Stock Bought: KMI

For my first purchase today I bought shares of Kinder Morgan (KMI), the third-largest energy company in North America. The company operates an extensive network of pipelines for transporting natural gas, crude oil, and petroleum products. Its business model is similar to a toll road in that the company collects volume-based fees for transporting raw materials, with limited exposure to the fluctuating prices of those commodities. This results in stable and growing cash flows as energy needs increase over time, and the company's massive asset footprint will likely help it dominate the midstream energy industry for many years to come.

The Kinder Morgan group of companies has an interesting corporate structure. The General Partner (GP) is Kinder Morgan, Inc. (KMI), which pays dividends based on distributions it receives from two Limited Partners (LPs). The first LP is Kinder Morgan Energy Partners, which is represented by two entities that differ only in that KMP gives cash distributions (similar to dividends) and KMR gives share dividends. The second LP is the recently acquired El Paso Pipeline Partners, which is represented by a single entity, EPB, that gives cash distributions. KMP and EPB are examples of Master Limited Partnerships (MLPs), which often have high yields but come with some tax complications. KMI is a C-corporation that provides a way of investing in MLPs without the extra tax issues. Moreover, because of its Incentive Distribution Rights as GP, KMI should be capable of greater dividend growth over time than the LPs.

KMI became a publicly traded stock in early 2011, so it does not have much of a dividend history at this point. However, the company has increased its dividend in 4 of the past 5 quarters and management has expressed a commitment to dividend growth. In fact, management is targeting a dividend growth rate of at least 10% for the next several years, which is not unrealistic given the 14% distribution growth rate for KMP over the past 16 years. In addition, Richard Kinder (the CEO) and other management own about 28% of KMI stock, so it is in their interest to maintain a solid dividend.

It is difficult to come up with a valuation for KMI because of the unique characteristics of the MLPs for which it is the GP. In addition, its balance sheet is difficult to assess because the company still has to "drop down" assets from its purchase of El Paso Pipeline Partners. However, using a Dividend Discount Model with a dividend growth rate of 10% (matching their target) and a discount rate of 14%, I calculate a fair value of $38.50 per share, which is slightly above the current stock price.

I bought 40 shares of KMI at the price of $34.85 per share, giving me a 4.00% yield on cost. (I set my limit price with the goal of getting that YOC.) At the current dividend rate, I can expect to receive quarterly dividends of $14.00, which will add a total of $56.00 to my annual dividend income. The stock will go ex-dividend later this month, so I will receive my first dividend payment in November. Kinder Morgan is now the 24th stock in my portfolio, adding some nice diversification in the energy sector.