The 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?