Image source: Kinder Morgan.
While Magellan Midstream Partners (MMP +0.00%) and Kinder Morgan (KMI 1.87%) are both energy infrastructure companies, the similarities really end right there. Magellan, for example, is an master limited partnership and pays a lucrative 4.6% yield. Meanwhile, Kinder Morgan is a C-Corp, and as a result of its recent dividend cut, the company's current yield is much lower at 2.5%. That said, these are not the only differences between the two, and it is their fundamental differences that make one the better buy right now.
Battle of the balance sheets
One of the biggest differences is how they manage their balance sheets. As the following chart shows, Kinder Morgan employs much more leverage than Magellan:
|
Company |
Credit Rating |
Debt-to-EBITDA Ratio |
|---|---|---|
|
Kinder Morgan |
BBB-/Baa3 |
5.3 |
|
Magellan Midstream Partners |
BBB+/Baa1 |
3.0 |
Data sources: Kinder Morgan and Magellan Midstream Partners.
That higher leverage came back to bite Kinder Morgan late last year. As a result of the deepening of the energy market downturn and an acquisition to increase its stake in a deeply indebted pipeline joint venture, the company's debt rose to more than 5.8 times EBITDA. That elevated leverage caused one of the company's credit rating agencies to warn that Kinder Morgan was at risk of losing its prized investment-grade credit rating. To avoid that fate, the company slashed its dividend and diverted that cash flow toward debt reduction and growth capex. As a result of that decision, and some targeted strategic transactions, the company's leverage is coming down and is on pace to get it back below five times.
Magellan Midstream Partners, on the other hand, has a much stronger credit profile, including one of the best credit ratings among MLPs. Because of that, the company continues to have open access to inexpensive capital. For example, it recently issued $500 million of 30-year senior notes at a paltry rate of just 4.324%, which it used to refinance notes yielding 5.65%. Because of that open access to cheap capital, Magellan was able to both fund its growth capex and grow its distribution during the downturn.
Clearly, Magellan has the better balance sheet.
Comparing the portfolios
At its core, Kinder Morgan is a natural gas pipeline company. It currently controls the largest natural gas pipeline network in North America, which supplies 57% of its annual earnings. However, the company is also the largest independent transporter of petroleum products and carbon dioxide as well as the largest independent terminal operator. Overall, product pipelines and terminals each supply 15% of its earnings while oil production, carbon dioxide transportation, and its oil sands pipeline contribute 7%, 4%, and 2%, respectively. Contrast this with Magellan Midstream, which is much more focused on refined products and crude oil pipeline, terminal, and storage assets. As a result, those segments supply 58% and 33% of its earnings, respectively, with marine storage contributing the final 9%.
The other big differentiator is the percentage of fee-based cash flow these companies collect from their assets. In Kinder Morgan's case, fees will supply 91% of its cash flow this year versus 86% at Magellan. Those fees have provided both companies with a reliable supply of cash flow during the downturn. However, Magellan's greater direct exposure to commodity prices is one reason why its distributable cash flow is down 6.5% so far this year while Kinder Morgan's is only down 2.3%.
Overall, Kinder Morgan's diversification and a greater percentage of fee-based cash flow give it the stronger business.
A look at the upside
Another benefit to Kinder Morgan's diversification is that it provides the company more opportunities to grow. That is evident by looking at its project backlog, which currently consists of $13.5 billion in capital projects spread across all of its segments. That is healthy growth, even for a company's of Kinder Morgan's size. For perspective, these projects represent 15% growth in the company's asset value as measured by enterprise value over the next five years. More importantly, the fee-based assets alone would boost earnings by $1.8 billion, which is an increase of 22%.
Contrast this with Magellan, which currently has just $1.3 billion of projects under construction though 2018 and another $500 million of potential projects under consideration. Given its current size, those projects would only boost Magellan's size by 9% if it completes all of them. That said, for the most part these are very lucrative projects, with earnings multiples averaging eight times EBITDA compared to the 6.5 times average multiple of Kinder Morgan's projects. Still, while Magellan has a solid backlog, Kinder Morgan's growth potential is visibly greater thanks in part to its diversification.
Investor takeaway
Magellan Midstream Partners is a strong company with a bright future. However, Kinder Morgan has a lot more upside potential due to its growth backlog and more ways to grow in the years ahead thanks to its asset diversity. That upside potential and diversification, in my opinion, makes it the better choice between the two right now.
