Recent Buy

A rising stock market is not my friend. More expensive stocks and higher valuations puts me in the unfortunate position where new capital does not go as far. Higher priced stocks provide an equity investor a lower percentage of ownership of said companies when purchased at a static dollar amount, and also provide a lower long-term total return and lower entry yield. A stock market that experiences drastic upward moves may look good on paper, as the portfolio value will inevitably follow the market’s march higher, but these increased stock values only serve you if you sell your stocks. As a dividend growth investor, my primary goal is to build an ever-rising dividend income stream from great companies with economic moats and strong fundamentals. That stream is hard to increase if I’m selling stocks.

This all being said, I also believe in finding value in all market conditions. I do not believe in market timing. If the DJIA falls 500 points tomorrow is it a good time to buy? How will you know? Maybe it’ll fall another 500 points the following day. I tend not to concentrate on the overall market valuations. I do use the DJIA, S&P 500 and Nasdaq numbers as rough overall guides to broad equity valuations, but it’s the individual companies I’m investing in, not the market. So, I decided to put further capital to work today.

As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.

I purchased 60 shares of Kinder Morgan Inc. (KMI) on 9/7/12 for $35.62 per share. This is a company that was high on my watch list for this month, and I decided to pull the trigger today.

As I recently discussed, KMI is an interesting stock. When buying KMI, you are buying into the General Partner of the Kinder Morgan Energy Partners Limited Partnership (KMP). With KMI, however you get a couple of advantages. You get none of the tax consequences (K-1 anyone?) that come with owning a Master Limited Partnership, but you still get to invest in the tax-advantaged business structure that is a MLP. You also get accelerated dividend growth when you invest in the GP, because of what’s called the Incentive Distribution Rights (IDR). A small drawback with investing in the GP is that the entry yield is typically lower than what comes with investing directly in the LP.

Kinder Morgan currently operates the largest natural gas pipeline network in North America. This investment gives my portfolio a holding in the natural gas/infrastructure industry. By investing in a pipeline, this gives me access to a business that effectively operates an underground energy highway that charges toll-like fees for use of its pipeline. 

An excellent article that defines how a Master Limited Partnership works, and how the General Partner can be a fantastic investment is here:

Discover Master Limited Partnerships

My entry yield on my investment with KMI is 3.93%, which is very attractive considering the growth in the dividend that KMI has provided over the last year. They’ve grown the dividend by over 157% in just over a year, and the growth should be strong over time because of the IDR. This investment will add $84.00 to my annual dividend total based on the current payout of $0.35 per share per quarter. The P/E ratio on this stock is quite deceiving because of how the GP is set-up and how the profitability and performance of the GP is based on the profitability and growth of the LP.

Using a Dividend Discount Model, and using a very conservative 10% dividend growth rate and an aggressive 14% discount rate I get a fair value of $38.50, which is about 8% higher than it currently trades for. Not much of a margin of safety, but I think the dividend growth going forward will be higher than 10%. I personally believe the stock is worth more than $40 currently.

With this recent buy I now have 29 positions in my portfolio.

Some analyst opinions on my recent purchase:

*Morningstar currently rates KMI as a 3/5 star valuation.
*S&P currently rates KMI as a 4/5 star Buy.

I’ll update my Freedom Fund in early October to reflect my recent addition.

Full Disclosure: Long KMI

What are you buying?

Thanks for reading.

Comments

  1. says

    DM,

    Nice write up. Sounds like a nice addition to your holdings. I have to admit my ignorance when it comes to MLPs. You have piqued my interest with this one.

    Have a great weekend!

    • says

      The Stoic,

      Thanks for stopping by.

      I’m glad I piqued your interest. I have long had an ignorance when it came to MLP’s, and some of that ignorance was self-imposed because I didn’t want additional tax headaches. I do my own taxes and they’re fun (cough, cough) enough as is.

      But, the fact is the pipeline business is wonderful and I’d like to own a (extremely) small percentage of it.

      KMI eliminates the tax headaches and gives me an investment in the General Partner. Sounds good to me. KMI isn’t a steal at today’s prices, but then again nothing on my radar is. It’s a solid price for the long-term investor, however.

      Best wishes!

  2. says

    Nice purchase! KMI is on my watch list thanks in part to your previous post, which motivated some due diligence that led to a favorable opinion of the company.

    Despite wanting to deploy some cash, I’ve managed to be remarkably patient lately. However, I may compel myself to make a purchase before the end of September, just to put some capital to work.

