- Kinder Morgan is concentrated in the energy midstream space whereas Berkshire has diversified operations, spanning a number of industries
- Berkshire retains all earnings for reinvestment whereas KMI pays all its cash flows out as dividends
- Berkshire is a favorite of long-term, value investors whereas Kinder Morgan is a favorite of dividend growth investors
Although most people won't look far past these superficial differences, those who dig deeper can start to see how similar both companies are. Both Kinder Morgan, Inc. and Berkshire Hathaway share a number of traits which are generally associated with market outperformance.
Portfolio of Competitively Advantaged Companies
Warren Buffett once described the type of business he prefers buying as being tollbooth-like, where the company has a natural monopoly and the ability to extract economic rent through this monopoly. Over the years Buffett has acquired a number of companies exemplifying this property: utilities, railroads and even pipelines.
Kinder Morgan has done the same. The company has grown its network of natural gas, petroleum products and carbon dioxide pipelines into the largest in the U.S., as well as being the largest terminal operator for both liquids and solids such as coal, coke and steel. These are classic tollbooth companies as building new pipelines requires extensive regulatory approval, and it is often easier for an existing pipeline to expand its capacity, both from a monetary and governmental approval standpoint. Also, a majority of interstate pipeline revenues are from capacity reservation, meaning there is little variability to its cash flows from year to year.
After its 2012, $38 billion acquisition of El Paso (EPB), Kinder Morgan, Inc. owns both the general partner interest in El Paso and Kinder Morgan Partnership LP (KMP), as well as owning limited partner interests in both of these companies and Kinder Morgan Management (KMR) (whose only purpose is to own KMP units and reinvest the dividends in new units). Each of these companies earns high returns on invested capital, and their large asset footprint means they have many opportunities to grow internally, by connecting points on their existing network.
Leveraged Play on Low Risk Equities
Most people look at Berkshire Hathaway's impressive growth over the years and put almost all of this outperformance on the shoulders of Buffett's investing acumen. Although Buffett is undoubtedly a skilled capital allocator, there are people who attribute the majority of this outperformance over time to both the use of leverage and the "low volatility anomaly" (Read this article for an in depth discussion).
Buffett uses leverage by purchasing investments with the float from his insurance operations, where he has the time between collecting premiums and paying this money out on claims to invest in equities, entire businesses or other securities. Kinder Morgan, Inc and other general partners have a different form of leverage through their Incentive Distribution Rights (IDRs). These IDRs allow them to collect an increasing portion of the cash flows paid to the limited partners, incentivizing them to increase distributions at a faster rate. This gives these GPs the ability to leverage the returns of their LPs without the risks inherent in buying stock on borrowed money (such as default, margin or volatility risk).
With KMI owning 2 IDRs they are at different points in the IDR schedule with each, as GPs earn as low as 2% of cash flows early on and up to 50% later, after meeting far out distribution targets. With KMP, KMI earns close to half of the total distribution paid out because they have been able to grow KMP's distribution considerably over the years (and a large portion of the distribution is given out at a 50% rate to the GP), and KMP's current LP distribution at $1.35 per quarter. With EPB, KMI has a far longer runway for growth with EPB shareholders only earning $.65 per quarter dividends, giving KMI only 25% of the total cash flow for its IDR.
The graph above shows how these IDR cash flows grow over time for KMI as they are able to increase their limited partners' distributions. This helps give KMI a faster dividend growth rate than either of their LPs. KMI's IDR will grow 16.5% faster than the LP distribution for KMP (a 6% growth in KMP's distribution grows KMI's payment by roughly 7%). This effect is far more prominent for EPB. KMI's IDR will grow 135% more than EPB's distribution (a 6% growth in KMP's distribution grows KMI's payment by over 14%). KMI also owns shares in each company, and a number of assets it plans on dropping down to its LPs with a fair amount of debt offsetting these assets, adding to its level of leverage.
Another important factor is the "low volatility anomaly" whereby lower volatility stocks tend to outperform over time. Buffett's stocks had a beta of .77 between 1980 and 2011, helping him benefit from this effect and making it easier for him to utilize leverage. KMI should also gain from this anomaly, as KMP and EPB have a beta of .47 and .23 respectively, possibly increasing KMI's returns and lowering its own beta.
High Level of Insider Ownership
Both Kinder Morgan, Inc and Berkshire Hathaway have large insider ownership, especially by their CEOs, Warren Buffett and Richard Kinder. Both Buffett and Kinder built these large companies from the ground up, amassing a large amount of personal wealth, rising to become the 2nd and 39th richest Americans.
Warren Buffett and Richard Kinder own roughly 26% of Berkshire Hathaway and 24% of KMI, respectively, helping to make sure they have the best interests of shareholders in mind. There is a healthy amount of research showing that high insider ownership often results in higher returns through this better alignment of interests.
Buffett has had a large number of high profile acquisitions over the years, with a number of notable recent purchases including the acquisition of Burlington Northern Santa Fe and purchasing a portion of Heinz along with 3G Capital.
Kinder Morgan has also pursued a number of opportunistic acquisitions over recent years. Their recent, major acquisition of El Paso made them the largest midstream company and has helped expand their internal growth opportunities significantly.
KMP has expanded through $22 billion in acquisitions and $18 billion in greenfield expansions over its 17 year history. Its recent $5 billion purchase of Copano shows management is not resting on its laurels and is looking to continue adding value with tuck-in acquisitions. Between EPB and KMP, Kinder Morgan has plenty of opportunity to pursue internal growth or acquisitions which should add shareholder value going forward.
Berkshire Hathaway and Kinder Morgan should both perform well going forward, due to a number of the structural reasons discussed above. I would recommend adding either one to a balanced, long term portfolio, with KMI being a better choice for investors seeking current or future income.