The primary draw of pipeline stocks like Kinder Morgan (KMI 1.06%) and Williams Partners (NYSE: WPZ) is that investors can collect sizable income streams since these companies typically pay out a significant portion of their cash flow to investors each year. Because of that focus on yield, most income investors will take one look at these pipeline giants and likely declare Williams Partners the better buy because it currently yields 6.4% while Kinder Morgan only offers a 2.6% payout. But if you dig deeper into the numbers, the scale tilts toward Kinder Morgan, because it offers a similarly solid financial situation and healthy growth prospects -- all at a much lower valuation.
The financial checkup
While income investors can get caught up in a stock's current yield, that payout is meaningless if it's not sustainable over the long term. One way to measure the sustainability of a dividend is to consider a company's underlying financials to see if they can support that payout. Here's a snapshot of the financial profile of both companies. as well as Williams Partners' parent Williams Companies (WMB 1.20%):
|
Company |
Credit Rating |
2017 Debt-to-Adjusted EBITDA Ratio |
Projected 2017 Distribution Coverage Ratio |
Percentage of Cash Flow Fee-Based or Regulated |
|---|---|---|---|---|
|
Kinder Morgan |
BBB-/Baa3 |
5.2 |
3.98 |
91% |
|
Williams Partners |
BBB-/Baa3 |
4.5 |
1.17 |
97% |
|
Williams Companies |
BB+/Ba2 |
5.25 |
1.4 |
97% |
Data sources: Kinder Morgan, Williams Partners, and Williams Companies. EBITDA = earnings before interest, taxes, depreciation, and amortization.
That table shows that these companies have conservative financial metrics for the pipeline sector and fairly predictable cash flow. That's good news for investors because it suggests that both can sustain their payouts. The the only significant difference is the fact that Kinder Morgan has a much higher distribution coverage ratio since it only plans to pay out about a quarter of projected 2017 cash flow via dividends. That decision is the primary reason why Williams Partners' current yield is much higher than Kinder Morgan's.
Image source: Getty Images.
The growth pipeline
These companies also boast similar growth potential. Williams Partners, for example, has $7 billion of expansions underway at its crown jewel Transco pipeline that runs along the Atlantic Coast from New York City to Texas. Projects entering service this year through 2020 should supply the company with $850 million of EBITDA on an annual basis. That represents 20% growth in adjusted EBITDA from its 2017 run rate. Meanwhile, the company has several additional projects in the pipeline not only along the Transco corridor but throughout its portfolio. Because of this, Williams Partners anticipates that it can increase its distribution to investors by 5% to 7% annually for the foreseeable future, which would drive 10% to 15% annual dividend growth for Williams Companies.
Kinder Morgan, meanwhile, has $11.7 billion of projects in its pipeline, including the massive Trans Mountain Pipeline expansion in Canada. Likewise, these projects should supply the company with a growing stream of cash flow as they enter service over the next several years, with the company anticipating that its fee-based projects alone could supply it with an incremental $1.5 billion of annual adjusted EBITDA by 2020. That represents similar 20% growth from its current earnings run rate. While the company has yet to put out a long-term dividend growth forecast, Kinder Morgan could potentially be a gold mine for income investors depending on the percentage of future cash flow it decides to pay out via dividends.
Price is what you pay; value is what you get
While Kinder Morgan and Williams Partners offer investors a similarly sound financial profile and healthy growth prospects, there is one area where these pipeline giants differ greatly. That's in the fact that no matter how we slice it, Kinder Morgan is much cheaper than Williams Partners these days:
|
Company |
Enterprise Value-to-Adjusted-EBITDA Ratio |
Enterprise Value-to-DCF Ratio |
Price-to-DCF Ratio |
|---|---|---|---|
|
Kinder Morgan |
11.2 |
17.9 |
9.4 |
|
Williams Partners |
12.4 |
20.0 |
13.3 |
Data sources: Kinder Morgan, Williams Partners, YCharts, and author's calculations.
Kinder Morgan currently trades at a historically low value -- well below not only where Williams Partners trades, but cheaper than other energy infrastructure giants, too.
Another way to put Kinder Morgan's valuation into context with Williams Partners' is to compare their free cash flow yields, which is what these companies would yield at their current trading price if each paid out 100% of distributable cash flow. In Williams Partners' case, it expects to generate about $2.80 per unit in distributable cash flow this year, which at its current $37.25 unit price implies a 7.5% free cash flow yield. Kinder Morgan, meanwhile, expects to produce $1.99 per share in distributable cash flow, indicating that it's selling for a 10.7% free cash flow yield at its current $18.50 share price. That's a remarkably high yield for a rock-solid company like Kinder Morgan.
Investor takeaway
While yield-starved investors might still prefer to buy Williams Partners, they're paying a premium for its higher yield. That premium isn't worth it, in my opinion, since Kinder Morgan has a similarly strong financial profile and growth potential, all for a much lower value, which makes it the better buy right now.
