Midstream energy giant Kinder Morgan (NYSE:KMI) is offering investors a fat 7% dividend yield, while Plains All American's (NYSE:PAA) yield is even higher at nearly 10%. Dividend investors would be right to salivate at these yields, but there's more to know about this pair of pipeline operators before you jump aboard. In the end, one of these two names is clearly less desirable than the other. But that may not mean the other one is a great buy.
Oh no, not again!
Plains All American has something of a troubled past when it comes to shareholder distributions. When the energy sector fell upon hard times between mid-2014 and early 2016, the master limited partnership was carrying a heavy debt load. Add in weak operating results due to the energy downturn at the time, and the end result was a 20% distribution cut at the end of 2016.
A company needing to make adjustments to get back on a more solid path isn't a terrible thing. The world changes, and sometimes, companies need to change along with them.
The real problem is that the 20% cut the company made wasn't enough, and just a year or so later, Plains All American trimmed the distribution again, but this time, an even more painful 45%. (The total reduction was nearly 60% across the two cuts.) The takeaway is that management's original plan to get things back in order proved insufficient, which doesn't instill confidence.
Fast forward to 2019, when Plains All American increased the distribution by a whopping 20%. Investors probably thought that the partnership was finally on solid ground again. But the steep fall in oil prices in 2020 has again exposed the weaknesses here, resulting in a 50% distribution cut.
The big problem this time around is that Plains All American's supply and logistics business -- around 24% of 2019 earnings before interest, taxes, depreciation, and amortization (EBITDA) -- is highly sensitive to market conditions. With that business expected to fall well short of its 2019 results in 2020, management had little choice but to trim the distribution. In the end, dividend-focused investors looking for income stability won't find it in Plains All American.
A much stronger story
The story of Plains All American's distribution this year makes Kinder Morgan's 5% dividend hike in 2020 sound pretty impressive. To be fair, in some ways, that increase is a testament to Kinder Morgan's strength, noting that it covered its distribution by nearly 1.7 times in the second quarter.
Effectively, given the troubles in the energy sector, it wanted to provide investors with an increase but didn't want to overextend itself. In fact, during Kinder Morgan's second-quarter 2020 earnings conference call, CEO Rich Kinder explained, "We want adequate coverage of that dividend, and we want to make damn certain that once we do a dividend increase, that dividend increase is permanent and that we're not retracting that at some later date."
That might seem like a reassuring statement if you didn't know that Kinder had telegraphed a 25% dividend increase in 2020. Moreover, it comes as the midstream giant has been working to regain investor trust after it chose to trim its dividend a huge 75% in 2016. The story may sound familiar to what happened at Plains All American, with Kinder carrying heavy leverage during an energy industry downturn. Indeed, with access to capital limited, management had to choose between the dividend and its capital investment plans. The dividend lost.
In fairness, that was the right move for the company. Moreover, in 2017, it announced a multiyear dividend plan that included a series of massive annual increases. The final year of the plan was 2020 and a 25% dividend increase. Only, as noted above, the increase so far in 2020 has only amounted to 5%.
Kinder has stated that it remains committed to the full hike at some point in the future, though perhaps not in 2020. As the CEO clearly highlighted, the company is taking a conservative approach to make sure it doesn't end up cutting the dividend again and eroding the trust it has rebuilt over the last few years. So far, Kinder Morgan looks like a much better option than Plains All American.
The problem is that Kinder's financial debt-to-EBITDA ratio of around six times is near the high end of its peer group. That's pretty much the norm, with Kinder historically making greater use of leverage than more conservative peers.
While Kinder Morgan's balance sheet is in better shape today than it was in 2016, when financial debt-to-EBITDA spiked to around nine times, it hasn't exactly changed its core approach to leverage. There are far more conservatively leveraged options, like Enterprise Products Partners and Magellan Midstream Partners, that have similar or higher yields and, more to the point, decades of annual distribution increases under their belts.
An easy win but maybe not a buy
Looking at just Kinder Morgan and Plains All American, the clear answer is that Kinder Morgan is a better option. But for conservative dividend investors, Kinder Morgan's longer-term dividend history and continued heavy use of leverage compared to peers should cause concern. In the end, most will likely find that there are other options in the midstream space that are better than both Plains All American and Kinder Morgan.