High Growth, High Yield - The Perks To Bet On

Includes: EPD, KMP, TRP
by: Core Equity Research

Stable dividends can be an investor's best friend in times of limited economic growth and the energy sector has been the most stable in providing the dividend stream desired by investors. Within the energy sector, the Oil and Gas Midstream has been outperforming the S&P 500 index over the past few years.

The Oil and Gas Midstream sector is capital intensive and comprised of long term contracts, which safeguards the sector from threat of new competition and from the changes in fuel prices. With the Shale boom and a potential of increase in demand for fossil fuel and also due to increase in economic activity, the prospects of this particular sector are very promising. It is this potential, which has brought my focus to this sector and in this article I will dig deep into Kinder Morgan Energy (KMP), Enterprise Products Partners (EPD) and TransCanada (TRP) and evaluate which one of them is a best buy.

Growth US$ 100 over horizon of 2008-YTD

(Click to enlarge)

Source: Morningstar

Kinder Morgan Energy Partners

Structured as a Master Limited Partnership ((MLP)), the third largest energy company in North America has an established infrastructure and achieved a revenue growth of 7.3% since 2010. Although the current trailing twelve months EPS of the company was negative the company is expected to report an EPS of US$ 2.53 at the end of the current year with an average growth in earnings expected to be 11.8 percent per annum over the next five years.

The company has recently closed the sale of their one-third interest in the Express-Platte Pipeline system. They have also completed an acquisition of a 50 percent interest in El Paso Natural Gas Company L.L.C. and fifty percent of the former El Paso Midstream assets in Utah and South Texas from Kinder Morgan Inc. (NYSE:KMI).

The company has also recently announced that KW Express LLC, a partnership between KMP and Watco Companies L.L.C., has entered into a long term agreement with Mercuria Energy Trading Company Inc., to construct 210,000 bpd crude by rail project at the Greens Port Industrial Park on the Houston Ship Channel.

With these steps in place, combined with the expected increase in Shale Production in the U.S., there will be opportunities for KMP to grow and diversify assets.

Currently Master Limited Partnerships provides a favorable tax treatment to investors, avoiding double taxation of earnings. However with ever increasing demand from politicians to raise revenues and an outright tax hike seemingly unlikely, the most ominous outcome would be the elimination of preferential tax treatment for carried interest. With the treasury reportedly losing US$1.6 billion to MLP's tax breaks and with the rapid expansion of the sector, this number is likely to expand. If such a change occurs in the tax policy it will effect adversely on the MLP sector as a whole.

Enterprise Products Partners LP

Also structured as a MLP, EPD owns and operates thousands of miles of pipelines and other infrastructure assets and has grown aggressively in the past through acquisitions. The company also generates substantial cash flows from operations and thus can continue to boost growth through acquisitions. The partnership has shown superior revenue and earnings growth over the past 3-years and a superior ROE than the industry. A high dividend yield and a stable dividend growth have attracted investors' in this stock.

The company has seen an improvement in its margins over the past three years, and with expectation of growing earnings and a stable leverage, the company's future outlook seem to be positive.

The company recently announced that it has received transportation commitments to support the development of a new 270-mile pipeline header system that will deliver ethane to petrochemical plants in the U.S. Gulf Coast region. The company also recently commenced operations at its expanded export facility, increasing the company's ability to load propane, butane and isobutene. Such steps are bound to bring in greater revenues and efficiency into the company in the future.

As the company is structured as an MLP, the changes in tax policy, as mentioned above, will also affect the value of the company adversely and investors may face some losses if such a change occurs.

TransCanada Corporation

Although TRP has been showing a bullish trend in the past few years beating the general market, it has underperformed when compared to the average industry. The company has higher operating and net margins from the industry, but they have stagnated and have shown little or no improvement over the years. The company's revenues and assets have also stagnated or declined over the past few years and with the current issue regarding Keystone XL pipeline, this trend is likely to persist in the future and the company is expected to grow lower than the industry average.

Faced with limited growth opportunities and steady flow of cash flows from operations, the company has rapidly increased its payout ratio in last three years. The company currently provides a dividend yield of 3.7% and they have increased dividends over the past 3-years at a rate of 13.1% and with limited growth in the future this trend is likely to persist.

Comparative Analysis

Kinder Morgan Energy Partners , Enterprise Products Partners and TransCanada Corporation have been able to continuously outperform the general market since 2008, as represented by the S&P 500 index, but all the companies seem to be overvalued compared to the industry average, with earnings yields lower than the industry average, and price multiples at or above the industry average. However stabilizing/improving revenues, improving margins and high dividend growth and yields may justify the high valuation given to these companies. KMP, TRP and EPD have all maintained a high payout ratio over the past years (in excess of 50%), and with high cash from operations, high expected earnings growth and large cash balances the companies are quite capable of continuing the trend into the future.

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Source: Yahoo Finance


I would give a Buy recommendation on KMP because even though the multiples show that it's an overvalued stock, in my opinion in this particular case multiples are misleading. With negative earnings the P/S for KMP is meaningless and also because P/B ratio does not incorporate the effects of future expected cash flows, I would give a lower weight to this ratio.

Due to the recent divesture and acquisitions, the future earnings for the company will be positive and the expected growth in earnings is 1.8%, 3.7% higher than the average expected industry growth. Also, the company has a strong balance sheet and cash from operations which means that the company is fully equipped to grow on the same lines into the future through acquisitions. Furthermore, the company offers a dividend yield of 5.8%, higher than the industry average, and an average growth in dividends over 3-years of 5.7%; so KMP is expected to provide handsome returns to investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.