to EPB's benefit.
Todd..great column. I was on the fence with KMI..(always looking for higher dividends, distributions) but I think this is a wise move. Never thought I'd look "down" on 4%+.
1 Nov, 01:41 PM! Report Abuse1
Todd Johnson Comments (2469)
Hi jg. Thanks for the feedback. It helps make writing worthwhile. ;)
I own higher yielding names, but KMI is where the lion's share of gains will come from in the future. Share holders will not tolerate - for the long term - KMI's excessive IDR fees. The direction clearly if for fewer GP IDR entities and more EDP's of the world.
I've owned KMP (or KMR) for over 5 years and seen frequent negative references to Rich Kinder's attitude toward unit holders and/or GP KMI's excessive IDR fees, and more recently, the unsustainability of the distribution. I've also owned EPD over that period of time and seen generally positive analyst comment on its management, financial structure, distribution coverage and reasonably benevolent attitude toward unit holders. Past performance is certainly no guarantee of future etc..., but looking back at a 5 year chart, both KMP and EPD have similar share appreciation – about 60% over that period – until KMP reached about 70% after announcing plans to purchase EP. Don't know what this new twist will add, but the market has not been making the value distinctions between the two that critical analysis would indicate is justified.
navigate
1 Nov, 02:54 PM! Report Abuse0
Todd Johnson Hi navigate, SEC filings, and sell-side analysts have made the distinction. KMP is not earning its dividends. It may not be priced in today, but it's unsustainable & obvious. It's embarrassing because Rich Kinder is successful and wealthy. To charge the fees he is - at the present time is outrageous.
Just my opinions & thoughts based upon buy side research amigos, and SEC filings.
Zacks, valueline can all confirm the KMP distribution issues as well.
Todd
1 Nov, 06:13 PM! Report Abuse0 |
