I Can't Buy This Investment -- but You Can

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This article is part of our Rising Stars Portfolios series.

When asked about the kind of investments he likes best, Warren Buffett often responds that Berkshire Hathaway is a prisoner of its own success. The insurance and investing behemoth's massive investment portfolio prevents it from meaningfully dealing in the small- and mid-cap space. These investments just don't move the needle, because they're too small.

Moreover, it's hard to actually buy these stocks. Sure, these guys have sophisticated trader-types doing their buying, but small- and mid-cap stocks don't trade a lot. When Berkshire makes a big splash in a teeny stock, the stock might move up. Even it doesn't, any position a giant like Berkshire could take would end up almost inconsequentially small, making the opportunity cost of owning and tracking these stocks almost stupidly prohibitive.

I've long envied that problem. Now I share it.

A bank account that pays 7.5%
I can't buy Kinder Morgan, Inc.'s (the general partner of Kinder Morgan Energy Partners (NYSE: KMP  ) ) exchange-traded debt, which trades as Lehman ABS Corporation 7.75% Co., under the ticker CVB, for my Rising Star Portfolio. In Rising Stars, TMF analysts are restricted from buying securities that lack liquidity, because the resulting pop might prevent you -- our readers -- from undertaking your own transactions at a fair price.

CVB is a chunk of Kinder Morgan debt that an investment bank, the now-defunct Lehman, made into a New York Stock Exchange-tradable instrument. Worry not: These aren't anything like other structured investments—RMBS, CMBS, CDO, synthetic CDOs, and other alphabet soup. They're Kinder Morgan bonds that trade on the New York Stock Exchange.

You're basically buying a bond that's yielding 7.5% annually. It matures in 2098 and pays interest semi-annually. I think of it as a no-brainer -- essentially an 80-plus-year bank account that pays 7.5%.

Turning "dirty" into "green"
Kinder Morgan's business is boring, beautiful, and predictable.

The company operates pipelines and gathering terminals that collect and transport natural gas, oil, coal, and carbon. It's the largest independent transporter of petroleum products in the U.S., owns or operates 24,000 miles of natural gas pipelines, and connects to just about every major oil and natural gas field in the continental U.S. Its underlying Energy Partners business isn't much different from its pipeline brethren, Enbridge Energy Partners (NYSE: EEP  ) and Enterprise Products Partners (NYSE: EPD  ) .

These assets are an essential component of our nation's energy infrastructure. Every time you switch a light, run a load of laundry, or turn on your TV, an ounce of some fossil fuel moves through pipelines like Kinder's in support of your habit.

These assets are basically regulated monopolies. In common terms, they're tollgates. Building and operating pipelines is about the widest-moat business out there. They're mighty expensive to build, and regulatory barriers to new permits are positively enormous, creating a legion of barriers to entry.

That makes success something of a self-fulfilling prophecy. The biggest and best pipeline operators have access to capital for new projects, reputational strength, and operational efficiencies which allow them to scale expenses. Smaller players just don't have the same advantages.

And Kinder Morgan? Well, they're the biggest and best.

Add it up
That's exactly why Kinder Morgan debt is such a no-brainer. The company might as well operate a cash-printing press. Because energy consumption is recurring and fairly stable -- natural gas consumption slipped only 1.6%, and oil 9.2%, during the 2007-2009 Great Recession -- making for consistent cash flow.

Because it pays a good-sized chunk of its cash flows to investors, Kinder needs to tap capital markets to fund new projects and refinance existing debt on a fairly regular basis. Consistency of cash flows is paramount, in order to retain the confidence of capital markets. And Kinder's got that in spades.

It produced $1.5 billion in distributable cash flow last year, and interest coverage sat at 3.9 times for the trailing-12-month period. Consequently, it's been routinely able to access capital markets to fund new projects and refinance debt. 

To my eye, that makes Kinder Morgan's ability to pay interest on CVB, and eventually refinance it, a pretty certain proposition.

