Buckeye Partners, L.P. (BPL) and Kinder Morgan, Inc. (KMI 0.23%) are two of the best known players in the midstream sector. Income investors will probably be attracted to Buckeye's 9% yield, while dividend growth investors will likely favor Kinder Morgan's plan for material dividend hikes this year and next. But there's more to know -- a lot more -- before you buy either of these midstream names.
A poor use of capital
Master limited partnership Buckeye Partners embarked on a diversification plan a few years ago. A key piece of the process was acquiring a 50% stake in a foreign energy storage facility owner called VTTI for $1.15 billion in early 2017.
Although Buckeye's history stretches all the way back to 1886, today it is a modest-sized midstream player with a market cap of roughly $10 billion, so the VTTI acquisition was a fairly large transaction. Included in the agreement was an additional capital infusion of around $200 million to facilitate VTTI's acquisition of a controlled partnership.
The goal of this deal was to expand Buckeye's reach globally, increasing its opportunities for growth. Much of the deal, however, was financed with debt. New units were issued as well, which required more cash for distributions. The extra leverage strained the partnership's balance sheet at a time when it was also looking to invest in domestic pipeline assets, and the additional units were a further drain on cash flow. With limited financial flexibility, the company was forced to get creative to fund its growth plans, including selling units that contained a payment in kind provision (allowing Buckeye to issue units instead of paying cash distributions).
Despite aggressive efforts to maintain the distribution and repeated promises that it would continue to pay out, Buckeye couldn't keep paying the disbursement, and cut it a touch over 50% in late 2018. Worse, management agreed to sell its VTTI stake for $975 million in early 2019 -- notably less than what it paid to acquire it roughly two years earlier. Essentially, Buckeye's management team made a terrible asset allocation call and unitholders took the hit, suffering a distribution cut and watching shares fall around 50%. Although there's recovery potential here, as Buckeye starts the process of digging itself out of the hole it created there are material trust issues that shouldn't be ignored. Most investors would be better off avoiding the partnership.
Don't forget the past
Compared to Buckeye, giant Kinder Morgan looks like an easy buy call. Although the yield is relatively small at just 4%, that has to be considered within the company's larger plan to increase the payment to $1.25 a year in 2020. The annualized rate in 2018 was $0.80 a year, so there's material dividend growth to come. And using the $1.25 figure and the current share price suggests a potential yield of roughly 6.25%, which should be much more enticing to income investors.
The only problem is that, like Buckeye, there's some history here -- including a 75% dividend cut in 2016. That cut came after management told investors to expect a dividend increase of as much as 10%. The reason for the cut was, effectively, Kinder's aggressive use of leverage, an approach that has long separated it from more conservative peers. When capital markets weren't available to help finance the company's growth plans, it had to choose between supporting the dividend or cutting it and using the freed up cash for investment. Cutting the dividend was probably the right move for the company, but investors counting on that income were blindsided because of the company's statements regarding the dividend's health.
One of the largest and most diversified midstream companies, Kinder is in much better shape today than Buckeye. And the dividend is clearly heading higher again as management continues to find growth projects to power the company into the future. However, leverage remains toward the high end of the industry, so there's still just as worrying a trust issue here as there is with Buckeye. Essentially, it appears that Kinder Morgan hasn't fully changed its ways, even though it is in better financial shape than it was leading up to the dividend cut.
Not a hard call
If one were forced to pick between Buckeye and Kinder Morgan today, the easy choice would be Kinder Morgan. It is, after all, back on the dividend growth track, and investing is about the future, not the past. However, sometimes, history provides important context. Kinder Morgan and Buckeye's shared history of distribution cuts makes them both troublesome choices. Most investors would be better off avoiding both of them. Indeed, there are too many other options in the midstream space, many of which are very good at running their businesses and rewarding investors, to bother with Kinder Morgan or Buckeye.