Investors in the energy infrastructure space are often faced with a tough decision when making investment choices: invest in a high-yielding MLP or its general partner owner-operator. Whether we are talking about Linn Energy (LINE) and Linn Co. (LNCO), CVR Refining (CVRR) and CVR Energy (CVI), Kinder Morgan Inc (KMI) and Kinder Morgan Energy Partners LP (KMP), or any number of other MLP-GP firm pairs, this question is a relevant one for investors. This article details the choice between industry old-timer and heavy-weight KMP and its new general partner KMI.
It is important to realize that while both stocks appear to be reasonable values at current levels, and both pay very nice dividends, both companies are likely to face headwinds from Fed tapering over the next year as many investors shift out of dividend paying stocks and into cyclical growth-oriented names. For current commentary and analysis of Fed tapering, see the article here, and for alternative income investments that look attractive at these levels, see the article here.
KMI owns the general partner and limited partner units in KMP as well as a 20% equity stake in the interstate natural gas pipeline company (NGPL). Furthermore, in 2012 KMI acquired El Paso Corp., which is the general partner for El Paso Energy Partners (EPB). This move solidified KMI's position as the leading natural gas pipeline company in North America, and gives it a roughly 42% stake in EPB through its ownership of El Paso. These combined ownership interests give large-cap KMI a broad set of energy infrastructure assets, stable cash flow, highly visible growth prospects, and an attractive dividend yield.
In general, KMI benefits whenever KMP raises its dividend or when the partnership issues equity, which will finance future growth. Given KMI's ownership structure and stock price history, the firm should grow at about 1.5x the rate of KMP. In addition, KMI is a standard corporate entity (C corporation) and as such it is attractive to institutional investors who are restricted from buying MLPs, as well as individual investors who simply may not want the hassle of dealing with K-1 tax forms.
Given all of KMI's assets and the likely ongoing growth of natural gas as a primary hydrocarbon in the U.S., the stock looks attractive. It sports a solid ~4.1% yield and has been consistently raising its dividend over time. Given the growth rates in KMI's partnership holdings, the firm should be in a position to see dividend increases of 5%-10% annually going forward. The chart below illustrates this.
Kinder Morgan Energy Partners owns substantial pipeline and storage assets throughout the United States and in recent years the firm has been on an acquisition spree. KMP has acquired significant interests or controlling stakes in Tennessee Gas Pipeline, Tallgrass Energy Partners, Trailblazer pipeline, Rockies Express Pipeline, and, most recently, Coprano Energy. In conjunction with these acquisitions, the firm has gone from trading at roughly $60/share in January 2010 to nearly $90/share today.
In contrast to its general partner parent, KMP is a master limited partnership (MLP). This means that the company pays out nearly all of its earnings to investors, resulting in a superb ~6.1% dividend. In addition, investors have to deal with the more complex K-1s for tax purposes rather than simpler dividend tax documents. Part of the reason for this is that MLPs have significant potential tax advantages that are reported on K-1s, but it also means that investors should probably retain a good accountant at tax time.
Analysts and firm management currently expect that KMP will be able to grow its dividend at a 5%-6% annual rate going forward. However, because the firm pays out most of its cash to investors, its ability to grow in the future is limited compared with a corporation that could retain more of its cash. Perhaps because of this, or due to concerns over Fed tapering, analysts are surprisingly sanguine about the stock's prospects with 13 of 19 analysts covering the stock rating it a "hold," while six rate it a "buy."
While the dividend yields may not indicate it, in many respects KMP is a more conservative investment than KMI. KMP tends to be less volatile than KMI, and KMP generates cash directly from its investments while KMP depends on the distributions it receives for all of its value. Put differently, were KMP to suddenly cease operations and stop making dividend payments, shareholders in KMP would have a direct claim to firm assets (after debt holders, of course), while KMI shareholders only have an indirect claim through that firm's ownership stake in KMP.
The price chart below compares KMP vs. KMI over the last few years. Here KMP is represented by the blue line, while KMI is in green. Consistent with KMI being a riskier firm, it has been more volatile than KMP since its IPO in early 2011.
Click to enlarge image.
In conclusion, while KMP and KMI are both solid investments paying high dividend yields, investors looking for safe consistent income should look at KMP. Investors who are looking for income, but with greater capital appreciation and future dividend growth opportunities should look at KMI. This general rule of thumb, buy income through MLPs and appreciation through the GPs, is a good starting point. But, of course, it is always important to analyze any given GP/MLP pair carefully as the situations do vary in many cases.
For more on picking effective income investments, see the article here.