But what of inflation?
The skeptics among you might say: Aren't bond prices absolutely eviscerated in highly inflationary environments? And isn't the Fed printing cash? To that, I'd say yes and yes. But I don't think it's a problem. Though it could be different this time, it seems that we're a long ways from the sort of profligate, runaway and widespread inflation that hits bonds.

Why? A few of the ingredients that typically presage high inflation are notably lacking: Unemployment still sits at 9.6%; September year-to-date new orders of durable goods (net of defense and transportation) sit at 93% of 2008 levels after falling 21% in 2009, meaning companies are still investing at a very measured rate; and capacity utilization's running at 74.8%. That's up from recession lows, but hardly the mark of a humming economy.

In short, a lot of that money's not finding its way into the economy at large, which isn't exactly a recipe for widespread inflation. While it's arguable that the Fed's grand money-printing experiment prevented a worst-case scenario, it might not be stimulating the economy as much as the folks in Washington had hoped. More importantly, if and when inflation actually rears its head, the Fed probably has time to rein it in before it gets out of control. It's not like the recovery will be an overnight phenomenon. So I'd peg the likelihood of high inflation as pretty low.

Moreover, even if inflation does happen, Kinder's earnings streams, and thus its ability to pay interest and access capital markets, are pretty well-protected from inflationary inputs. In the long term, Kinder bonds are sitting pretty.

The bottom line
As the stock markets vacillate amid concerns over the next European debt crisis, inflation and/or deflation domestically, and the state of budget deficits worldwide, a staid and safe 7.5% per annum seems a nice gambit.

I'm guessing that's a bet Buffett wishes he could take.

Berkshire Hathaway is a Motley Fool Inside Value choice. Berkshire Hathaway is a Motley Fool Stock Advisor selection. Enterprise Products Partners LP is a Motley Fool Income Investor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days.

Michael Olsen owns shares of Kinder Morgan. He's also the Senior Analyst at Motley Fool Special Ops, where he routinely seeks investments Buffett can't buy. Eat your heart out, Warren. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 04, 2010, at 1:34 PM, cdvision wrote:

    I've seen some other income investments like this in the past, PFH for example which is JC Penny's debt. Is there a good resource for finding these kind of fixed income investments? I'm thinking that I would like to start accumulating them.

  • Report this Comment On December 05, 2010, at 12:08 PM, TMFEnochRoot wrote:

    @cdvision - you can do a lot of basic due diligence on exchange traded debt at That's the best resource by far that I've found for these type of instruments. It's free registration, but I'd recommend throwing some cash their way if you find the site useful, since they live off of donations and it's a LOT of work to keep up to date on these esoteric securities.


  • Report this Comment On December 06, 2010, at 10:13 AM, cdvision wrote:

    Alex, you rock.

  • Report this Comment On December 07, 2010, at 3:46 AM, saurabhu wrote:

    The bonds underlying these certificates are KMI 7.45% bonds. These bonds are trading at 85 price at the moment, which implies an yield of 8.7%. Even if I could buy the certificates at 10 (trading at 10.9 in the market now), I would still only get an yield of 7.75%. Doesn't look very attractive for BB rated risk

  • Report this Comment On December 07, 2010, at 4:26 PM, TMFAgewone wrote:

    I can understand your reservation saura, and thanks for the comment. But barring some seriously stupid moves on the part of management, I'd argue KMI's cash flows are a pretty surefire thing. That makes the likelihood of the debt being repaid, or refinanced, pretty high in the long-run.

    I understand that we live today, but if you're willing to look past the fact that the stub may move in response to perceived credit risk, interest rates, inflationary expectations, and other--the long run looks pretty solid. KMI's cash flows are underpinned by KMP, and they're about as solid as they come. Sure, the credit rating's BB, and I'm not credit analyst. But do I perceive KMI as a default risk? I was glancing over the recently placed prospectus a few days back, and I'd wager no.

    I could prattle on, but that's my take. Keep the comments coming, and thanks for reading.


  • Report this Comment On December 08, 2010, at 7:45 AM, pcarbon wrote:

    Ever heard of peak oil ? There won't be any fossil fuel left in continental US in a few years...

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