I made my first purchase of Kinder Morgan, (KMI +2.77%) through Kinder Morgan Energy Partners last year. I was initially interested in the company because of its tremendous position in the oil and gas industry, stable cash flow, and extremely high yield.
Now that Kinder Morgan has completed its consolidation, former KMP investors may be wondering whether to stick with their investment, given the fact they received a hefty premium for their units. Even though it is tempting to take profits, I fully intend to keep Kinder Morgan as a core holding through the acquisition period and beyond. Here's why fellow Fools should do the same.
Merger created substantial value for investors
Kinder Morgan is paying $70 billion to acquire Kinder Morgan Energy Partners and El Paso Pipeline Partners. KMP rallied after the merger announcement, which makes it tempting to sell at this price and cash out. But I fully intend to hold units long after the acquisition closes, because the deal will create substantial value for investors. First, it reduces Kinder Morgan's cost of capital by eliminating the incentive distribution rights. Incentive distribution rights are fees paid to the general partner of an MLP to share in the distributable cash flow provided by the partnership. Essentially, when an MLP has to pay incentive distributions, it means less distributable cash flow available for unit holders of the limited partnership. Eliminating IDRs is a great sign, as it will shave about $1 billion off the company's cost structure. Since master limited partnerships must effectively manage cost of capital, and Kinder Morgan operates a highly capital-intensive business, this will create value for investors.
Another reason I plan to hold Kinder Morgan for many years is because I believe the U.S. energy boom is just beginning. Production of oil and gas is still ramping up, and all this output growth will place a huge demand on energy infrastructure. That will make Kinder Morgan a big winner in the years ahead. This is already starting to show up in Kinder Morgan's financial results. Last quarter, the company's five businesses collectively produced $1.5 billion in earnings before depreciation and one-time items, up 10% year over year. Growth was led by increased demand for oil and natural gas transportation and storage.
Kinder Morgan should see continued growth. For evidence of this, consider that Kinder Morgan has an impressive backlog of expansion opportunities. This includes $3.3 billion in natural gas projects set for 2017 and beyond, such as the need for transport capacity from the Marcellus and Utica shale plays to growing areas of demand near the Gulf Coast. Kinder Morgan has also identified $5.4 billion in projects in Canada in the same time frame. In all, Kinder Morgan has identified nearly $18 billion in organic growth projects, which is spread across its business segments. This signifies that there is plenty of growth left in the company's pipeline.
One of my favorite aspects of owning Kinder Morgan is its incredibly reliable cash flow, driven by its focus on stable, fee-based assets. Kinder Morgan's business operates much like a toll road. It collects fees based on the volumes of oil and gas it treats and transports. As a result, it's not particularly sensitive to changes in commodity prices. This makes it less volatile than most oil and gas companies.
Hold Kinder Morgan for the long term
Another of my favorite reasons for owning Kinder Morgan Energy Partners is its high distribution yield. Kinder Morgan Energy Partners' $5.60 annualized distribution gives me a 7.5% yield based on my cost basis, and that figure rose with each reinvested distribution. One reason why I might consider selling now is that Kinder Morgan is a lower-yielding stock than Kinder Morgan Energy Partners. This could compel investors to take the cash and search for a reinvestment opportunity with a similar yield as KMP, so as to not lose income.
But that would be a short-sighted decision, and long-term minded Fools should hold on. Kinder Morgan management said the combined entity under KMI will pay $2 per share in dividends next year. That represents 16% growth versus KMI's intended 2014 dividends. Through 2020, KMI intends to increase the dividend by 10% per year. This is approximately double KMP's average distribution growth per year. This means current KMP investors should hold through the acquisition because future dividend growth will make up for the loss of current income.
As a result, even though the significant acquisition premium and loss of income may seem like reasons for KMP unitholders to cash out, I intend to hold through the deal closing and for many years afterward. Kinder Morgan's growth opportunities, reliable cash flows, and high future dividend growth are too compelling to sell.
