Recent Buy

buyThe strong performance of the stock market YTD has left little attractive opportunities on the table for value investors to get interested in. I consider valuation of an individual stock paramount to long-term success, and it’s imperative that you don’t overpay for an ownership stake in even the most high quality business. Doing due diligence and determining a fair price to pay for a stock is part art and part science, but if you determine a range of fair value and buy with a sufficient margin of safety below that value, you should do well over the long haul. It’s all about focusing on quality and price. Getting a high amount of the former and a low amount of the latter is key.

As such, I’ve had my eye on a high quality business over the last week or so that’s trading at what I feel is an attractive price. I was waiting on slight price weakness to try and get this quality at a small discount. The stock market has allowed few such discounts to come to fruition, but I feel that over the long haul I’ll be happy with the investment in the company I’ll discuss below.

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 50 shares of Kinder Morgan Inc. (KMI) on 3/18/13 for $36.31 per share. This is an addition to a position I already have in this company. I feel very comfortable adding to the amount of capital I have invested with KMI at current levels.

As I discussed in my initial investment in KMI, this is a very attractive business. You get to invest in the structured partnership of a MLP, but with none of the paperwork/tax headaches. But, that’s really just a minor reason to invest with KMI. One of the major reasons I want to be a part-owner of KMI is due to the Incentive Distribution Rights (IDR) that come with being the General Partner (GP) of the underlying partnerships – in this case Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB). The IDR’s, based on how the partnership is structured, ensures that KMI receives accelerated, or increasing, distributions as the partnership continues to progress and grow. This growth is evidently seen as KMI is targeting a 12% dividend growth rate for the foreseeable future. Looking at the dividend growth rate that we’ve already seen, they’ve raised the dividend every single quarter except for one since the IPO in early 2011.

Another reason to be excited about KMI is the underlying business itself. Kinder Morgan is the largest natural gas pipeline operator and storage operator in the U.S. They are largely shielded from commodity price swings as they operate a toll-like business with an underground highway of pipelines that are used to transport energy products like natural gas, petroleum and CO2. I can’t imagine the U.S. not using more energy, and more natural gas, 10 years from now. This bodes well for Kinder Morgan.

This purchase comes with an entry yield of 4.08%. Getting an entry yield over 4% with a substantial dividend growth rate is obviously very attractive. This purchase will add $74.00 to my annual dividend income total. Of course, I anticipate a dividend raise or two before the end of the year.

Getting back to the valuation I was discussing earlier, I think shares are worth at least $40 currently. Using a Dividend Discount Model with a 10% discount rate and a very conservative 7% dividend growth rate (well below forecasts), I get a Fair Value of almost $49 per share. Current share prices allow for a pretty sizable margin of safety in my analysis (over 20%). One other statistic to note is that KMI has handily underperformed the S&P 500 YTD, up 2.58% vs. the S&P 500’s 8.83% gain for the year.

Keep in mind, however, that this is a highly leveraged entity. That includes the General Partner and the partnership itself. I find this okay, as this debt is used to grow the partnership and keep distributions coming. Also, this business is based in infrastructure. Infrastructure, by its nature, requires big, expensive projects with very large, pricey assets. This usually requires debt. I’m okay with the debt load as the majority of my portfolio is invested with companies with fairly attractive balance sheets.

I currently have 30 positions in my portfolio, as this was an addition to an existing investment.

Some current analyst opinions on my recent purchase:

*Morningstar rates KMI as a 3/5 star valuation with a FV estimate of $38.00.
*S&P rates KMI as a 4/5 star Buy with a 12-month target price of $42.00.

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

Full Disclosure: Long KMI

What are you buying?

Thanks for reading.

Photo Credit: Stuart Miles/FreeDigitalPhotos.net

Comments

    • says

      Journey,

      AFL looks very good here. I’d be buying more AFL myself if I wasn’t already heavily invested. I think it’s very attractive even after the heavy run-up from the low $30’s.

      Energy also looks nice. The swings can be quite dramatic with some of the oil majors, as their stock prices correlate somewhat with the underlying price of their commodity (oil). But, I still think there is some value there. I think CVX would be a better investment overall, but COP has that very juicy yield.

      Best wishes!

  1. Anonymous says

    I have been following your blog for quite awhile but this is my first time commenting. KMI is a good pick…I have been in KMR since it was in its $40’s but just recently started looking at KMI (hoping to get it under $35 if there is a decent correction. Keep up the good work. Your effort is not only paying off by the growth of your portfolio but also by the many who are encouraged and motivated by your discipline and journey that you so freely share.

    • says

      Anonymous,

      Thanks for following the journey and I appreciate you stopping by and commenting for the first time.

      KMR is a nice pick here since it typically trades at a discount to KMP and pays out in shares.

      I think you may see KMI under $35 if we get a broad market decline. I think it’s attractively priced as it is, but getting in under $35 would be even better!

      Thanks for the kind words and I’m glad that you find yourself encouraged and motivated by my openness!

      Best regards.

    • says

      Chad,

      Great move on AFL. I think that one is still cheap by almost every measure you throw at it.

