There are just a small number of really, really large midstream companies in North America that have the heft to be consolidators in an industry that's facing material growth headwinds. Two of the most notable names on the U.S. side of the border are Enterprise Products Partners (NYSE:EPD) and Kinder Morgan (NYSE:KMI). Which one is the better buy? That's a tough call; here's why.
You might want to, despite the history
Kinder Morgan cut its dividend in 2016 after telling investors to expect a dividend increase of as much as 10%. That has created a trust issue that I have a hard time getting past. But I also recognize that management has made great strides to earn back investor trust and, for anyone looking at the midstream space today, it deserves to be considered. In fact, at this point, there's little doubt in my mind that the company can support the dividend it's paying. If you have an open mind and can forgive past transgressions, it's worth a closer look.
Notably, Kinder Morgan has increased its dividend every year since 2018. Basically, it used the 2016 dividend cut to help reset the business, reducing leverage while still investing in its business for growth. Since that point, the dividend has increased from $0.125 per share per quarter to $0.27. The last increase, in early 2021 at roughly 3%, was a little light, but that's not shocking given the energy sector backdrop and ESG headwinds today. In fact, you might view it as a prudent decision that helps ensure the integrity of the dividend going forward, noting that Kinder Morgan's distributable cash flow covered its dividend by a hefty 1.6 times in the third quarter.
Meanwhile, the roughly $37 billion market cap giant has the heft to roll up smaller competitors that don't have the scale to compete long-term in a market that's facing material pressures. To be fair, its leverage is still notable, with a debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio of around 5.1. However, that's not out of line with other large peers, like Canadian giants Enbridge and TC Energy. With Kinder Morgan's dividend yield of 6.7%, investors looking for a way to play the out-of-favor midstream sector should take a look.
Going too slow?
This brings us to Enterprise Products Partners, which has increased its distribution annually for 24 consecutive years. That puts it one year away from Dividend Aristocrat status, an impressive milestone in the cyclical energy sector. The yield is roughly 8.3% and the distribution was covered by 1.7 times in the third quarter. Meanwhile, its debt-to-EBITDA ratio of 3.9 is lower than Kinder Morgan's. In fact, with its $48 billion market cap, Enterprise has a long history of making conservative use of leverage relative to its closest peers (like Kinder Morgan, it has the heft and diversification to be an industry consolidator).
However, distribution growth has slowed to a crawl over the past five years or so. To put some numbers on that, over the trailing-five-year period that annualized distribution increase was just under 3%. Over the past three years it dipped to under 2%. And the last increase was a miserly 1% or so. There's a reason for this shift, as Enterprise has been trying to hoard cash so it can self-fund more of its own growth efforts.
But at this point, it is no longer the distribution grower that it once was. Indeed, that last hike makes Kinder Morgan's 3% increase look pretty generous by comparison. The higher yield helps to make up for the slower distribution growth, but if dividend growth is what you are after, then Kinder Morgan probably has a leg up on Enterprise right now.
That said, there's one more wrinkle here. Enterprise is a master limited partnership (MLP), which is a corporate structure that is a bit more complicated than your traditional company. You'll have to deal with a K-1 form at tax time, and MLPs don't play well with tax-advantaged savings accounts. There are some benefits to the MLP structure, as well, including the ability to reduce taxable income, so the extra work could be worth it for some investors.
Still, the MLP structure might keep some investors away and push others to consult with a tax pro. And yet, if your goal is to maximize the income you generate, it's likely the better bet here -- but only if you are happy accepting that the 8.3% yield is probably going to represent the vast majority of your future performance.
The winner is...
As the midstream space consolidates, both Enterprise Products Partners and Kinder Morgan are likely to be net winners. The problem here is that there's no easy answer to the comparison of the two, since it really depends on your investment approach. If you are looking for dividend growth, then Kinder Morgan seems like a better choice, assuming you can look past the 2016 dividend cut that helped to reset the business. Its willingness to use more leverage, in fact, could actually be a net positive on the acquisition front, as long as it doesn't get too aggressive with its balance sheet.
If you are a conservative type looking to maximize the income your portfolio generates, however, then Enterprise Products Partners will likely win the day. You'll just have to go in knowing that distribution growth is likely to be modest, at best, from here -- and even when it does choose to buy assets, the partnership's conservative nature suggests that they may be more bolt-on deals than giant transformational events.