Recent Buy

It’s one of my favorite times of the month: converting the combined power of fresh capital and reinvestment of dividends into equity in a high quality company. While cash is guaranteed to lose value over the long haul, equity in great companies will usually compound at attractive rates when averaged over long periods of time. I consistently choose to place my bets on equity.

December is shaping up to be a relatively light month for me in terms of these conversions due to my aforementioned participation in the Mother of All Car Deals. However, that doesn’t mean my mantra goes by the wayside. Quite the contrary, I’m even more motivated to squeeze every ounce of efficiency out of my now limited capital. So what you see here is my attempt to do just that. While this purchase was a bit smaller than most I tend to make, I still wanted to put some of my capital to work in what I thought was an attractive opportunity.

I purchased 30 shares of Kinder Morgan Inc. (KMI) on 12/11/13 for $32.71 per share.

KMI owns and manages a diverse set of energy transportation and storage assets. Through subsidiaries, they own and operate pipelines that transport natural gas, gasoline, crude oil, carbon dioxide and other products. KMI operates as the General Partner (GP) within the Kinder Morgan master limited partnership. They own both the Incentive Distribution Rights (IDRs) of the partnership – which allows the company an increasing share of the cash flow that can be distributed to partners – as well as a significant portion of the limited partner units of Kinder Morgan Energy Partners, L.P. (KMP), Kinder Morgan Management (KMR) and El Paso Pipeline Partners, L.P. (EPB).

This is now my fourth purchase of shares in KMI, and I now own a total of 180 shares in this company.  While I wasn’t actually planning on adding to my position right now due to not only the fact that it’s already a large position for me, but also the complicated nature of the partnership structure and the debt load within, KMI is trading below my cost basis by a healthy margin and I wanted to average down here.

Some people may not be aware of this, but Kinder Morgan is actually the third largest energy company in North America. Pretty interesting fact. Furthermore, they’re actually the largest midstream energy company on the continent. They own an interest in or operate 75,000 miles of pipelines 180 terminals. There are some companies out there with a lot of equity in patents, services, intellectual property or brand names, but Kinder Morgan owns actual pipelines that are necessary to connect supplies to demand. And they’re the biggest in the biz. While operating an asset-heavy business means high capital expenditures, it also means there is a fairly high barrier to entry as you can’t just go out and build thousands of miles of pipelines tomorrow.

Can’t build it overnight

Investing in Kinder Morgan is a bit of a bet on natural gas. While the Kinder Morgan partnership is mostly insulated from the pricing swings of the underlying commodity, an increase in usage of natural gas over the long haul bodes very well for this company. There appears to be a fundamental shift from coal to natural gas here in the United States, and seeing as how we’re sitting on a ton of NG, it burns cleaner and it’s priced attractively, this makes sense.

KMI has seen weakness lately, mainly due to weaker guidance regarding El Paso Pipeline Partners, L.P. (EPB). Specifically, investors were concerned about an expected just 2 percent increase in distributions for EPB. However, what I focused on was the forecast for KMI’s dividends, as Kinder Morgan expects to declare a total of $1.72 in dividends per share during 2014. That’s a 7.5 percent increase from the $1.60 they’ll end up declaring for 2013. There’s not many places you can find a 5% yield with 7%+ growth. Furthermore, KMI receives most of its revenue by way of KMP general partner distributions and KMP/KMP limited partner distributions. EPB will grow in time, but KMI is still busy dropping down assets to the underlying partners and focusing on becoming more of a pure play GP.

KMI has actually been extremely wonderful thus far in terms of raising its dividend. The company has raised its dividend almost every single quarter since going public in early 2011. Due to the wonderful assets they own and the likelihood of increasing usage of natural gas domestically, I expect this growth to continue. And reiterating the $1.72 the company expects to declare during 2014, that puts the forward yield on shares at today’s prices over 5.2%. You can see how one’s yield-on-cost can rise quite quickly. Furthermore, it should be noted that Richard Kinder (the CEO of KMI, KMR, KMGP, and the general partner of EPB) has his personal assets in KMI. If you believe in investing with insiders because they have special knowledge of the operations, KMI is the pick here.

