Oil and natural gas midstream giant Kinder Morgan Inc. (NYSE:KMI) just announced plans for a 60% dividend increase in 2018. That increase is to be followed by 25% increases in 2019 and 2020. That sounds great, but it still doesn't get the company's dividend back to where it was before the 2016 dividend cut, a move partially driven by a heavy debt load. And that's why Enterprise Products Partners L.P. (NYSE:EPD) and Magellan Midstream Partners, L.P. (NYSE:MMP) are better buys.
The back story of a dividend cut
Toward the end of 2015, Kinder Morgan announced that it expected to increase its dividend in 2016. Management explained that it was committed to "continue to return cash to our shareholders in increasing amounts." Just a month or so after those statements, however, Kinder Morgan slashed its dividend a massive 75%.
That was a tough decision and was probably the right choice for the business. A deep downturn in the energy industry had left the company short of the cash it needed to keep investing in its growth projects. A big part of that cash shortfall, however, is related to debt. The company's debt-to-EBITDA ratio peaked at around 9.5 in early 2016. Although debt isn't as big a deal at this point, as debt to EBITDA is down to around 6.6, Kinder is still more leveraged than many of its peers. If you want to avoid any further surprises, you might want to consider midstream players such as Enterprise and Magellan that aren't as leveraged.
Just as big
One of the things to like about Kinder Morgan is its size and diversification. Enterprise Products Partners is every bit as large and diversified, if not more so. More notable, Enterprise's debt-to-EBITDA ratio is around 4.4, meaning it's nowhere near as leveraged as Kinder Morgan. That helps explain why Enterprise was able to keep investing in its business right through the energy industry downturn without the need for a distribution cut.
In fact, Enterprise kept increasing its distribution every quarter right through the downturn. Its annual streak is up to 20 consecutive years, within which is a 52-quarter streak of increases. And there's no reason to expect that streak to end anytime soon. For example, distribution coverage was roughly 1.2 in the second quarter, providing ample coverage. And Enterprise has around $9 billion worth of growth projects currently in the works.
Enterprise probably won't excite you with distribution increases, which will average around 5% a year, just as they've averaged over the past decade. But with a yield of nearly 6.5%, compared with Kinder's 2.6%, that's really not a big deal. In fact, even after three years of huge dividend increases, Kinder's dividend yield, using today's price, will only be around what you can get from Enterprise today.
Fast and consistent
Another option to consider is Magellan Midstream Partners. This partnership is much smaller than Kinder and Enterprise. However, it is also much less leveraged. Its debt-to-EBITDA ratio is a measly 3.4. And like Enterprise, it managed to keep growing through the downturn without a distribution cut. Magellan's streak is up to 17 years. And, like Enterprise, it covered its distribution by a healthy 1.2 times in the second quarter.
Distribution growth at Magellan, meanwhile, is backed by around $1 billion in spending plans. It has another $500 million worth of projects that's it's considering adding to that total. And it recently set up an at-the-money equity program, which will allow it to tap equity markets for growth capital when it needs to -- helping it to avoid leveraging up with debt.
A key differentiator for Magellan is distribution growth, which has averaged around 11% on an annualized basis over the past decade. That's roughly twice as much as what Enterprise has historically offered and over three times as fast as the historical growth rate of inflation. The lowest debt; the highest distribution growth rate. Although the partnership's roughly 5.4% yield is slightly lower than Enterprise's yield, a notable yield with faster distribution growth is worth careful consideration.
The actions a company takes can speak volumes. And Kinder's decision to slash its dividend by a painful 75% isn't an action investors should forget -- especially since the company's leverage is lower, but still not as low as competitors such as Enterprise and Magellan. Since both offer high yields today and longer histories of increasing their distributions, I think most investors should forget Kinder Morgan, because these two partnerships are simply better high-yielding buys.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. The Motley Fool has a disclosure policy.
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