Sometimes the best choice is the most obvious one. Midstream master limited partnerships, or MLPs, are in demand these days for good reason: Investors are looking for reliable sources of income with decent yield and high cash flow visibility. Pipelines offer a good yield without some of the "junky" attributes of comparable assets such as high-yield sovereign or corporate bonds.
One of the oldest and biggest players in the pipeline space is Kinder Morgan Inc (NYSE: KMI ) . Back when MLPs were just getting started as an asset class, Richard Kinder and David Morgan founded Kinder Morgan Energy Partners (NYSE: KMP ) based on the idea that there was much more oil and gas in the U.S. than originally thought. In particular, they believed that natural gas would soon flow from the Rockies (an area where Kinder and Morgan thought there would be great supply) to the northeast (the traditional source of demand).
While the Rockies prediction has not yet come true, the basic premise that there would be a huge need for hydrocarbon transportation was correct in a big way. Kinder Morgan has since established itself as one of the biggest players, with a focus in natural gas transportation. Right now I believe that Kinder Morgan is unfairly discounted when compared to other pipelines, and that it can be picked up right here at current prices. This article will focus on the partnership business, KMP. The chart below shows how badly KMP has lagged behind the other big pipelines.
As you can see, Kinder Morgan is down by about 7% over the last twelve months while Plains All American (NYSE: PAA ) has been flat and Enterprise Products Partners (NYSE: EPD ) has marched higher. The reason for Kinder Morgan's relative underperformance is a somewhat complicated ownership structure, concerns over growth, and a tight distribution coverage ratio.
The market's preference for Plains All American and Enterprise Products Partners is somewhat understandable. Both of these companies are looking to grow distributions by high single-digits, while Kinder Morgan Energy Partners is looking at 5%-6% distribution growth. In addition, Plains typically carries a distribution to distributable cash flow coverage ratio of around 1.1 times. Enterprise often has considerably more cushion at around 1.4 times. Kinder Morgan Energy Partners, however, typically distributes nearly all of its distributable cash flow, and carries a tighter ratio of just 1.01 times. It is true that there is less margin for error with Kinder Morgan.
However, Kinder Morgan Energy Partners now yields just over 7%, which is significantly higher than Plains All American at 4.4% and Enterprise Products Partners at 3.8%. In fact, Kinder Morgan Energy Partners yields more than any of the large pipeline partnerships. As a dry gas-focused partnership, Kinder Morgan is exposed to the best long-term growth prospects, as the chart below shows.
Management believes that over the next ten years, gas exports to Mexico will grow by over 50%, LNG exports will double, petrochemical use of natural gas will increase by 50%, and that dry gas electricity use will nearly triple. This is all thanks to recent discoveries which have made natural gas cheap and abundant. No other pipeline moves as much dry gas as Kinder Morgan, and about half of the partnership's revenue comes from this source. In regards to growth over the long-term, Kinder Morgan has an advantage over the other pipelines.
There's no doubt that other pipelines have higher coverage ratios and better short-term growth prospects than Kinder Morgan Energy Partners. However, the partnership's focus on the steady, secular growth of natural gas use will benefit it more than most of its competitors over the next decade. At this time, units of Kinder Morgan yield a very generous 7%, and I believe they are a buy right here.
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