There are drawbacks to this investment. First, as mentioned there are costs to owning such a large network of pipelines. Capital expenditures will likely remain fairly high for the foreseeable future, and the debt load for the company is also pretty high; the partnership has over $30 billion in long-term debt right now.

I valued shares using my traditional Dividend Discount Model analysis. I used a 10% discount rate with a 6% long-term growth rate (below the historical growth rate) and calculated a fair value on shares of $43.46. It’s hard to really pinpoint a growth rate with KMI because it has only been publicly traded for a couple of years. However, based on the continued building out of natural gas here in the U.S., Kinder Morgan’s dominant market position and the Incentive Distribution Rights ensuring an ever larger piece of the Kinder Morgan pie I anticipate this growth rate being sustainable.

This purchase adds $49.20 to my annual dividend income based on the current quarterly payout of $0.41.

I still have 43 positions in my portfolio, as this was an addition to an existing investment.

I’m going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate.

*Morningstar rates KMI as a 4/5 star value, with a fair value estimate of $40.00.
*S&P Capital IQ rates KMI as a 4/5 star Buy with a fair value calculation of $30.10.

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

Full Disclosure: Long KMI

How about you? Think KMI is a good purchase at these levels?

Thanks for reading.

Photo Credit: Stuart Miles/FreeDigitalPhotos.net

Map Photo Courtesy of Kinder Morgan

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42 Comments

  1. I’m looking to pick it up closer to $30, DM. Provided it actually gets there. I have some confidence in KMI, given Richard Kinder having so much of his personal money tied up in it. One thing for sure, Kinder Mogan has a heck of a distribution network
    -Bryan

  2. Like the purchase as I recently added to my position as well by picking up 40 more shares earlier this month. With the shift to NG under way and therefore better ways to transport it I see KMI to be set up quite nicely for long-term shareholders. Plus as you mentioned, having the CEO, Richard Kinder, having so much of his personal wealth tied to the performance of the company, management is going to have shareholders’ interests firmly in mind.

  3. Nice purchase — I also bought more KMI recently, making it my largest position. I am looking at other stocks for possible purchases to close out the year. Most of the stocks on my watch list that are near my target prices are names that I already own, but there is a chance I might start a new position. It would be nice to see a broad market dip to start off the week.

  4. Man, everyone has been buying this stock. I have never spent much time reading about it. CVX is a big piece of my portfolio so I am trying to pick up other industries before buying more energy. Looks like a solid play here.
    -RBD

  5. Bryan,

    KMI could certainly see $30, especially with a broader market pullback. I think at those levels I might be tempted to add even a little more.

    Kinder Morgan does indeed have an incredible distribution network. They’re the dominant player in getting supplies to market, and I don’t see any reason that won’t continue going forward.

    Best wishes!

  6. SWAN,

    I hope BA raises its dividend. I don’t really follow that company much, but their success bodes well for GE.

    I think KMI’s current price is attractive here. I’ve been averaging down since my first purchase in the upper $30s, and if it falls further I’ll be tempted to buy more. It’s now one of my largest positions, however, so any further purchases will have to be tempered.

    Best regards.

  7. Pursuit,

    I agree. Management, and specifically Kinder, should definitely have shareholders’ interests at heart. I’ve actually been glad to see KMI take such a tumble lately, as that allowed me to increase my stake with a relatively small amount of money. I’ll be happy to see those KMI dividends roll in!

    Take care.

  8. Pursuits,

    Thanks. I agree that the yield and growth profile of KMI is hard to find anywhere else. I would say your best bet to find similar numbers are in tobacco stocks.

    Cheers!

  9. DGM,

    I’m with you. I’d also like to see a broader market pullback. However, if we got one I wouldn’t have much cash to play with. The Corolla purchase really lightened my wallet, unfortunately. I was glad just to be able to put this much capital to work. I was afraid I wouldn’t be making any stock purchases at all this month.

    Looking forward to seeing your next buy! Happy shopping.

