The midstream sector of the energy industry has fallen out of favor on Wall Street, leaving both Enterprise Products Partners (EPD 0.45%) and Kinder Morgan (KMI -0.64%) with attractive yields. But as investors consider this pair of midstream giants, there's a backstory that has to be looked at.
If you are seeking to create a safe passive income stream, you'll probably be happier with the higher yielding of these two investments.
A pair of toll-takers
Both Enterprise and Kinder Morgan hail from the midstream sector. This means that they both own assets, like pipelines, that help to move oil, natural gas, and the products into which they get turned around the world. The key is that most of the revenue generated here is from fees for the use of these assets, so energy prices aren't the driving factor for these businesses. Demand, which tends to remain robust even when energy prices are low, is far more important.
Image source: Getty Images.
Thus, Enterprise and Kinder Morgan have fairly stable cash flows to back their big yields. Enterprise's distribution yield is currently around 7.2% while Kinder Morgan's dividend yield is roughly 6.6%. The longer-term problem here is that midstream companies grow by building new assets, which is an expensive and time-consuming effort. And, unfortunately, most of the best opportunities for new midstream assets have already been developed. So growth is likely to be modest going forward for both Enterprise and Kinder Morgan. The yield will likely represent the lion's share of the total return.
So as investors look at these two high-yield midstream options, it pays to consider the safety of that income stream. Today, there's a rough similarity. For example, Enterprise's distribution is covered by distributable cash flow at a rate of roughly 1.8 times while Kinder Morgan's figure is roughly 1.7 times. But there's a small historical wrinkle that shouldn't be ignored.
Two very different histories
Enterprise's distribution history is pretty easy to explain. It has increased the disbursement every year for 25 consecutive years. The master limited partnership rewarded unitholders very well for sticking around. Although distribution growth probably won't be huge, perhaps in the mid-single digits, if you couple that with the yield and the historical distribution track record, the overall story is pretty attractive.
KMI Dividend Per Share (Annual) data by YCharts
Kinder Morgan's history is quite a bit trickier to describe. As the chart above shows, the dividend was cut drastically in 2016. And while it has started to grow again, it remains well below pre-cut levels. Although the dividend looks to be on solid footing today, that's a much less exciting backstory. And there's still one more factor that has to be discussed.
Back in 2015, Kinder Morgan's management team was telling investors to expect a dividend increase of as much as 10% in 2016. And then, just a couple of months later, ended up slashing it. Then, in 2020, management forecasted a 25% dividend increase which it promised as part of a multi-year plan to, basically, regain investor trust. But when times got tough thanks to the coronavirus pandemic, management ended up raising the dividend just 5%. It wouldn't be the least bit surprising if more conservative dividend investors had trust issues when it comes to Kinder Morgan.
KMI Financial Debt to EBITDA (TTM) data by YCharts
There were logical reasons for each dividend shortfall, but one key difference between Kinder Morgan and Enterprise can be found on their balance sheets. Kinder Morgan has a history of using more leverage, which limits financial flexibility during difficult periods. As the chart above shows, Kinder Morgan's leverage is still higher than that of Enterprise. So while dividend coverage is similar, there's a fundamental difference in the ways these two midstream players operate that hints that one is a safer income bet than the other.
Higher yield, more reliable, and the better choice
Often a high yield is a sign of increased risk. In the matchup between Kinder Morgan and Enterprise Products Partners, that doesn't appear to be the case, at least if you value income reliability. In the end, these two midstream players are similar in many ways, but the few ways that they aren't (dividend history and leverage) will probably lead most income investors to favor Enterprise. That you get a substantially higher yield is just icing on the cake.
