The midstream niche of the energy industry has been hit hard by the coronavirus pandemic. Canada's Enbridge (NYSE:ENB) is down roughly 16% so far in 2020, while Kinder Morgan (NYSE:KMI), based in the United States, is off by 30%. However, with largely fee-based businesses, this pullback could be a buying opportunity for dividend investors. Here's what you need to know to compare these two industry giants.
Kinder Morgan's yield is roughly 7% today. That's generous, given that the yield of the S&P 500 Index, using SPDR S&P 500 ETF as a proxy, is roughly 1.6%. But Enbridge's yield, at 7.4%, actually edges Kinder Morgan out. For dividend investors looking to maximize the income their portfolios generate, that extra 40 basis points could be enough to tip the scales here. But in the grand scheme of things, the two midstream giants are on pretty equal footing yield-wise.
2. Dividend history
What really sets Enbridge apart is that it has increased its dividend annually for 24 consecutive years. Kinder Morgan has increased its dividend annually since 2018. But the real story is that the latter company cut the dividend 75% in 2016. In other words, for those that prefer companies with a proven history of returning value to investors via regular and growing dividend payments, Enbridge is the easy win.
But there's more to the story for Kinder Morgan. Without a doubt, cutting the dividend was the right move for the company. At the time, raising capital in the stock and bond markets was difficult, and the company had to choose between paying its dividend or investing in growth projects. Funding its capital spending plans obviously won. The problem here is that just a couple of months before it announced the dividend cut management was telling investors to expect a dividend increase of as much as 10%. All in all, there are some trust issues to consider here.
3. Dividend growth
Enbridge has been expanding its dividend rapidly over the past decade, with an average annualized increase of roughly 13%. However, over the past year the dividend was increased at roughly half that rate. Given the situation in the North American energy sector, it's more likely that dividend growth will be in the mid-single digits going forward than in the low teens.
That brings up Kinder Morgan, which increased its dividend 5% in 2020. That sounds pretty good, and roughly on par with Enbridge, until you find out that management was telling investors to expect a 25% hike before the year began. That was intended to be the capstone increase on a multi-year dividend growth plan laid out after the 2016 dividend cut, which was basically an effort to rebuild investor trust. But the global pandemic upended things. Kinder Morgan made the right call again by moderating the dividend growth plan, but investors worried that management has a history of breaking its promises might not be so pleased.
4. Dividend coverage
The key to Kinder Morgan's 2020 dividend decision is that it didn't want to end up in a position where it would have to cut the dividend again. That's a positive. And management has stated that it still wants to get to the intended dollar increase, but it might take longer than expected given the current market environment.
That said, the company had a solid distributable cash flow payout ratio of roughly 55% in the third quarter. So there's ample room for adversity here -- and, assuming the world gets back on its feet at some point, dividend growth. Enbridge targets a distributable cash flow payout ratio of around 65%, and has been around that level recently. Kinder Morgan looks stronger here, but not materially so.
5. The future
Enbridge and Kinder Morgan both have similar businesses, backed largely by a diversified portfolio of fee-based midstream energy assets. And they each have material footprints in North America, with portfolios that span the region. On that score, they are pretty similar. The bigger question for investors is what happens from here?
The answer is far from clear, given the supply/demand imbalance that's been created by the economic shutdowns being used to slow the spread of the coronavirus. Simply put, there's not likely to be material demand for new midstream assets in the near term. Some projects will continue to get built, and both Enbridge and Kinder Morgan have plans on that front. But it is highly likely that the future will see increased consolidation in the space.
The best-positioned companies will be large and financially strong, since that will allow them to buy out smaller players. But both Enbridge and Kinder Morgan sit at the high end of the sector when looking at the key leverage benchmark of financial debt to EBITDA. That said, Enbridge's financial debt to EBITDA ratio is currently just shy of 7 times, while Kinder Morgan sits at 5.7 times. Neither can afford to aggressively take on debt, but Kinder Morgan appears to have a little more room on its balance sheet than Enbridge.
For most investors looking for a dividend stock in the out-of-favor midstream space, the winner of this matchup is likely to be Enbridge. That said, if you are looking for the stock with more growth appeal, Kinder Morgan could end up being a slightly better choice given its lower leverage and strong dividend coverage numbers. However, if you take the dividend cut in 2016 and the less-than-promised 5% hike in 2020 into account, those wishing to err on the side of caution will probably still end up preferring Enbridge.