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Why Investors Should Treat This Pipeline MLP With Caution

The recent suspension of Boardwalk Pipeline Partners' (NYSE: BWP  ) Bluegrass Project is a notable event. The setback could significantly impede the firm's future growth -- an important consideration for pipeline company shareholders. Investors may be better served by a more cautious take on Boardwalk, while looking more favorably upon more assured growers like Kinder Morgan Inc  (NYSE: KMI  ) or The Williams Companies (NYSE: WMB  ) .

A serious setback
The fact that Boardwalk Pipeline's Bluegrass Project has been suspended could be a serious setback for stakeholders. The planned natural gas liquids pipeline, connecting growing Marcellus and Utica shale production to users in the south, was arguably the major driver for future company growth. Its derailment, thanks to insufficient customer commitments, may have substantially damaged Boardwalk's long-term outlook.

Growth for pipeline companies is very important, especially for those structured as a master limited partnership (MLP). Investor cash payouts are a significant part of an MLP's appeal. Unit, or share equivalent, holders have become accustomed to these typically generous distributions, and have increasingly demanded they increase annually. Because the pipeline business often does not provide sufficient organic growth to guarantee rising distributions, MLPs typically need to take income-accretive steps, such as acquisitions or sizable growth projects, to meet stakeholder expectations.

Boardwalk's growth prospects without the Bluegrass Project appear uninspiring. The lack of demand for a pipeline project that runs out of a major natural gas "hot spot" is troubling. It suggests that excess pipeline capacity could engender an unfavorable contract-renewal pricing environment that will likely pressure future revenue and cash flow gains.

It's not all bad news for Boardwalk, however. The company has a relatively appealing valuation. Its units, valued at about 7.2 times last year's operating cash flow, have apparently already priced in some of the growth headwinds the pipeline operator is likely to face. A discounted enterprise value at 13.5 times cash flow also seems to confirm a lack of Boardwalk investor optimism.

A project partner with alternatives
The Williams Companies, a partner in the Bluegrass Project, can more easily brush off the development's deferral. Williams, the operator of an immense oil and gas transport network -- much of it through a majority stake in Williams Partners LP -- seems to have several large-scale projects ready to boost future results.

One of its most exciting developments relates to the Transco pipeline system. Transco is a major mover of natural gas from the Gulf Coast to the Southeast and Atlantic Seaboard, including major metropolitan areas in New York, New Jersey, and Pennsylvania.

Williams' Atlantic Sunrise expansion plan looks to increase Transco's capacity even further. This development will connect producing regions in northeastern Pennsylvania to markets in the Mid-Atlantic and the Southeast. It will deliver enough natural gas to meet the daily needs of more than 7 million American homes. There's also strong demand from producers for this transport route; Atlantic Sunrise has already received binding commitments for the full amount of its flow.

Williams is well regarded by the market. An expected 50% rise in adjusted pre-depreciation and amortization segment profits during the next few years, and an anticipated 20% increase in full-year dividends for both 2014 and 2015, have helped the shares price at a lofty 13.6 times last year's cash provided by operations.

An intriguing, but controversial, competitor
Kinder Morgan, the largest midstream and the third largest energy company in North America, is another interesting industry peer. The firm, with ownership in roughly 80,000 miles of pipeline mainly through interests in Kinder Morgan Energy Partners and El Paso Pipeline Partners, has faced some controversy. Analysts have noted concerns about Kinder Morgan's accounting presentation and use of non-standard metrics to report results.

The company continues to deliver good perfomance, however. Cash available to pay dividends increased 12% year over year in the latest quarter -- gains that should help fuel an expected 8% rise in the annual dividend this year. Kinder Morgan also has more than $16 billion in expansion projects and joint venture investments planned, a likely source for continued growth into the future.

One interesting avenue of growth is marine transport. Kinder Morgan recently entered the sector by purchasing two firms for nearly $1 billion. The acquisitions, American Petroleum Tankers and State Class Tankers, are both engaged in the water-borne domestic transportation of crude oil and refined products, commonly called the Jones Act trade. Kinder Morgan believes that rapidly increasing U.S. energy production, in combination with insufficient pipeline and rail capacity, will likely present significant Jones Act trade opportunities.

Much of the enthusiasm surrounding Kinder Morgan Inc's potential appears to have been squelched by accounting worries. The controversy has apparently held down share prices to an attractive 8.1 times last year's operating cash flow, and provided a moderately appealing enterprise worth of 17.3 times cash generation. These are valuation levels where investors who can be comfortable with its financial presentation might want to give Kinder Morgan some regard.

Bottom line
Investors in pipeline companies, especially MLPs, tend to expect generous and rising annual distributions. Pipeline operators usually need to expand successfully if they wish to deliver the higher payouts. When companies like Boardwalk run into problems with their main growth initiatives, investors may want to be wary. Higher-priced peers with better prospects, like Williams or Kinder Morgan, could end up being a more prudent investment consideration.

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Bob Chandler

A dedicated Graham-style value man, Bob bought his first stock in 1986 and though he’s a miserable market timer, longer-term calls let him earn a meager living from his investments. With an MBA and MS in Accounting, Bob relies more on Hetty Green's advice for successful investing: "Buy cheap and sell dear. Act with thrift and shrewdness and be persistent."

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Related Tickers

8/28/2015 3:17 PM
BWP $13.51 Up +0.09 +0.63%
Boardwalk Pipeline… CAPS Rating: ****
KMI $32.53 Up +0.53 +1.66%
Kinder Morgan CAPS Rating: *****
WMB $48.42 Up +0.74 +1.55%
Williams Companies… CAPS Rating: ****