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Oil prices have collapsed, taking a lot of energy stocks with them. Learn why this may be just the time to buy high-yielding companies like Kinder Morgan.
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The speed and scope of the recent oil collapse has stunned Wall Street and left almost all energy investors reeling. Even midstream operators, who typically have far less exposure to commodity prices thanks to a large portion of cash flows tied to long-term fixed-fee contracts, such as Kinder Morgan, Inc. (KMI +0.01%), Enterprise Products Partners (EPD +0.01%), Magellan Midstream Partners (MMP +0.00%), and Energy Transfer Partners, (ETP +0.00%) haven't been spared from the slaughter.
Let's take a look at whether the market's recent punishment of these energy investments makes this the perfect time for investors to buy.
Cheaper yes, but are they undervalued?
| Company/MLP | Price off 52-Week High | Price/Distributable Cash Flow | Price/Operating Cash Flows | Historical Average Price/Operating Cash Flow |
| Kinder Morgan Inc | 5.8% | 19.6 | 8.4 | 10.1 over the last 5 years |
| Enterprise Products Partners | 17.4% | 15.9 | 16 | 12 over last 18 years |
| Energy Transfer Partners | 10% | 9.6 | 7.5 | 9.1 over last 13 years |
| Magellan Midstream Partners | 12.3% | 26.1 | 18.1 | 11.8 over last 15 years |
Two things immediately stand out about this table. First, these midstream companies haven't suffered nearly as much as some oil producers and offshore drillers which have seen their stocks fall by as much as 50% to 60% in just the last three months.
Second, while Enterprise and Magellan are down by more than 11%, they are not necessarily cheap. For example, while Kinder Morgan and Energy Transfer Partners are trading at a 17% and 18% discount to their respective historical price to operating cash flow ratios, Enterprise and Magellan are still trading at 33% and 53% premiums to their historical valuations, respectively. Does this mean that Kinder Morgan and Energy Transfer are good buys now, but investors should wait for better prices for Enterprise and Magellan? Not necessarily, because these companies have certain characteristics that make them compelling buys right now.
Security and growth prospects of the distribution
| Company/MLP | Yield | Distribution Coverage Ratio | Projected 5 Year Annual Payout Growth | % of Gross Margin Protected by Fixed-Fee Contracts |
| Kinder Morgan Inc | 4.5% | 1.1 | 10.69% | 82% |
| Enterprise Products Partners | 4.2% | 1.58 | 6.96% | 85% |
| Energy Transfer Partners | 6.3% | 1.22 | 17.58% | 64.10% |
| Magellan Midstream Partners | 3.4% | 1.6 | 14.43% | 85% |
| S&P 500 | 1.94% |
As this table shows, Enterprise Products Partners and Magellan Midstream Partners have two of the safest distributions in the industry as indicated by their distribution coverage ratios. A ratio of 1.1 or higher is considered safe and sustainable for a growing payout.
In addition, their cash flows are almost completely protected by fixed-fee contracts (with annual price increases baked in) and strong hedging against declines in oil transport demand -- something that can't be said by competitor Energy Transfer Partners.
Meanwhile, Kinder Morgan, with 94% of its 2014 earnings before interest, taxes, depreciation, and amortization, or EBITDA, secured by either long-term contracts or hedging, also has a highly secure dividend that income investors can likely count on to survive the current oil price collapse. For example, Kinder Morgan currently has $400 million in excess DCF to protect its dividend and management is expecting to generate a surplus of $500 million in DCF in 2015.
What are the risks?
Source: Enterprise Products Partners investor presentation.
As this chart shows, even if oil prices average $65 throughout 2015, U.S. oil production is likely to increase -- just at a slower rate than previously expected. That means continued demand growth for all of these MLPs' pipelines and storage services. However, if the price of oil continues to fall and averages below $55 per barrel, then not even Kinder Morgan's dividend will be safe next year.
That's because the low price of oil is already having a massive impact on future drilling projects. For instance, new drilling permits declined by 40% in November, a level that surpasses even the worst case projections of MLPs like Enterprise Products Partners.
This is perhaps why Enterprise just announced the cancellation of a major project, the 30-inch diameter pipeline it had planned to between North Dakota's Bakken shale fields with Cushing, Oklahoma.
The 1,200 mile pipeline would have had an initial capacity of 340,000 barrels per day that would have been expandable to 700,000 barrels per day, but under present market conditions, Enterprise feels the economics of the deal no longer make sense.
Bottom line: Now is the time to buy these high-yield energy companies
Some may argue that Enterprise and Magellan, while cheaper, are not yet undervalued. However, I do believe that for the quality of the management and the safety and continued income growth prospects that investors get with these MLPs; the current downturn does represent a good long-term buying opportunity. The same goes with Kinder Morgan and Energy Transfer Partners, both of which are trading at discounts to their historical cash flows and offer secure income opportunities, despite the threat that short-term low oil prices may pose.
