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Our Top 5 Energy Stocks for 2012: Kinder Morgan

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This article is part of Our Top 5 Energy Stocks for 2012 series.

It is impossible to read the news without coming across something related to natural gas these days: We're in a boom, folks. Production is up across the country and companies are working around the clock to secure land rights and drill wells. There is so much gas underneath the earth that some operations are flaring it off in places like the Bakken Shale because there is simply nowhere to put it all.

The price of dry natural gas (methane) is the lowest it's been in since 2008, and while producers continue to pursue it, margins are slim and it's becoming increasingly difficult to generate profits without producing a significant amount of natural gas liquids and oil as well. If only there were a way to play the natural gas boom that wasn't tied directly to the commodity's price -- investing in a company that transports natural gas, for example.

Enter one of the Fool's Top Energy Stocks for 2012: Kinder Morgan (NYSE: KMI  ) .

The upside to pipelines
America's largest midstream energy company is positioned perfectly to play the current energy boom. Pipeline transmission rates are set and controlled by the Federal Energy Regulatory Commission and do not fluctuate with the price of oil and natural gas, ensuring reliable income for the Houston-based company that currently operates more than 37,000 miles of pipeline across North America.

This isn't to say that Kinder Morgan does not benefit from high commodity prices, as much of the energy being developed in the U.S. and Canada right now comes from unconventional sources that are prohibitively expensive to produce if the prices of oil and gas drop below a certain point.

The other upshot to operating a regulated pipeline business is that competing pipelines must be approved by regulators, and will only earn such approval if there is a demonstrated need, establishing a pretty safe economic moat for Kinder Morgan.

2012 outlook
KMI's growth is driven by its general partner stake in Kinder Morgan Energy Partners (NYSE: KMP  ) , the master limited partnership that holds most of the Kinder Morgan assets. Ninety-eight percent of the distributions KMI receives come from KMP, though the company also has a 20% stake in the Natural Gas Pipeline Company of America. With that in mind, let's take a look at what KMP expects from 2012:

  • $4.4 billion generated in business segment earnings; $560 million more than 2011.
  • Cash flow in excess of $50 million after distributions.
  • Distribute $1.7 billion back to limited partners.
  • Invest $1.7 billion in expansions and small acquisitions.

It is a short list, but right away the emphasis on growth and shareholder return, two priorities held dear by almost all investors, is clear.

Fast-growing dividend
Aside from its general partner role in KMP, KMI owns its incentive distribution rights, as KMP increases its payout to investors, KMI's share increases as well. Ultimately, KMI shareholders earn a smaller absolute dividend compared to KMP shareholders, but it grows much quicker.

In 2012, KMP expects to pay out $4.98 per unit, up 8.3% from last year. KMI will pay a dividend of $1.35, up 16.4% over last year.

El Paso deal
The big news for Kinder Morgan in 2011 was its announcement of a bid to take over El Paso (NYSE: EP  ) . In the midst of a second request by the Department of Justice, the merger still has some antitrust regulatory hurdles to clear, but both companies expect the deal to be approved in the second quarter of 2012.

Once approved, KMI will take control of El Paso's assets. Current plans are to divest El Paso's exploration and production operations and drop down (sell) the midstream assets to KMP and El Paso's pipeline MLP El Paso Pipeline Partners (NYSE: EPB  ) .

The merger and subsequent drop downs are expected to generate positive dividend accretion for KMI, but is not factored into any of the companies' 2012 projections. This means what looks to be a great year for Kinder Morgan may end up being even better than expected.

Other projects
Kinder Morgan has two other large projects under way right now, one in Canada and one in the U.S., that should boost future returns.

The company is building a $130 million condensate processing facility in the Houston Ship Channel. Expected to come online in 2014, the project was designed to exploit the glut of petroleum condensate coming in from the Eagle Ford Shale. The facility is the perfect complement to the new pipeline Kinder Morgan expects to begin operating in the second quarter of 2012, which runs from the Eagle Ford to Houston.

North of the border, Kinder Morgan is making a play to take advantage of increased Alberta oil sands production by adding seven oil storage tanks to its terminal in Edmonton. The project is slated for completion by 2013 and will cost the company $210 million.

Foolish takeaway
Kinder Morgan has experienced 15 years of continuous growth and the future remains bright. CEO Richard Kinder is one of today's elite business leaders and is committed to running excellent companies, putting emphasis on controlling costs and protecting his shareholders' investments. The combination of excellent management and growth potential makes Kinder Morgan, without a doubt, a top stock for 2012.

I think Kinder Morgan is a great pick for the future, but our analysts have selected a different stock that they believe is poised for tremendous growth in 2012. Find out which company in our new free report: "The Motley Fool's Top Stock for 2012." Thousands have already requested access and it'll only be available for a limited time. Simply click here -- it's free."

Fool contributor Aimee Duffy doesn't own shares of the companies mentioned in this article. If you have the energy, check out what she's keeping an eye on by following her on Twitter, where she goes by @TMFDuffy.

Motley Fool newsletter services have recommended buying shares of El Paso Pipeline Partners. Try any of our Foolish newsletter services free for 30 days. 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 (4) | Recommend This Article (16)

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 22, 2011, at 5:13 PM, durango58 wrote:

    Controlling costs, yes. Kinder takes a salary of $1 per year. Parks in the employee parking lot and all executives fly coach. He makes his money like we do--dividends. Ergo his interests are perfectly aligned with unitholder's interest. Can't find a better equity to own in good times or in bad. I've accumulated 8,500 and wish I had more.

  • Report this Comment On December 22, 2011, at 6:30 PM, shamapant wrote:

    I hope you don't mind my advertising, but my blog post is a perfect compliment to this:

  • Report this Comment On December 28, 2011, at 9:34 AM, 3chains wrote:

    Honestly, no article about Kinder Morgan should be undertaken without addressing the two Kinder MLPs, KMP and KMR. Why collect a paltry 4% dividend that is taxed (KMI), when you can own one of Kinder's MLPs directly, and collect 5.7% tax deferred distributions with KMP, or 6% tax deferred share splits with KMR? MLPs are a pain at tax time, and you shouldn't own them in IRA's, but an extra 2% is worth a little paperwork.

  • Report this Comment On January 02, 2012, at 9:12 PM, UFOFred wrote:

    Hi All,

    I'm interested in KMI rather than KMP because I want to avoid potential tax record keeping headaches. However, I cannot find historical information on KMI -- not covered in Valueline. (KMP is covered by VL -- last report dated Dec. 9.)

    Anyone out there have a source of historical (~10 years) data, including sales, net profit, tax, earnings, etc.?

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