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Like many energy stocks, pipelines have taken a beating lately, drifting downward on concerns of oil supply overcapacity. To the more casual observer this may seem strange. After all, most pipelines don't have direct exposure to commodity prices.
However, with the way things are going now, pipelines are often lumped in with upstream energy companies because both are sometimes traded within similar exchange-traded funds, or ETFs. Therefore, when the big producers go down, they sometimes take the big pipelines along with them. When we add the pressure on high-yield stocks from rising interest rates, it's not much of a surprise that pipelines are down so much.
But let's look at the bigger picture. If pipelines can grow earnings and distributions by the mid single-digits, are they really the same as static bonds? And if not, how much should these names really be hurt by higher rates? And aren't higher rates usually a sign of economic strength, which could only be good for pipelines? Finally, that pipelines may trade in lockstep with some of the more commodity-exposed names should be seen as a blessing in disguise. If pipelines are the proverbial baby thrown out with the bathwater, we should see this as an opportunity to buy in at a reasonable or even discounted price.
KMP or KMI?
Collectively, pipeline giant Kinder Morgan Energy partners is a solid buy right now, but which Kinder Morgan security to buy, Kinder Morgan Energy Partners (UNKNOWN: KMP.DL ) or Kinder Morgan, (NYSE: KMI ) , depends on your preferences and time horizon. Both names are at or near their 52-week lows. KMI, for its part, is listed as a corporation and is eventually meant to be a general partner. At the moment, KMI does still have substantial assets, which it is dropping down to KMP. The most important takeaway is that KMI has a lower distribution coverage ratio and hence more room for distribution growth than does KMP. In 2014 management expects to grow KMI's distributions by about 8%. On the other hand, KMI's yield is a lower 4.78%.
KMP is the actual partnership vehicle that holds the bulk of (but not all of) Kinder Morgan's assets. Because KMP's distribution coverage ratio is a much tighter 1.01 times, and because KMI as a general partner has distribution rights, there is less room for growth out of KMP. Management expects about 5%-6% distribution growth, a bit less than KMI. However, KMP does yield a much nicer 6.93% right now, which makes it the better income option. If you don't mind having a partnership in your portfolio, KMP is a good bet as well, although its thin coverage ratio is a bit tight.
Just plain good
While Kinder Morgan is certainly the biggest of the pipelines, by no means is it the only one trading around its low. Plains All American Pipeline (NYSE: PAA ) has declined from a high of almost $60 this year to $48.90 today. That is a drop of over 18%. As a pipeline partnership, Plains has hitched its wagon to North American oil production and the displacement of seaborne crude imports. And that story is booming. It's no surprise, then, that Plains expects to grow both EBITDA and distributable cash flow by 11% and 12% respectively for the course of 2013. Plains' coverage ratio sits at a very high 1.41 times trailing 12 month cash flow, but that is expected to drop as the performance of the supply and logistics division comes back down to earth. But overall, a yield of 4.9% and expected growth of 11% backed by a solid secular growth story make Plains All American Pipeline a compelling choice right here.
There's a lot to like about pipelines right now: good yields, solid growth, and contracted cash flow well into the long term. All three names; Kinder Morgan, Kinder Morgan Energy Partners, and Plains All American, are great places to start.
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