This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Investing in pipe(line) dreams
Shareholders of once-and-future pipeline king Kinder Morgan (NYSE: KMI  ) are feeling pretty good this week, basking in the afterglow of a bullish report on their company from Goldman Sachs.

On Friday, Goldman came out with a series of recommendations concerning the Kinder Morgan family of pipeline companies. At the lowest level, Kinder Morgan Energy Partners (NYSE: KMP  ) owns or operates some 29,000 miles of oil, natural gas, and other sorts of pipelines. One level up, Kinder Morgan Management LLC "holds interests in" KMP. And one level higher is Kinder Morgan itself.

It's a complicated ownership structure, and if you're really interested in finding out who does just what (or if you're a financial masochist), you can find all the nitty-gritty details in my fellow Fool Aimee Duffy's column "Rake in Dividends With This $1 CEO." For the purposes of today's column, all you really need to focus on is this: Goldman isn't enthused about subsidiaries KMP or KMR. But Goldman really likes KMI -- a lot.

How much do they like it?
As it turns out, Goldman likes KMI so much that it's the only company in the entire Kinder Morgan empire that this banker thinks you should buy.

Now, on the one hand this makes sense. Earlier this month, Chesapeake Energy (NYSE: CHK  ) made headlines when no sooner had it announced a plan to sell its pipeline assets, than an offer was received and accepted. Such lightning-fast deal-closing suggests there's huge interest out there for owning pipeline assets. The premium price Chesapeake received -- $4 billion, or about 1.67 times book value -- also argues in favor of pipelines being a popular asset class. So it's no wonder Goldman is now looking for similar opportunities, and wondering aloud whether KMI might offer one.

Praising KMI's "strong general partner cash flow outlook," and predicting the company will produce "double-digit dividend growth from a higher proportion of stable, fee-based natural gas pipeline assets," Goldman argued the stock should hit $37 a share within a year.

To which I can only reply: Seriously? You think KMI is worth buying for its dividend growth alone? Well, let's hope so, because there don't seem to be any other compelling reasons to own the stock.

Consider: At KMI's current share price of roughly $32, the shares already sell for about 49 times trailing earnings. (Yes, I know free cash flow is strong here, but even valuing the company on free cash flow only gives us a P/FCF ratio of 23.) In any case, whether you value the company on P/FCF or plain-vanilla P/E, KMI's projected 11% long-term growth rate prevents our calling this stock a bargain.

As far as dividends go, the company is generous in the payouts department, sending shareholders 4.1% dividend checks annually. But there are at least two good reasons not to buy KMI for its dividends.

First, dividends at KMI currently consume all of the company's annual profits, and more. Indeed, Yahoo! Finance puts the "payout ratio" at Kinder Morgan today at 184% of net profit. Now, adding new revenue streams from the firm's El Paso acquisition may be sufficient to bring this ratio down a bit. (El Paso brings with it 12,000 miles of new pipeline, and all the revenues and profits that come with them.) But even so, analysts estimate that over the next five years, KMI's own revenue growth, plus the influx of El Paso revs, will still only average out to 11% annualized growth at KMI.

Technically, that's "double-digit dividend growth," just like Goldman says. But only just barely. And it's not double-digit enough to justify the high share price.

Foolish takeaway
I have to admit that I'm surprised to see Goldman's "buy thesis" fail on so many levels. But even so, this doesn't mean you have to discard the analyst's bullish enthusiasm for pipeline companies -- or dividends -- entirely. For example, KMI rivals Williams Companies (NYSE: WMB  ) and Enterprise Products Partners (NYSE: EPD  ) both offer a combination of lower P/E ratios than you'll find at KMI, plus faster growth rates and richer dividends. Either one should make a better fit for your portfolio than would KMI.

And they're just the start. If it's great dividend payers you're after, we've got nine (count 'em, nine!) recommendations available for your perusal in our new investment report "Secure Your Future With 9 Rock-Solid Dividend Stocks." Download it for free today.

Fool contributor Rich Smith holds no position in any company mentioned, but The Motley Fool owns shares of Chesapeake Energy Corporation, and Motley Fool newsletter services have recommended buying shares of Enterprise Products Partners and Chesapeake Energy Corporation.

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.


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