The energy market is in transition. The global economy is slowly weaning itself off fossil fuels and switching to cleaner power sources. That shift will take some time. Many expect a slow and steady transition, fueled in part by natural gas.
With that in mind, two of our energy contributors staged a friendly debate over whether gas pipeline kingpin Kinder Morgan (KMI 0.40%) is a better buy these days versus clean energy upstart NextEra Energy Partners (NEP 1.41%). Here's what they had to say.
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Resilient earnings
Daniel Foelber (Pipelines-Kinder Morgan): Kinder Morgan isn't the flashiest company. Nor is it trying to be. As one of the largest natural gas pipeline companies in North America, Kinder Morgan is focused on generating stable and reliable distributable cash flow (DCF) which it then uses to fund its dividend. Dividends give Kinder Morgan's investors a steady stream of income without having to sell its stock. Therefore, investors should view Kinder Morgan primarily as a good way of generating investment income, rather than as a means of beating the market.
To achieve predictable DCF, Kinder Morgan writes long-term contracts with its customers, which helps reduce uncertainty. Kinder Morgan showed the effectiveness of this business model in 2020. So far this year, Kinder Morgan has taken only minor hits to its revenue and earnings and has raised its dividend by 5%. Compare that to droves of bankruptcies and dividend cuts throughout the energy sector.
Since 2015, Kinder Morgan has made it clear that it's only interested in purposeful growth that will generate positive cash flow to support the dividend. The result has been an impressive increase in DCF and decreased spending.
Kinder Morgan recently released guidance for 2021. It predicts DCF to be 3% lower than in 2020. But at an estimated $4.4 billion, the company's DCF would still be a whopping $1.2 billion in excess of its dividend payments and discretionary capital (like debt repayments and expansion capital for joint ventures). Kinder Morgan's treasure trove of extra cash means that investors can count on a dependable dividend even in times of lackluster growth.
Purposeful investments
As secure as Kinder Morgan's long-term contracts are, they will end. The main bearish argument is that demand for natural gas will decrease over the long term, which could mean less favorable contracts going forward. Kinder Morgan expects renewables to grow and take market share away from coal and oil, but not so much natural gas. In fact, it expects U.S. natural gas demand to grow, driven mainly by liquefied natural gas (LNG) exports, increased use of natural gas in industrial processes, and exports to Mexico. Other agencies like the U.S. Energy Information Administration (EIA) support Kinder Morgan's optimism. After a rough 2020, the EIA predicts U.S. LNG exports will rise 30% in 2021. If its planned and proposed projects are completed on schedule, the U.S. could become the largest LNG exporting nation as early as 2024.
Kinder Morgan's investments demonstrate its confidence in a growing U.S. LNG export market. Its Permian Highway Pipeline project is expected to go into service in early 2021, transporting natural gas from West Texas to LNG export terminals along the Gulf Coast. Many of the world's largest economies (like China, Japan, and South Korea) are energy-dependent and need natural gas. Lacking international pipelines, these countries take advantage of their expansive coastlines by importing LNG, processing it through regasification terminals, and then transporting it through a network of national pipelines.
Kinder Morgan may not be a fast grower, but its investments are purposeful and support its long-term strategy of generating DCF to support its dividend. With a dividend yield of 7.1%, Kinder Morgan is arguably one of the safest and most attractive energy dividend stocks on the market today.
A high-powered growth engine
Matt DiLallo (Renewable energy-NextEra Energy Partners): I agree with Daniel that Kinder Morgan is a cash flow machine. I've owned it for years because I think management does a great job allocating its cash flow, which includes paying the aforementioned high-yielding dividend. However, while I'm content to continue owning Kinder Morgan for that payout, I'm reluctant to buy more shares. The reason being: Kinder Morgan just isn't growing. As Daniel mentioned, Kinder Morgan expects cash flow to decline 3% in 2021, and that's on top of a 10% decrease this year. Meanwhile, 2022 probably will be more of the same because the company is cutting its growth spending due to a lack of attractive investment options.
Contrast this rather dim outlook with what NextEra Energy Partners sees ahead. Like Kinder Morgan, the company owns natural gas pipelines that generate steady cash flow backed by long-term contracts. However, that's less than a third of its business. The rest is renewable energy assets like wind farms and solar energy generating facilities. The company sells this power via fixed-rate power purchase agreements that also generate steady cash.
That focus on the fast-growing renewable energy sector has paid big dividends for NextEra Energy Partners:
NEP Total Return Level data by YCharts
That's outperformance is worth noting since neither company plans to deviate from their recent strategies.
In NextEra Energy Partners' case, it intends on using renewable energy as the primary power source to keep growing its dividend, which currently yields 3.8%. While that's not quite as high as Kinder Morgan's payout, what NextEra Energy Partners' dividend lacks in size it more than makes up for in growth potential. The company currently expects to grow its dividend at a 12% to 15% annual rate through at least 2024.
Powering that ambitious plan is its ability to acquire additional clean energy assets from its parent, leading utility NextEra Energy (NEE 3.39%). That company has the largest renewable energy portfolio on the planet and an even bigger backlog of new projects. Because of that, it has a vast inventory of assets it can steadily drop down to its affiliate, using the cash it receives to reinvest into new projects.
The only concern I have with NextEra Energy Partners is its balance sheet. The company has a fairly high leverage ratio and sub-investment grade credit. However, that hasn't stopped NextEra Energy Partners from accessing capital to fund its growth. It has tapped various private capital sources, like private equity funds and asset managers, that have provided it with creative funding solutions. As long as this private market funding option remains available, the company shouldn't have any problem achieving its bold dividend growth plan. I don't foresee any issues here, given its ties to renewable energy powerhouse NextEra and the growing demand for renewable-backed investments. That sets it on a course to generate strong total returns that will likely outpace Kinder Morgan's over the long-term.
Invest in what matters more to you
While Kinder Morgan and NextEra Energy Partners both pay high-yielding dividends, they offer investors differing return profiles. Kinder Morgan is primarily an income play because its main attraction as an investment is its stable, high-yielding dividend. On the other hand, NextEra Energy Partners offers the promise of higher total returns if it can deliver on its ambitious renewable-powered dividend growth plan. Because of that, the better stock to buy comes down to whether you desire reliable income or are willing to take on slightly more risk for higher upside potential.
