It's one of my favorite times of the month: converting the combined power of fresh capital and reinvestment of dividends into equity in a high quality company. While cash is guaranteed to lose value over the long haul, equity in great companies will usually compound at attractive rates when averaged over long periods of time. I consistently choose to place my bets on equity.
December is shaping up to be a relatively light month for me in terms of these conversions due to my aforementioned participation in the Mother of All Car Deals. However, that doesn't mean my mantra goes by the wayside. Quite the contrary, I'm even more motivated to squeeze every ounce of efficiency out of my now limited capital. So what you see here is my attempt to do just that. While this purchase was a bit smaller than most I tend to make, I still wanted to put some of my capital to work in what I thought was an attractive opportunity.
I purchased 30 shares of Kinder Morgan Inc. (NYSE:KMI) on 12/11/13 for $32.71 per share. KMI owns and manages a diverse set of energy transportation and storage assets. Through subsidiaries, they own and operate pipelines that transport natural gas, gasoline, crude oil, carbon dioxide and other products. KMI operates as the General Partner (GP) within the Kinder Morgan master limited partnership. They own both the Incentive Distribution Rights (IDRs) of the partnership, which allows the company an increasing share of the cash flow that can be distributed to partners, as well as a significant portion of the limited partner units of Kinder Morgan Energy Partners, L.P. (NYSE:KMP), Kinder Morgan Management (NYSE:KMR) and El Paso Pipeline Partners, L.P. (NYSE:EPB).
This is now my fourth purchase of shares in KMI, and I now own a total of 180 shares in this company. While I wasn't actually planning on adding to my position right now due to not only the fact that it's already a large position for me, but also the complicated nature of the partnership structure and the debt load within, KMI is trading below my cost basis by a healthy margin and I wanted to average down here.
Some people may not be aware of this, but Kinder Morgan is actually the third largest energy company in North America--a pretty interesting fact. Furthermore, they're actually the largest midstream energy company on the continent. They own an interest in or operate 75,000 miles of pipelines 180 terminals. There are some companies out there with a lot of equity in patents, services, intellectual property or brand names, but Kinder Morgan owns actual pipelines that are necessary to connect supplies to demand. And they're the biggest in the biz. While operating an asset-heavy business means high capital expenditures, it also means there is a fairly high barrier to entry as you can't just go out and build thousands of miles of pipelines tomorrow.
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|Can't build it overnight|
Investing in Kinder Morgan is a bit of a bet on natural gas. While the Kinder Morgan partnership is mostly insulated from the pricing swings of the underlying commodity, an increase in usage of natural gas over the long haul bodes very well for this company. There appears to be a fundamental shift from coal to natural gas here in the United States, and seeing as how we're sitting on a ton of NG, it burns cleaner and it's priced attractively, this makes sense.
KMI has seen weakness lately, mainly due to weaker guidance regarding El Paso Pipeline Partners, L.P. (EPB). Specifically, investors were concerned about an expected just 2 percent increase in distributions for EPB. However, what I focused on was the forecast for KMI's dividends, as Kinder Morgan expects to declare a total of $1.72 in dividends per share during 2014. That's a 7.5 percent increase from the $1.60 they'll end up declaring for 2013. There's not many places you can find a 5% yield with 7%+ growth. Furthermore, KMI receives most of its revenue by way of KMP general partner distributions and KMP/KMP limited partner distributions. EPB will grow in time, but KMI is still busy dropping down assets to the underlying partners and focusing on becoming more of a pure play GP.
KMI has actually been extremely wonderful thus far in terms of raising its dividend. The company has raised its dividend almost every single quarter since going public in early 2011. Due to the wonderful assets they own and the likelihood of increasing usage of natural gas domestically, I expect this growth to continue. And reiterating the $1.72 the company expects to declare during 2014, that puts the forward yield on shares at today's prices over 5.2%. You can see how one's yield-on-cost can rise quite quickly. Furthermore, it should be noted that Richard Kinder (the CEO of KMI, KMR, KMGP, and the general partner of EPB) has his personal assets in KMI. If you believe in investing with insiders because they have special knowledge of the operations, KMI is the pick here.
There are drawbacks to this investment. First, as mentioned there are costs to owning such a large network of pipelines. Capital expenditures will likely remain fairly high for the foreseeable future, and the debt load for the company is also pretty high; the partnership has over $30 billion in long-term debt right now.
I valued shares using my traditional Dividend Discount Model analysis. I used a 10% discount rate with a 6% long-term growth rate (below the historical growth rate) and calculated a fair value on shares of $43.46. It's hard to really pinpoint a growth rate with KMI because it has only been publicly traded for a couple of years. However, based on the continued building out of natural gas here in the U.S., Kinder Morgan's dominant market position and the Incentive Distribution Rights ensuring an ever larger piece of the Kinder Morgan pie, I anticipate this growth rate to be sustainable.
This purchase adds $49.20 to my annual dividend income based on the current quarterly payout of $0.41. I still have 43 positions in my portfolio, as this was an addition to an existing investment. I'm going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate.
*Morningstar rates KMI as a 4/5 star value, with a fair value estimate of $40.00.
*S&P Capital IQ rates KMI as a 4/5 star Buy with a fair value calculation of $30.10.
I'll update my Freedom Fund in early January to reflect my recent addition.
Disclosure: Long KMI