    • says

      DGM,

      Glad I could bring it to your attention. I’ve read many favorable opinion and fundamental pieces on the KMP partnership and its individual pieces, but I never was interested due to the tax consequences. KMI is a great way to get a piece of that business without the negative tax implications.

      I’ve been fairly patient as well, and watched Thursday’s advance in horror. Just not many opportune moments to deploy cash lately. I always try to remember that it’s the individual valuations that matter most as I’m not an index investor. Sure, KMI could go lower with a broad market sell-off, but that just gives me the opportunity to average down. If it doesn’t go lower from here then I have my foot in the door. Either way, my capital is working.

      Best wishes!

  3. says

    DM, welcome to the Richard Kinder family. He has been very good to investors over the years.

    KMI should be a good long term holding with double digit % dividend increases over the next few years. I am long KMI and KMR and will add to both on pullbacks.

    I am heavy cash now but have been nibbling on BBL, TEVA, AFL, CAT, MCD, and EXC.

    • says

      Accumulating Assets,

      Thanks for stopping by. You are an unstoppable buying machine. Good for you! I like your approach.

      I see you’re very long KMI. I agree that it should deliver strong returns for shareholders and I’m glad I can count myself as one of many.

      Looks like interesting purchases. I’ve followed TEVA from time to time, and it seems to be consistently undervalued. CAT is interesting, as it’s been pretty beaten down over the last six months or so. MCD is a favorite of mine and EXC is interesting. Certainly a high value/high dividend play there, but the lack of sustained growth is troubling.

      Take care!

  4. says

    Welcome to the Kinder Morgan train!!!!:)

    It has served me well.

    Big ups to DGI for bringing it to my attention…Kinder Morgan is a huge company…Monstrous.

    Glad you got in on it.

    • says

      Joe,

      All aboard! I’m glad to be on that train…sounds like the next destination is Profitville!

      I do remember DGI talking about KMI at one point or another. I’ve consistently been abashed about MLP’s, but KMI does offer the very interesting GP play on it and I think it’s a solid price. Not extremely cheap at these levels, but as always I’m willing to pay for quality.

      Best regards.

    • says

      Big J,

      As my taxes get more and more complicated perhaps I’ll become a CPA! All kidding aside, I just simply want to keep things as easy as possible.

      KMR seems like a good play. You get additional units and it seems to be usually undervalued compared to KMP.

      Kinder Morgan is certainly not without options for investors!

      Stay in touch.

      Take care.

  5. says

    I recommend KMR if you want the higher yield and no K-1 tax issues. The dividend is simply paid in additional shares. This has many advantages such as simplified tax prep, suitably in an IRA, and KMR trades at a discount to KMP!

    I haven’t yet bought any of these issues, I want better pricing. I stubbornly want to buy KMI at 32, or KMR at an effective yield of 7%.

    • says

      SFI,

      Thanks for stopping by!

      I’ve also noticed that KMR trades at a discount to KMP, which is strange. Perhaps to account for the additional cost of selling shares if you need the income? Not sure. Kinder Morgan management doesn’t seem to get that one either.

      I didn’t buy KMR for a number of reasons. I don’t have an IRA, and more specifically I didn’t want to keep such close track of my cost basis. Eventually the cost basis will go to $0 as far as I understand it and then it will be taxed as a capital gain…which could be significantly higher than a dividend tax. Hard to say what will happen with tax laws in the future, but KMR does have added complexities to it.

      KMI is easier to invest in and understand, and it offers a direct investment into the General Partner and the very attractive IDR. The lower yield would be the one drawback, but the patient investor will catch up to the KMR/KMP investor and surpass him.

      Best regards!

    • says

      I appreciate you touching on the cost-basis-goes-to-zero point in KMR (as new shares are given to me, my cost basis gradually goes down)…But even when that happens, and I sell my shares to fund my retirement, it will be long term capital gains, which are taxed pretty low…especially for someone in a low tax bracket….So I’m not horribly concerned, and locking in a pretty high yield of 6+ percent.

      But I appreciate if you want to “keep it clean” and have a uniform, well oiled 1099 div machine.

      It’s so fun!

      BTW, as a complete aside, I also nibbled on some BBL. Massive, massive, massively diversified commodities company. It’s slightly speculative and I know we boring dividend investors shouldn’t invest in commodities, but I just like how diversified it is. Rising divs for 10 years.

    • says

      Joe,

      I’ve not looked at BBL in quite a while. It’s one I’ll have to revisit.