    Best wishes.

  10. RBD,

    KMI has indeed been popular lately. It reminds me a bit of NSC when it took a big tumble and everyone was buying it in the $50s. I think it just comes down to people recognizing value when it’s staring you in the face. I was hesitant to add only because it was already a large position for me, and I’m also allocated quite heavily to energy as a sector. However, I’m hoping over time that I can balance my portfolio with future purchases.

    Best regards.

  11. I still think it’s going to do increases most quarters, so I say nice purchase. Maybe we only get 3 increases next year instead of 4, oh the humanity! I teeter back and forth about adding to my already KMI large position, I think comparisons to NSC last year might end up true! Normally you can’t expect above average dividend growth at the 5% yield level…

  12. Hey DM,

    I think this a good buy. I have added shares twice in the last couple of months. I don’t mind being a little overweight as I know my portfolio has a long ways to go and will average out over time. I also like the future for natural gas.

    I did have a question. Where did you get a dividend of 1.60 for the year? I came up with 1.56 for a 10% increase next year.

    Take care

  13. I have yet to buy KMI, but a lot of Dividend Growth Investors have been accumulating it lately. Looks like it is at an attractive price and some good dividend growth is ahead. I may look to accumulate more of some other shares, but tempted to add KMI at the same time. I guess I’ll see what I can do.

    I expect Boeing (BA) to raise the dividend for March perhaps soon!

  14. CI,

    Yeah, normally with a 5% yield you don’t get a lot of growth. With higher growth you attract a lot of investors, which bids the prices up and yield down. I think it’s only with some tobacco stocks and certain REITs that you also see this type of combination (high yield and growth).

    We’ll see what we get. I’m hopeful! 🙂

    Take care.

  15. trisha,

    I was once a rookie too. We all have to start somewhere. If you’re interested, I compiled a list of resources for those just starting out. You can access it here:

    https://www.dividendmantra.com/p/for-beginners.html

    Per your question, Scottrade charges me $7 per transaction. So whether I purchase 30 shares or 300 shares the fee is the same. The only exceptions I’m aware of is stocks priced less than $1 or certain pink sheet stocks.

    I hope that helps!

    Best regards.

  16. AAI,

    I agree. I also think the future for natural gas looks bright. There’s plenty of it, it’s cleaner and it’s fairly cheap. Coal looks to be in a state of secular decline, so that bodes well for Kinder Morgan.

    The dividend totals I used above came right from Kinder Morgan’s press release (a link is included in the article). The language they used is “declared dividends” not paid dividends. So if you take the last three dividends paid and add in another $0.41 (assuming the dividend stays static for another quarter) you get $1.60. At least, that’s the math I’m seeing and assume they’re using as well. If you use the actual paid amount for 2013 then the increase for 2014 is actually larger. Either way, Kinder Morgan has been wonderfully transparent with forecasting dividend payments. It’s quite refreshing.

    Cheers!

  17. AJ,

    I prefer KMI over KMP due to the higher growth profile and less complications regarding taxes. Based on how an MLP is set up, it just makes sense that over the long haul the general partner will stand to make the most and have the best growth profile. By investing in KMI you’re indirectly investing in KMP anyhow, as KMI makes money off the IDR payments KMP is able to sent its way, as well as the distributions on the limited partner units they own.

    I hope this helps!

    Take care.

  18. Bought some myself. It was kind of a no brainer. Also started a position in TGT. It’s fun to find some value inspite of this overpriced market.

  19. Solid purchase! I bought KMP because I needed quality yield. I would initiate a position in KMI, except I am already well allocated in the energy sector. I just love what these companies do, their revenue stream is super reliable…I [heart] pipelines!

  20. I have all variants – KMR, KMP and KMI! I personally believe all are wonderful investments. In the long term, they will serve the diligent investor well.

  21. I am a rookie, but I have been enjoying all the information. I want to know how Scottrade charges you. Are you charged $7 for each stock you buy or charged $7 for each order you make regardless of how many stocks you purchase? I have a Share Builder account and am charged $6.95 for each item I purchase or sell.

