There's nothing like a solid dividend stock for an investor looking to add stability to their portfolio. Energy stocks generally offer high dividend yields, and pipeline behemoth Kinder Morgan (KMI +0.82%) and midsize player Magellan Midstream Partners (MMP +0.00%) are no different. Compared to an S&P 500 index fund's yield of 1.76%, Kinder Morgan currently yields nearly triple, and Magellan yields nearly quadruple.
Although both pipeline stocks offer high yields, Kinder Morgan and Magellan are quite different in both their business structures and history of dividend payments, revealing one stock as the better buy.
Different strokes for different structures
A good investment means more than just a high dividend, which is why it's vital to understand the different structures of Kinder Morgan and Magellan. Magellan is a Master Limited Partnership (MLP), and Kinder Morgan is a corporation, although Kinder Morgan used to be a general partner with limited partnership(s) under its umbrella before buying out all of its subsidiaries in 2015.
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MLPs differ from corporations in a few key ways. If you buy a share of Magellan, you are considered a partner or unitholder, not a shareholder, which is why MLPs are designed to pass income through to their unitholders in the form of a distribution. These distributions can end up being quite large if management decides to pass most of the distributable cash flow (DCF) to the unitholders.
Another key difference is that corporations pay taxes on earned income even if they distribute it in the form of a dividend, whereas MLPs do not. Shareholders who receive the already taxed dividend from a corporation also pay taxes on the dividend, hence the term "double taxation." When MLP unitholders receive distributions, they pay taxes on them just as a partner in a restaurant business would pay taxes on the profits from the business. Similarly, Magellan doesn't have to pay taxes on the portion of its earnings it distributes to unitholders; only the unitholders do. In essence, the benefits of structuring an entity as an MLP is that it reduces the overall tax burden to stakeholders.
Dividend breakdown and comparison
Kinder Morgan's 2015 buyout of both of its MLPs, Kinder Morgan Energy Partners, L.P. and El Paso Pipeline Partners, L.P., as well as the management company Kinder Morgan Management, LLC., streamlined the pipeline giant's business. However, the strength of the dividend has been in question since late 2015 when Kinder Morgan slashed its dividend by 75% during the oil market downturn.
To illustrate, Kinder Morgan paid a $0.51 quarterly dividend in Oct. 2015, which was then cut to $0.125 a quarter until April 2018 when the company started raising the dividend again. Kinder Morgan's most recent quarterly dividend was $0.25, about half of what it used to be but at least higher than a few years ago.
On the contrary, Magellan has been able to increase its distribution every quarter since 2001 and pay out a substantial portion of its distributable cash flow, as is custom for MLPs.
Magellan's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the nine months ended Sept. 30, 2019, was $1.147 billion, and its DCF was $939.6 million.
DCF takes into account such things as maintenance capital and interest expense, excluding debt issuance and cost amortization, to get a more accurate reading on the cash available to distribute to shareholders. For the nine months ended Sept. 30, 2019, Magellan paid out $688.6 million to unitholders with another $233 million paid on Nov. 14, keeping Magellan on track to increase distributions by 5% in 2019 as management had initially targeted.
By comparison, Kinder Morgan had an adjusted EBITDA of $5.598 billion and DCF of $3.639 billion for the nine months ended Sept. 30, 2019. DCF per common share was $1.60, but dividends per common share were less than half of that at $0.75 for the nine months ended Sept. 30, 2019. That's because, as a corporation, Kinder Morgan is retaining earnings to grow its integrated midstream business consisting of gas processing, transportation, and storage.
Magellan is mostly a pipeline company that has historically distributed the vast majority of its DCF, but the difference between DCF per unit and payout has been growing over the past three years. Still, though, Magellan's recent distribution of $1.02 per unit from a total DCF of $1.34 gives Magellan unitholders a higher percentage of DCF than Kinder Morgan shareholders.
The MLP dividend aristocrat
Investors are presented with two attractive stocks in Magellan and Kinder Morgan. Magellan has shown no signs that it will slow down its distribution growth, and Kinder Morgan seems to be picking itself back up from a disappointing dividend cut in 2015.
The investment thesis for both stocks lies in their dividends more so than potential capital gains available in successful growth stocks. Kinder Morgan retains more earnings and therefore has more capital to grow than Magellan, but Magellan is three times smaller and yields 6.6% compared to Kinder Morgan's 4.9%. Since inception on the public markets, Magellan has proved to investors that it is committed to increasing distributions time and time again, despite the ups and downs of market cycles.
On the other hand, Kinder Morgan's track record signals that the company could halt dividend hikes or even cut the dividend again. Even though Kinder Morgan is the more established and larger midstream company, Magellan gets the edge for its stable dividend. Both companies could be considered at this point, especially for investors who think the market will stall near its current all-time high, thereby making a shift into dividend stocks and away from stocks that rely solely on capital gains a savvy investment strategy.