      As far as not investing in commodities, I don’t know about that. We certainly, as DGI investors, own oil majors most of the time (CVX, COP, XOM), and Nucor (NUE) is also very popular. I think commodities are a little riskier than your standard fair consumer goods investments due to the cyclical nature of demand, and with China’s growth potentially slowing there is risk there too…but overall companies like BBL still supply the world with needed/wanted raw supplies. I mean to say that 50-100 years from now, will we still need aluminum, iron and the like? Most likely.

      I missed BBL’s most recent dividend, as the ex-divi date just passed. I’ll have to keep this one on my watch list.

      Best regards!

  6. says

    Nice buy there Mantra. I’ve been watching the various flavors of Kinder Morgan for a while and actually like all three. KMP has a fantastic yield which is tax deferred until sold; KMR has a better yield and is suitable for accounts that are already tax advantaged; KMI stands to gain the most from the whole empire being that they are the general partner. KMI should grow the dividends the fastest. I can see reasons to own all three. K-1′s really aren’t that hard on Turbo Tax, but I can understand wanting one less thing to worry about. I try to keep my life simple, I don’t want extra stress from small things.

    I like this purchase a lot!

    • says

      CI,

      Thanks for stopping by.

      I agree that all three investments, for the right investor, are fantastic opportunities. KMI seems to offer me just the right flavor.

      This partnership seems to be a juggernaut, so I’m glad to have a very small piece of it. I imagine that natural gas in terms of demand and price will certainly go up in the future, as there is some support for using it in increasing applications. I wonder if we won’t see the day when passenger car engines run on NG.

      Best wishes!

  7. says

    Hi DM,

    Really nice purchase! KMI is on my radar as well and I hope to initiate a position soon. As you mentioned, investing in KMI eliminates the tax hassle associated with MLPs but still allows us to profit from the limited partnership. For a novice investor like me, that is best.

    I am glad that you are continuing to invest even though the market may not present the best value. Over the long run, your purchases will average out, all the while continuing to build your dividend stream!

    All the best!

    -Samir

    • says

      Samir,

      You make some excellent points there. I also consider myself a novice investor, and keeping things simple, while still profiting from a great business, works for me.

      I also agree with you on averaging out the purchases. I believe in valuing companies on a case-by-case basis while still being aware of overall market levels. Will the DOW be at 20,000 10 years from now, or will it be at 12,000? I don’t know, and because I don’t know I continue to invest and increase my dividend stream. Win-win either way. :)

      Thanks again for keeping in touch. Your portfolio has been really growing. Keep up the great work!

      Best regards.

  8. says

    Since reading your original watch list article about KMI, I’ve been doing some research into MLPs. I think the K-1 might not be too difficult for one or two investments, but as a portfolio of MLPs builds up, it could add quite a bit of recordkeeping to the process.

    I did stumble on a few MLP ETFs which sound like a nice idea (diversification across several dozen MLPs), except for the pesky management fee. AMLP seems to be the largest MLP ETF but sports an 0.85% expense ratio. Relative newcomer MLPA has almost half that expense at 0.45%. I’ll be watching both of these. I may choose to go this route if I decide to get into MLPs since they will only produce 1099 distributions instead of K-1 events.

    • says

      The Executioner,

      I agree with you. One or two MLP’s might not be too bad, but if you have multiple MLP’s among 35-40 other positions that can become a minor headache. When I think of passive income, I want to make it as passive as possible. If I’m giving up some gains, then so be it.

      Your idea on the ETFs might be the way to go. That would spread your risk/reward profile across many MLP’s. I think KMI is right for me, but a lot of dividend investors really dig the limited partnership side.

      Best wishes!

    • says

      Larry,

      Thanks for stopping by. There is no “tax problem” with owning MLPs, but rather a tax complication. That isn’t necessary a problem.

      A good rundown on MLPs and the associated tax implications is here:

      http://seekingalpha.com/article/247714-mlps-part-7-mlp-investor-taxation

      It’s important to keep in mind that distributions by an MLP are not dividends, and are taxed as return of capital and, hence, your cost basis is reduced as such. When you sell your MLP units you will pay the difference between the sale price and your reconfigured cost basis and pay income tax on this.

      I’m no tax expert, but the above article can give you some insight.

      Best regards!

    • says

      Larry,

      MLPs can be a fantastic investment, but they just need to be thoroughly understood, including the risk/reward and potential extra work. I hope you’re not selling for the extra tax work, as they can still be great additions to a portfolio.

      Best wishes.

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