Better Buy: Kinder Morgan vs. Plains All American Pipeline

Pipeline companies Kinder Morgan (KMI 0.40%) and Plains All American Pipeline (PAA 0.58%) have struggled in recent years because of the energy market's downturn. Weakening oil prices cut into their cash flow, which put pressure on their balance sheets. These pipeline giants slashed their dividends in response -- twice in the case of Plains All American -- which caused their stock prices to crater.

However, both have made moves to shore up their financial situation in recent years. As a result, they're entering 2019 in their best position in quite some time, and they're becoming increasingly attractive options for income-seeking investors.

But after looking at their numbers, one stands out as the better pipeline stock to buy right now.

Image source: Getty Images.

A quick peek at their financial profiles

As mentioned, these pipeline giants have made significant strides to improve their balance sheets in recent years. Here's how they currently stack up:

Data sources: Kinder Morgan and Plains All American Pipelines. Note: Kinder Morgan's payout ratio assumes a 25% dividend increase in 2019.

As that table shows, Kinder Morgan and Plains All American have similar financial profiles. Both generate around 90% of their cash flow from stable sources and pay out about 50% of that cash flow in dividends.

Where things differ is on the credit side. While Plains All American has a lower leverage ratio, it also has a lower credit rating, including a "junk" rating from one agency. However, the company is working to get leverage down to its target level of 3.5 to 4 times debt to EBITDA by the first half of 2019, which would be a huge improvement from 5.6 in late 2017. Once that happens, it could be in line for an upgrade. Kinder Morgan, meanwhile, already achieved its 4.5 leverage target -- much better than 5.9 in late 2015 -- which recently won it a ratings upgrade from two agencies while putting it in line for a third in the first half of this year. That higher credit rating gives Kinder Morgan a slight edge in this category, since it will enable the company to borrow money at a lower cost than Plains All American in the future.

Considering their growth prospects

After a couple of down years, Plains All American and Kinder Morgan started growing earnings again last year. Kinder Morgan's cash flow rose about 5% in 2018 even though it sold a major pipeline system while Plains All American was on pace to increase earnings more than 20%. Meanwhile, both companies anticipate continued growth in 2019. In Kinder Morgan's case, it sees cash flow growth accelerating to 10% this year, while Plains All American expects at least another 10% earnings increase in 2019.

Looking further ahead, both companies have solid expansion prospects. Plains All American has several oil pipeline expansions in development, which could enable it to continue growing cash flow at a healthy pace over the next few years. Meanwhile, Kinder Morgan has a few large-scale projects under way and several more in the pipeline.

What sets these two companies apart, however, is their opportunity set. Plains All American's main focus is on oil pipelines, which represents a $321 billion market opportunity over the next decade and a half. Kinder Morgan, on the other hand, not only has exposure to the oil pipeline market but the even bigger gas infrastructure segment, which boosts its opportunity set up to $800 billion. That diversification gives Kinder Morgan an edge.

Comparing their valuations

Investors have punished these pipeline stocks in recent years, with both down more than 60% from their peaks in 2015. They therefore trade at much cheaper valuations now that their earnings are on track to hit record levels in 2019. 

In Kinder Morgan's case, it's on pace to haul in $2.20 per share in cash flow this year. With shares currently trading at around $17.75 apiece, the stock sells for just 8 times cash flow. Plains All American, meanwhile, was on track to earn $2.25 per unit last year and should grow that number by at least 10% in 2019. Its units currently sell for about $23.25 each, giving it a valuation multiple of around 9 times cash flow. Since the peer group average is closer to 10 times cash flow, both are cheap on a relative basis, though Kinder Morgan's stock is cheaper than Plains All American's.

Verdict: Kinder Morgan is the better buy

Both pipeline companies have come a long way in recent years. However, Kinder Morgan is one step ahead of Plains All American in many ways, since it has a higher credit rating, better long-term growth prospects, and a cheaper valuation. Add in the fact that Kinder Morgan's dividend yield will soon be up to 5.6% after it officially announces a 25% increase in 2019 -- compared with Plains All American's current 5.2% yield, which, admittedly, could also head higher in 2019 -- and it's the better buy right now.

Check out the latest Kinder Morgan and Plains All American Pipeline earnings call transcripts.