  22. DM,

    Yeah I suffered through the 3 year dividend freeze of Boeing and multiple 787 delays. I sold 5 of my shares last year I think. I do believe the company will reward shareholders though. I’m still in the DRIP plan which is making my average price paid rise from just under $60 per share to a little over now.

  23. Spoonman,

    I also heart pipelines! Since I also own a piece of NSC I get a piece of the action whether you’re moving energy by rail or pipeline. You move it, I collect. 🙂

    I recently read your updated journal over at ERE. You guys are getting very close to your early retirement date. Very exciting stuff! Looking forward to seeing the successful conclusion.

    Cheers!

  24. DM,

    Have you considered changing to a Merrill Edge Self-Directed account? Seeing as how you are easily over the $50,000 threshold, you could get yourself 30 free trades a month, bringing down the costs of your investments meaning more money can go towards increasing your dividends rather than fees!

    Best,
    Brian

  25. I’m curious on your thinking between KMI vs KMR? I’ve been leaning towards KMR over KMI due to the higher starting yield (~7.4%) with its distribution linked to KMP, but without the K-1 tax complications since it pays as a stock distribution. I also prefer that there aren’t taxes owed until choosing to sell, which allows faster compounding. But, everyone seems to prefer KMI and I’d love to hear some thoughts on the pro’s/con’s as others see it. Definitely interested in accumulating more soon!

  26. I’m a fellow NSC owner as well (I doubled down on it when it was in the mid-$50’s). I get a thrill every time I see one of my choo-choo trains out and about.

    We’ve been making solid progress toward our target passive income, at which point we’ll call it quits. Selling the house and investing part of the proceeds in DG stocks has turbo charged our progress.

  27. Good purchase, Jason!

    One question: Is KMI a LP or MLP like KMP?

    And why is one company from Kinder Morgan a LP and the other company not?
    I don´t unnderstand the meaning of this construction…

    Best regards
    D-S

  28. Mike,

    Absolutely. I’ve always stated that I love averaging down on a stock if the fundamentals remain strong, I have capital available and the portfolio weighting makes sense. I did the same thing recently with DLR. KMI hasn’t really changed much since I first initiated my position, other than forecast a slightly slower growth rate. All in all, however, this is still a very attractive business to be in.

    Best wishes!

  29. Anonymous,

    I chose KMI for a number of reasons. First, you have the IDR and the higher growth profile that comes with based on how the partnership is set up. KMR doesn’t allow for that. Second, I chose to side with Richard Kinder – he seems to have an idea on how all of this works. Third, I want my dividends in cash because in less than a decade I’ll be using the cash to pay for expenses. If I was interested in selling shares to raise capital I’d be investing a different way.

    Just my $0.02. 🙂

    Cheers!

  30. D-S,

    The best thing to do would be to read up on how a master limited partnership works, what a general partner does, what IDRs are, etc.

    Wikipedia actually provides a decent concise explanation of the basics:

    http://en.wikipedia.org/wiki/Master_limited_partnership

    To answer your question, KMI is the general partner. They operate as the management of the partnership, and receive fees in kind. These fees are usually set up in a structure known as Incentive Distribution Rights. This is a structure that allows the general partner to receive tiered distributions from the MLP based on certain performance metrics.

    Hope that helps!

    Take care.

  31. I like Kinder Morgan as it is beaten down these days making it cheaper to buy. I am buying KMP however. Also recently they filled an application in Canada to start building a pipeline or so. Don’t remember exactly now what it was. I think they are expanding nicely.

  32. Yahoo Finance says KMI payout ratio is 139%… is that correct?
    I’m trying to add more CANADIAN stocks to my portfolio, but this one is tempting…

  33. Adam,

    The payout ratio is based off of earnings, and earnings are not the most appropriate way to determine profitability of a master limited partnership. You have to look at distributable cash flow. And to value shares, I use a DDM. But a DCF would probably work much the same way.

    Because of amortization and depreciation expenses (much like a REIT), earnings skew P/E ratios pretty strongly for MLPs.

    Cheers!

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