Investors looking for steady income and a touch of capital appreciation have been turning to energy master limited partnerships, or MLPs, the past couple of years. One of my favorites is the largest pipeline operator in the world, Kinder Morgan Management (KMR). Here’s a quick look at what makes it tick.
KMR owns or operates approximately 37,000 miles of pipelines and 180 terminals in North America. The company expands, builds, and acquires assets that bring oil, natural gas, and CO2 from producers to consumers.
The uses of oil and natural gas for transportation and heating are obvious, but the demand for CO2 may be surprising. Carbon dioxide is a pressurizing agent used in oil drilling, a solvent to remove caffeine from coffee, a preservative for carbonated soda, and a coolant in its solid form, dry ice.
Kinder Morgan was founded in Houston, Texas in 1997 with an initial enterprise value of $325 million. Now the company is worth $30 billion. It operates with a great deal of transparency as it claims to be the only S&P 500 company to publish its annual budget.
Like recently profiled Enterprise GP Holdings (EPE) which gained 10% for Strategic Advantage subscribers in June, KMR is organized as a master limited partnership to help investors obtain the tax benefits of a limited partnership with the liquidity of a publicly traded security. MLP structures nearly eliminate federal and state taxes, allowing the company to pass a majority of its cash flow directly to investors in the form of dividends. Think of them as REITs that own pipelines instead of buildings.
Unlike large oil and gas exploration companies that are dependent on the price of commodities, Kinder Morgan benefits from rising global demand for energy through its role in the transportation of fuels. The company has minimal exposure to oil and gas price volatility because KMR does not typically own the energy products that it transports and stores.
Its refining and distribution businesses thrive when demand and prices are high. But when supply exceeds demand, KMR earns sizable storage fees. Most recently, natural gas prices tumbled 70% in 2009 but no major MLPs missed a dividend payment.
KMR’s dividend distributions increased 2.9% in 2009 and are forecasted to increase 4.76% in 2010. The firm has increased its quarterly payout 35 times over its 13 year history.
In the chart above, you can see that investors are flocking to the safety and stability of the firm. It’s up 13.2% vs. -1.8% for the S&P.
Natural gas currently supplies 25% of total American energy consumption, and projections indicate that the United States may harbor enough shale natural gas to power the country for more than 100 years. Tremendous advances in the extraction process have made it economical to drill in shale rock despite low natural gas prices. KMR invested heavily in natural gas pipelines in 2008 and 2009 and should see cash flow increase significantly in 2010.
Kinder Morgan has a big presence in Canada as the owner or operator of the Cochin, Trans Mountain, and Puget Sound pipelines. Since Canada is the largest supplier of crude and refined oil imports to the United States (13% of total U.S. consumption), KMR’s Canadian presence will drive growth.
One potential risk facing KMR is government regulation of CO2 emissions. Some proposals include flat taxes on energy consumers or a cap and trade system. Transport and storage firms such as KMR are neither producers nor consumers of energy and may be able to avoid the brunt of the tax.
KMR is the holding company for Kinder Morgan Energy Partners (KMP). Mathematically, KMR should trade exactly like KMP as one share of KMR gives its owners the same distribution rights as one KMP unit. The only difference is the KMP holders receive a 6% cash dividend while KMR owners receive additional shares. Think of KMR as KMP with a built-in dividend reinvestment plan.
Analysts expect KMR to earn $1.96 in 2011 pricing the company at 30x forward earnings. The company has consistent cash flow, growth potential, and a 6.8% reinvested dividend that have led investors to value the MLP at very high earnings multiples. In a low interest rate environment with few stable alternatives, look for KMR to trade up to $71 over the next year, or 19% upside. It’s a buy on dips if you don’t own it. If you do, keep holding.
For more ideas, check out my Trader’s Advantage and Strategic Advantage newsletters.
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