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.
Great buy! It seems like everyone is buying KMI lately. Hopefully I'm not missing out by not buying haha.ReplyDelete
Henry: Thanks! After my purchase I saw that a couple of fellow bloggers had bought it, too. There must be some sort of DGI wavelength permeating the blogosphere. :)Delete
Great purchase. You got in at a better price than I did last month. I actually added to my position yesterday, and I'll be talking about that tomorrow.
I think Morningstar has a fair value rating on it right about where you put it. I think the fair value is slightly higher as their targeted dividend growth is actually over 12%, and I think they'll at least reach that level.
This is just a monster company, and KMI should be very shareholder friendly going forward. I'm really looking forward to seeing where this one goes. How can you not like an underground toll highway?
This was a pretty well researched article on KMI that popped up on SA yesterday:
Dividend Mantra: It seems like quite a few DGI blogger-investors have been buying KMI this week! I agree that it's a very shareholder friendly company that should provide good dividend growth for many years. I also noticed that article on SA yesterday -- it had a lot of useful information.Delete
Great buy! I originally had my limit order set for $34.86 but then changed it this morning. I don't see his you can go wrong investing in a toll company that transports vital resources that are used in just about everything.ReplyDelete
Passive Income Pursuit: It's nice to see that you also picked up some shares in KMI today. I think we can look forward to years of dividend growth.Delete
Very nice DGM. It's crazy that you can enter a 14% (holy crap) discount rate and still determine that there is a margin of safety present. And yeah the dividend growth is supposed to actually be higher... This leads me to believe KMI is an abosolute steal or the the calculator doesn't always work right. FAST graphs couldn't handle it either...ReplyDelete
I believe in the Kinder story. I hope to see better prices in future as I want to increase my stake!
Good post, I enjoyed the read.
Compounding Income: Thanks! The valuation of KMI is tricky and the DDM result is quite interesting. Regardless of the correct intrinsic value, I think I'll be happy getting a 4% yield with the potential for double-digit dividend growth. I will also be looking to increase my position in the future.Delete
Hi, I'm new to your blog. I've been interested in Kinder Morgan stock for quite a while but held back because of the severe withholding taxes on MLP's that Canadians have to endure. I hadn't considered "KMI". Would there be any withholding tax on this one if I purchased it for my retirement account (RRSP)?ReplyDelete
Bernie: Given that KMI is a C-corporation rather than an MLP, its dividends would likely be treated in the same way as those of other U.S. corporations. However, I am not very familiar with Canadian RRSPs, so I don't know whether there would be any withholding tax. I suggest asking your brokerage about it. Thanks for stopping by!Delete
Hi Thanks for the information, was looking at the fidelity earnings stats on KMI, the payout ratio appeared to be highReplyDelete
Dividend Key Stats
Annualized Dividend $1.440000
Annualized Dividend Yield 4.22%
Payout Ratio (TTM) 107.56%
Dividend Growth 1 Year 20.00%
Dividend Growth 5 Year Average
I am assuming there could be justification on the numbers. (same as ATT with the charge for Tmobile showing the payout ratio as high), any thought comments on why the payout ratio show so high
Anonymous: Thanks for your comment. For MLPs and corporations involving them, such as KMI, the payout ratio based on earnings is misleading. A more appropriate measure is the payout ratio based on funds from operations (FFO), which reflects cash flows. I don't have the exact number for KMI on hand, but the FFO payout ratio for KMP is about 60%.Delete
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