Saturday, November 18, 2017
Stock Market

Ignore Kinder Morgan, Here Are 2 Better High Yield Options to Buy

by Reuben Gregg Brewer

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Kinder Morgan Inc (NYSE: KMI) is a giant in the midstream oil and gas industry, and it just announced plans to increase its dividend from an annual rate of $0.50 a share to $1.25 by 2020. That’s a huge hike, amounting to an average increase of 25% annually. If you are an income investor, you should stop and take notice.

But I don’t think you should buy Kinder Morgan; instead, I’d suggest Enterprise Products Partners LP (NYSE: EPD) or Magellan Midstream Partners, L.P. (NYSE: MMP). Here’s why.

The cutter

The first reason I would avoid Kinder is the company’s 2016 dividend cut. The giant midstream company makes heavy use of leverage compared to peers like Enterprise and Magellan. When oil prices started to tumble in mid-2014 it found it didn’t have the financial flexibility to maintain its dividend and continue spending on its growth plans. The dividend was cut a painful 75%.

To be fair, the cut was probably the right decision for the business. However, it was a tough pill to swallow for investors depending on that income. That’s doubly true since just a month or two earlier Kinder was projecting a 2016 dividend increase of as much as 10%. There’s a trust issue here with management, and I have a hard time looking past it. But that’s not the only reason I prefer Enterprise and Magellan.

Some better options

One of the first things I think investors should consider when looking at Kinder is leverage — that’s what got the company in trouble in the first place. While the midstream giant’s debt to EBITDA ratio has come down since peaking at over 9.5 times in 2016, it’s still high at around 6.5. That compares to Enterprise’s 4.4 and Magellan’s 3.4. In other words, one of Kinder’s core problems is better, but far from solved. Enterprise and Magellan are much better-situated leverage wise.

KMI Financial Debt to EBITDA (TTM) data by YCharts

Then there’s the issue of yield. Kinder Morgan offers investors a yield of around 2.75% today. That pales in comparison to Magellan’s 5.25% and Enterprise’s 6.8%. If you are building an income portfolio today, Kinder just doesn’t stack up.

But what about those dividend hikes between now and 2020? After all of the increases, using Kinder’s current stock price, the yield will be roughly the same as what you would get from Enterprise today. There’s no point waiting, particularly since Enterprise is every bit as large and diversified as Kinder and perhaps more so.

That quick take, however, ignores the distribution growth that’s likely to take place at Enterprise and Magellan. For example, assuming just inflation-matching 3% distribution growth, Enterprise would yield around 7.25% in 2020. Magellan, meanwhile, expects distributions to increase around 8% a year over the next few years. Assuming that growth rate is achieved, its distribution would go from $3.49 at the start of 2017 to $4.39 a share, which would make the yield based on today’s price around 6.4%. Not as high as what you might expect from Kinder, but not far enough behind to dismiss the partnership when you consider that Magellan is the most conservatively financed of this trio.

Comparing the Midstream Players
Name Current Yield Projected 2020 Yield Debt to EBITDA
Kinder Morgan 2.75% 6.9% 6.5
Enterprise Products Partners 6.8% 7.25%  4.4
 Magellan Midstream Partners  5.25%  6.4%  3.4

Which brings up the next big reason to prefer Enterprise and Magellan: commitment to the distribution. While Kinder cut its dividend in 2016, Enterprise and Magellan kept right on increasing. At this point, Enterprise’s annual streak of increases is up to 20 years, and Magellan’s is at 17. It’s also worth noting that both of these midstream partnerships have quarterly increases stretching for over a decade. That’s like getting a raise every quarter.

Sticking to the steady payers

There’s nothing particularly wrong with Kinder Morgan’s assets or ability to operate them. It’s a well-run business, even if it makes heavy use of leverage. But it isn’t a business that has proven capable of reliably rewarding investors with dividend hikes (that’s the downside of leverage here). The current round of proposed hikes doesn’t change that.

That’s why I’d prefer to own Enterprise or Magellan over Kinder. They have higher yields today and long histories of rewarding investors with steady (if relatively slow) distribution growth, and are more conservatively financed. And even after Kinder is done with all of its dividend increases it won’t offer a compellingly higher yield. If you are an income investor, Magellan and Enterprise look like better options.

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