If you are looking for dividend stocks, then the downturn in the midstream oil and natural gas sector is fertile ground for high-yield investment opportunities. Industry giant Kinder Morgan, Inc.'s (KMI -0.06%) recently announced plans to more than double its dividend between 2018 and 2020 might be the type of news that catches your attention, for example. However, don't jump at those planned dividend increases until you take a look at ONEOK, Inc. (OKE -1.02%), which appears to be a better stock for dividend investors.
A quick look at Kinder
Kinder Morgan is one of the largest midstream players in North America. It has a largely fee-based business and a long history of successful operation and expansion.
However, there's a larger story here that every dividend investor needs to understand. Kinder had difficulty accessing the capital markets to fund its growth plans after oil prices cratered in mid-2014. As a result, it chose to cut its dividend by a massive 75% in 2016.
That dividend cut is the backdrop to the current round of dividend hikes. In fact, even after the pipeline company has increased its dividend from the $0.50 per share per year it paid in 2017 to $1.25 in 2020, the absolute value of the dividend will still be lower than it was prior to the dividend cut. Yes, the yield will be around 8% in 2020, based on Kinder's current stock price, but that's not the complete story.
Which leads to a bigger question -- why did Kinder need to cut the dividend? The short answer is to fund its growth plans while it was having trouble accessing the capital markets. The longer, more troubling answer is leverage. In 2016 Kinder's debt to EBITDA ratio rose to more than nine times. That's an unhealthy number that suggests the dividend cut was the right move for the company, even if it was a painful one for dividend investors who were counting on that income. The company has done a solid job of managing its leverage since that peak, dropping the debt to EBITDA ratio to around 6.5 times by the end of 2017. But that's still relatively high compared to peers like ONEOK.
A better dividend option
ONEOK is a smaller company, but still a material player in the North American midstream space. It offers a current yield of around 5.4% (Kinder's current yield is roughly 3.3%) with plans for 10% annual dividend growth through 2021. Based on those dividend growth projections, the yield will be roughly 7.4% in 2020 using today's stock price.
That's a little lower than what Kinder will offer, but you get to collect the larger dividend between now and then. There are two more little nuances. First, ONEOK has increased its dividend for 16 consecutive years. Kinder Morgan clearly can't match that.
And then there's leverage. ONEOK ended 2017 with a debt to EBITDA ratio of around 4.9 times. That's notably less than Kinder's, suggesting that ONEOK has more leeway to deal with hard times if they come around again. Interestingly, ONEOK's leverage peaked at the start of 2016 at roughly the level Kinder is supporting today. ONEOK is looking to reduce leverage further as well, so that metric should improve over time.
Slow and steady wins the dividend race
At the end of the day, income investors who buy ONEOK over Kinder will get a higher yield today at a pipeline company with plans for robust dividend growth, less leverage, and a stronger history of rewarding investors. Sure, you'll be giving up the potential for a higher yield in 2020, but the income between now and then coupled with a less leveraged capital structure is the type of trade off that will let you sleep well at night. This isn't to suggest that Kinder is a bad pipeline company -- that's not the case. However, if dividends are what you're looking for, ONEOK appears to be a better option when you look at the larger picture.