      I think AFL and KMI are a couple of the more attractive opportunities in an otherwise expensive market.

      Happy shopping!

      Best wishes.

  2. says

    One stock I am not seeing mentioned for consideration by anyone on the dividend growth blogs is Apple. with a P/E of 10 and a 2.6% yield, and alot more room to grow that dividend not just based on cash flows but also the fact that they have a pile of money sitting around. I feel like although they have been beaten down there is a lot of upside, especially if they increase the dividend this year.

    • says

      Gutierrez012,

      I hear you on AAPL. It’s definitely cheap, and all that cash on the balance sheet is enticing.

      However, I am concerned about whether or not this company can continue the innovation. You can already see sales slowing because the last few iterations of the iPhone have been pretty much the same. Innovation is the name of the game with this company, and that’s hard to keep up on a regular basis. I’d much rather try and stick with companies that sell products that we need or want every single day, and that don’t require as much innovation. Take Coke. Not much innovation is really necessary there, and it’s a low-cost product.

      The cash on that balance sheet can also be a problem. If they don’t spend it wisely that can destroy shareholder value.

      It’s certainly one to watch, but they’ve become largely a smartphone company and that’s a field littered with a lot of competition. I’m naturally tech shy, so maybe I’m a bit biased. IBM and ADP would be companies I’d be much more interested in as far as tech goes because there is less direct competition and they’re typically entrenched in their businesses due to high switching costs. There’s really not much to keep current iPhone customers from switching to the “next hot thing”.

      Take care!

    • says

      AAI,

      I see you did! Great minds think alike. The high entry yield at over 4% coupled with that growth (projected at 12%) is just too much to pass up.

      I agree with you that this seems like a prudent purchase in an otherwise pricey market.

      Best wishes!

  3. gibor says

    Did you buy into registered or non-registered account? I’ve heard that you get some dividend tax on MLP even if you hold it in registered account.

    • says

      gibor,

      It sounds like you’re speaking about Canadian accounts. I’m based here in the U.S., so I’m guessing you mean registered as in a retirement account? This was purchased in a taxable account, which I believe would correspond to a non-registered account. I do not fund an IRA.

      And, keep in mind this is not a MLP. This is set up as a normal corporation, just like Coca-Cola or Johnson & Johnson. It’s the GP of a partnership, not an MLP directly.

      Hope that helps!

      Take care.

    • says

      DGM,

      It’s great to be a fellow shareholder!

      I think KMI will be a great holding for the long-term. You can’t just go out and build a pipeline tomorrow. These assets are very valuable and the relative insulation from commodity price swings is also wonderful. If the dividend growth is able to reach projections over the next five years we’ll be doing very well.

      Best regards!

  4. Anonymous says

    I really enjoy your posts, in fact, yours is my favorite blog!

    I am curious about your thoughts as to why you think KMI is undervalued? P/E, debt ratio, other?

    Steve from Canada

    • Anonymous says

      Hi Man,

      I’m with Steve.

      According to Bloomberg P/E ratio for KMI is about 33 and to Yahoo Finance is 105. It seems a bit pricey. Isn’t that a good filter metric?

      Very truly,
      Manefla

    • says

      Steve and Manefla,

      You can’t value MLPs and REITs by a P/E ratio because earnings are skewed based on the structure of the entity.

      KMI is even more difficult to value than an MLP based on the layering of the structure. KMI owns some assets directly, but plans on dropping all of them down the underlying partnerships. Basically, KMI (as the GP) exists to own units in KMP and EPB and also owns the IDR due to being the General Partner. How do you value the IDR? I’d say it’s worth quite a bit, and something that’s obviously not a hard number. So, valuing them is difficult. The best way I know to value them is using a DDM because of the strong yield and consistent growth.

      I hope that helps!

      Best wishes.

    • Anonymous says

      Agree Mantra, but I really didn’t understand how KMI is funding the dividends.

      I know I need to study a lot more, but the dividends seem to be funded with new issuances from the MLPs, isn’t it?

      Probably I’m wrong, but I’m having a Telefonica deja-vu.

      Very truly,
      Manefla

  5. Anonymous says

    Hi DM, Can you comment on 3 stocks: DGX, OXY and USB? Their price did not go up as much as others did year to date (so better value), but paying decent and sustainable dividend.

    • says

      Anonymous,

      Hmm, interesting and varied list there.

      I like USB and wrote about it and WFC a while back on The Div-Net when I thought both were on the verge of rising and becoming major dividend growth stocks again. It’s my second favorite major U.S. bank currently. If I were to invest in another major domestic bank it would be USB. I like WFC more right now as it’s slightly cheaper and the yield is much higher. I think both are high quality, however.

      OXY is one that has been mentioned a few times here and I’ve read about it quite a bit. It’s one that’s currently on my watch list. I like many things about it, but my only concern is that it looks slightly pricey against other major energy plays. The yield is nice and the dividend growth has been outstanding. I’m currently looking at it.

      I can’t comment intelligently at all on DGX. I’ve never followed it. I’m sorry I can’t offer more on that.

      Best wishes!

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