10 Core Stocks for Your Portfolio: Kinder Morgan Energy Partners

This week and next, we're presenting 10 core stock ideas -- stocks our writers believe can serve as the foundation for a long-term-focused portfolio.

If you're looking for a company you can buy, hold, and perhaps never need to sell, you'll want one with a strong economic moat, to assure it has long-term staying power. You'll also want one that pays its owners well. After all, the only ways to make money off a stock are through dividends or through selling, and if you're selling, the stock is hardly a core investment.

Kinder Morgan Energy Partners (NYSE: KMP  ) is one of the few companies that hit both criteria. With an impressive (and covered by operating cash flows) 6.3% yield, its distribution currently beats highly rated bonds. And since what it does is about the closest you can get to a 'tollbooth' operation, it's more or less is in the business of digging its own moats. Those two factors make it an extremely attractive long term holding.

Snapshot

Company Name & Ticker

Kinder Morgan Energy Partners (KMP)

One sentence statement of operations

The company owns energy pipelines and storage facilities.

Recent Price

$68.69

Market Cap

$21.2 Billion

P/E Ratio

45.7

ROE

19.1%

Data from Capital IQ, a division of Standard & Poor's, and Yahoo! Finance.

The business
Kinder Morgan Energy Partners along with its conjoined twin, Kinder Morgan Management (NYSE: KMR  ) , transports energy and energy related products. In essence, it's an oil and gas pipeline company that builds, owns and operates much of the infrastructure that moves around the energy that powers our economy.

In addition to its own pipelines, Kinder Morgan partners with others in some cases. Recently, it completed the giant REX natural gas pipeline linking Western Colorado with Eastern Ohio, where it partnered with ConocoPhilips (NYSE: COP  ) and Sempra (NYSE: SRE  ) . Between the pipelines it exclusively owns and the ones it shares with partners, Kinder Morgan is one of the largest companies in its line of business on the continent.

And if you do happen like the oil production business, Kinder Morgan also claims to be the second largest oil producer in Texas.

Why it's a core stock
Refiners like Valero (NYSE: VLO  ) are exposed to market risk based on the crack spread (the difference between the price of oil and the price of gasoline). Drillers like Transocean (NYSE: RIG  ) are heavily dependent on high oil prices to spur demand and high rates on their services and equipment. And even integrated giants like ExxonMobil (NYSE: XOM  ) prefer to see high oil prices in order to get good returns on their investments.

But pipeline companies like Kinder Morgan? They earn their revenues more on the quantity of oil that passes through their infrastructure, rather than its price. In addition, the business is very capital intensive due to long pipeline and expensive right of way acquisition costs. In addition, it has a huge NIMBY (Not In My Backyard!) factor attached to it. Those two factors often scare away competition, so once one pipeline sets up, it's unlikely to see many others pop up locally.

Yet what ultimately makes it such an attractive business is that once a pipeline is set up, it's a significantly cheaper way to move oil than, say, trucking it around the country.

Risks
As a company with lots of flammable and toxic liquids moving around its infrastructure, the occasional explosion or leak can have nasty consequences. While nothing from Kinder Morgan has risen quite to the level of BP's recent oil spill, there have been occasional fatalities. As an investor, you face headline risk whenever there's a disaster, and a large enough one could result in permanent loss of capital.

From a financial point of view, the company's structure as a partnership adds risk as well. As a partnership, its unit holders are personally taxed based on the company's income, rather than just on the dividends they receive. As a result, to attract investors, Kinder Morgan Energy Partners typically pays out more than it technically reports as earnings.

While its payout tends to be covered by its operating cash flows, such a high distribution level leaves the company with little to reinvest. Because of this, the company regularly taps the financial markets and dilutes its existing unit holders to get the capital it needs to expand. As long as it can successfully invest that capital at high rates of return, existing unit holders should do fine, but if it can't, those units can stumble.

Sum
If you're looking for an investment that pays you well while you own it and delivers a service that's critical to our modern life, you could do far worse than Kinder Morgan Energy Partners. As long as we need oil and natural gas, and as long as the fields that produce it are far away from major population centers that demand it, there will be a need for pipelines like the ones it owns.

At the time of publication, Fool contributor Chuck Saletta owned shares of Kinder Morgan Management, and Chuck's wife owned shares of Valero. The Fool owns shares of ExxonMobil. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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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 September 18, 2010, at 7:53 PM, GrumpyGopher wrote:

    This one is one of my core holdings IRL and its fun to watch it compound.

  • Report this Comment On October 07, 2010, at 4:05 PM, Classof1964 wrote:

    I would be interested in knowing what anyone thinks about owning Master Limited Partnership like KMP in an IRA or a Roth. In the Roth my understanding is that one would not be taxed on any part of the distributions or captial gain ever.

    In an IRA or Keogh I believe that once all your capital is either returned in the form of the annual distribution and reduced by any net passive losses, one could be taxed on the subsequent distributions, but one would not be taxed on the capital gain if sold within the IRA or Keogh. So it would not matter in an IRA that one could not use the passive losses to offset the capital gain because there would be no capital gains tax. There would of course be a tax at your marginal rate when you actually did withdraw any funds attributable to your owning KMP. So is there any net advantage, to owning KMP in an IRA?

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