Nobody likes a dividend cut. Not management, not investors, and certainly not the stock market. But sometimes it's unavoidable.
That's what happened to U.S. oil and gas pipeline operators Kinder Morgan, Inc. (NYSE:KMI) and master limited partnership (MLP) Plains All American Pipeline (NYSE:PAA) in 2016. Both made a major dividend/distribution cut. Both stocks took a hit. And neither one has recovered: Plains All American is down 53.3% over the last three years, while Kinder Morgan is down a painful 63.1%.
But what goes down can sometimes come back up. Let's look at which of these beaten-down pipeline industry heavyweights is the better buy today.
Since their respective dividend/distribution cuts have a lot to do with where the companies' shares are trading today, let's get into the nitty gritty.
In early 2016, Kinder Morgan cut its annual dividend by more than 75%, from $2.04/share to just $0.50/share. The company's cash flow was expected to increase modestly throughout the year, but management made the tough decision in order to fund its expansion capital requirements without going further into debt and destroying its investment-grade credit rating.
Plains All American, on the other hand, went through a "simplification" process in 2016 that, despite its name, was actually very complicated. Briefly, it involved assuming the debts of an affiliate of its general partner in exchange for elimination of its incentive distribution rights, among other things. The upshot was that the partnership's distribution was cut by 21% from $2.80/unit to $2.20/unit in exchange for a much healthier balance sheet. Unfortunately for Plains All American, it had to cut its annual distribution again in 2017, this time by 45% to $1.20/unit. Once again, this was part of a debt reduction plan.
Currently, Plains All American's yield is much higher than Kinder Morgan's -- unsurprising, considering MLPs have special tax status that almost always result in high yields -- at 7%. But Kinder Morgan has announced it's increasing its dividend by 60% this year, with the first boosted payout coming in mid-May. At the current share price, that would be a roughly 5.2% yield. And that increase, coupled with Plains All American's double distribution cut, gives Kinder Morgan a win in this category.
Winner: Kinder Morgan
Since debt was a big consideration for both companies, let's take a look at their current balance sheets to see how they're doing.
Energy infrastructure companies like Kinder Morgan and Plains All American Pipeline often use debt to finance massive projects like pipelines and terminals: there would simply be no other way to finance such projects within reasonable amounts of time. High amounts of debt are the rule in this industry, rather than the exception. But generally speaking, a net debt load of 5 times EBITDA is considered to be the upper limit of what's acceptable. Companies that have higher debt levels usually see their credit ratings suffer, and as a result need to pay higher interest payments on their debt, which further hurts the bottom line and can jeopardize dividend or distribution payouts, or growth projects.
Kinder Morgan is currently sitting right at that threshold, with a net debt to adjusted EBITDA ratio of 5.05 times. But, according to CEO Rich Kinder, the company is committed to getting that number lower.
[W]e remain committed to continuing the important work of strengthening our balance sheet and attaining a Net Debt-to-Adjusted EBITDA ratio of at or below five times. For the foreseeable future, we expect to continue funding all growth capital through operating cash flows with no need to access capital markets for growth capital.
Plains All American is in slightly better shape, with a net debt to adjusted EBITDA ratio of 4.6 times, but the partnership is similarly committed to reducing that figure. During the most recently reported Q4 2017, Plains reduced its total debt by $1.5 billion. It has also identified a target long-term debt to adjusted EBITDA ratio of 3.5 times to 4 times, which it expects to achieve by 2019. And if the partnership can continue to execute its strategy well, that should be easily doable.
Winner: Plains All American Pipeline
So the score is 1-1 going into the final metric, which is valuation. Both of these companies have taken some lumps from the market: does one look like more of a bargain than the other?
Here's how the two compare on some standard valuation metrics:
|Metric||Kinder Morgan||Plains All American Pipeline|
|Enterprise Value to EBITDA (Trailing Twelve Months)||12.1||14.3|
|EV to EBITDA (Forward)||9.9||12.5|
|Price to Earnings Growth (Forward)||0.002||0.4|
|Price to Cash Flow from Operations Per Share (TTM)||7.6||6.9|
I use EV to EBITDA rather than a standard PE ratio because EV to EBITDA strips out depreciation, which is always a major expense for infrastructure companies. As you can see, we have something of a mixed picture here. Kinder Morgan's EV to EBITDA is lower on both a trailing and forward basis (lower is better). Its forward PEG ratio is also lower. But its price to CFO is slightly higher on a trailing basis.
Both companies look undervalued by these metrics compared to many of the other players in the midstream pipeline space. But Kinder Morgan looks to have a slight edge here, at least for now.
Winner: Kinder Morgan
And the winner is
By virtue of its recent dividend increase and slightly superior valuation metrics, Kinder Morgan edges Plains All American by a nose to claim the title of better buy. However, that doesn't necessarily mean that Plains All American is a bad company: far from it. Both of these oil and gas infrastructure gems have excellent yields, good growth prospects, and attractive valuations. You could probably even feel comfortable buying a bit of both.