There are a lot of potential winners in the midstream industry right now. The energy production boom has turned many of these high-yield stocks into compelling investment opportunities. As with any industry, not all opportunities are created equal. Today we'll take an in-depth look at a stock I consider the best of the best: Kinder Morgan (NYSE: KMI ) .
Kinder Morgan was formed in 1997 when Richard Kinder and Bill Morgan purchased a pipeline from Enron for $40 million. It was the smallest of beginnings for what would become the country's largest pipeline network 15 years later.
Kinder remains as CEO of Kinder Morgan, and has a personal 24% stake in the company. Working for a symbolic $1 a year, he puts shareholders' interests first and has established a company culture that prohibits wasting money. Kinder Morgan is one of the better investments going, so let's see what makes it tick.
How it works
Kinder Morgan is technically a holding company. It doesn't actually own any assets, instead it makes its money by owning stakes in the other Kinder Morgan companies: Kinder Morgan Energy Partners (NYSE: KMP ) , Kinder Morgan Management (NYSE: KMR ) , and El Paso Pipeline Partners (NYSE: EPB ) . It also owns a 20% stake in a natural gas interstate pipeline called NGLP.
But really, KMP is KMI's primary asset. KMI owns the general partner and incentive distribution rights in KMP, but it also owns 11% of the limited partner units, and together its ownership in KMP amounts to more than 95% of KMI's cash flow. Essentially, when KMP makes money, so does KMI.
Between KMP and EPB, there are an awful lot of assets under the Kinder Morgan umbrella. Let's start with the 75,000 miles of pipeline that run across the U.S. and into Canada. The sheer size of this network means that Kinder Morgan is connected to essentially every energy producing play in the U.S. It has considerable assets in Texas and Florida, the top two markets in the country for natural-gas-generated electricity.
KMP also owns the Trans Mountain pipeline. The 300,000 barrel per day pipeline connects Alberta's oil sands to British Columbia. The company is currently trying to double capacity on the line, which is frequently oversubscribed, but is running into a bit of opposition from environmental groups and local citizenry.
This isn't just a pipeline company, folks. Kinder Morgan is also the second-largest oil producer in the state of Texas. Approximately a quarter of KMP's cash flow comes from oil. One of the advantages of a midstream company over an explorer and producer is supposed to be reduced risk to commodity price volatility. Clearly that is not the case here, but to the company's credit, it employs a smart hedging strategy. While KMP will not clean up if the price of crude skyrockets, it will also not suffer from a precipitous drop.
Though it can be a little difficult to understand where the money is coming from at times, there is one huge upside to investing in KMI versus KMP: taxes. KMI is set up as a tax-paying corporation, which means that investors don't have to deal with the potential headaches of a K-1. For this reason, it is also more IRA friendly. Ultimately, given this convenience, superior management, and KMP's expansive asset base, I'm hard-pressed to recommend a better all-around midstream opportunity than KMI.
All the time investors save not worrying about paperwork can be applied to gushing about dividend yield. Kinder took KMI private in 2007, but brought it public again in 2011. Though it was only listed for part of the year, the stock returned 11%, and is up over 9% so far this year.
Historically, both Kinder Morgan and KMP have been able to pay out more than what the respective entities have budgeted for distributions and dividends. For example, in 2011 KMI budgeted $1.16 annualized per share, but ended up paying out $1.20. Exceeding expectations is par for the course at Kinder Morgan.
The El Paso merger and ensuing asset dropdowns to KMP, the increased volumes across its system, and the likely growth of its carbon dioxide business mean that the future at Kinder Morgan is quite bright. Distributions to KMI will continue to increase, making the stock a very compelling opportunity for dividend investors. Said investors may also want to check out the Fool's special free report for dividend investing.