Energy Transfer Partners (ETP) and Kinder Morgan (KMI 0.27%) are two of the biggest natural gas pipeline companies in the country. Kinder Morgan leads the way by operating the largest gas transmission network in North America, with more than 70,000 miles of pipelines, though Energy Transfer isn't too far behind, owning about 61,000 miles of gas pipelines. Overall, both networks generate predictable revenue streams, enabling these pipeline giants to collect billions of dollars in cash flow each year.
Despite those similar businesses, these two companies couldn't be more different in how they allocate their cash flow for investors. That contrast could make a meaningful difference in how much wealth these companies create for their investors in the coming years.
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Digging into the cash flows
Kinder Morgan recently closed the books on 2017, generating $4.48 billion of distributable cash flow (DCF). The company used that money to pay $1.1 billion in dividends to support its 2.9%-yielding payout, invested about $2.9 billion into growth projects, and had roughly $380 million to spare. The company allocated about $250 million of its excess to repurchase shares and used the rest to pay down debt. Meanwhile, the pipeline giant has a slightly different capital allocation strategy for the $4.57 billion of DCF it expects to produce in 2018. It plans to spend $2.2 billion on expansion projects and pay $1.8 billion in dividends -- 60% higher than last year -- leaving it with about $570 million in excess cash that it could use on additional share repurchases or invest in more high-return growth projects.
While Energy Transfer Partners hasn't reported its full-year results from last year, nor provided an outlook for 2018, we still get a good flavor for its capital allocation strategy. Through the third quarter, the pipeline giant had generated $2.95 billion of DCF and distributed $1.8 billion to investors in support of its 12.4%-yielding payout and sent a net $722 million to its parent Energy Transfer Equity (ET -0.19%). That left it with roughly $425 million to finance a small percentage of its expansion budget. However, the company wouldn't have generated any excess cash if Energy Transfer Equity hadn't agreed to give up a portion of its management fees.
With nearly all of Energy Transfer's cash either going back to investors or heading to its parent, the company has had to work hard to secure funding for its roughly $10 billion expansion plan. Among the many levers pulled to access capital was issuing $1 billion of equity last August, even though it had lost a third of its value in the past year, which made for a highly dilutive offering that increased the unit count nearly 6%. The company will probably continue diluting investors in the future so it can keep expanding.
Contrast that approach with Kinder Morgan, which doesn't require any outside capital to finance growth. In fact, by paying out a smaller portion of its cash flow, and not sending money to a parent, the company has the flexibility to repurchase shares, with its current authorization potentially reducing the share count by 5% over the next three years. This balanced strategy should create more value for shareholders in the long term.
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A look at who owns what
One reason Kinder Morgan's focuses on creating value for shareholders is that management owns 14% of the company, which helps align the management team with investors' interests. That's why, when the stock started tumbling in late 2015 as oil market conditions deteriorated, the company chose to cut its dividend and divert that cash to finance growth projects instead of significantly diluting investors by issuing more shares to fund expansion.
Energy Transfer Partners, on the other hand, has continued issuing equity even as its valuation has tumbled. That might be because management owns a significant stake in parent company Energy Transfer Equity. CEO Kelcy Warren holds a 17.4% interest, making up the bulk of his net worth. Since Energy Transfer Equity makes most of its money from the management fees received from Energy Transfer Partners, which rise alongside the distribution, it creates an incentive to grow those fees at all costs, even if investors experience significant dilution in the process.
Focused on creating value for investors
Kinder Morgan prides itself on being run by shareholders, for shareholders. That's driving the company to allocate its cash flow to create value for investors through a combination of dividends, share repurchases, and growth projects. Energy Transfer Partners, on the other hand, sends an outsize portion of its cash flow back to its management-backed parent company, which hamstrings its ability to create value for investors. That's why I think investors should just forget about Energy Transfer's big yield and instead consider Kinder Morgan's more balanced approach, which I believe will create more value for shareholders over the long run.
