I’ve finally got the chance to take a look at the Kinder Morgan consolidation, and am finally getting around to that promised post on the deal. The Kinder Morgan investments have fascinated me for awhile because it’s probably the highest-quality American firm that never quite reached blue-chip status in the eyes of the casual investing public. It’s always been seen as a few notches below Exxon, Chevron, and Conoco.
If I had to guess why that perception exists, my speculation would be that people think “Kinder came from Enron. Enron bad. Used to be friends with Ken Lay. Therefore, Kinder-Morgan will eventually blow up.” Even though most people would agree that guilt by association logic is bunk, it has probably crept into the analysis of Kinder Morgan (perhaps even non-deliberately).
For those of you who haven’t followed Kinder Morgan’s growth in the past two decades, the firm is often-cited as a toll-booth company. What that jargon means is this: Kinder Morgan runs the pipelines used to transport oil and natural gas across the country (and it’s got 80,000 miles of it), and they charge a fixed fee for doing so. This doesn’t automatically make your profits higher over the long-term, but it does make your profits more consistent because you still collect your fee for shipping oil if it falls from $105 to $80 per barrel, or whatever the fluctuations ruling the business cycle may be.
I’ll use Kinder Morgan Energy as an example. From 2008 to 2009, the profits at Kinder Morgan Energy held steady throughout the financial crisis: in 2007, Kinder Morgan Energy made $1.010 billion in net profit. In 2008, $1.337 billion in net profit. In 2009, $1.302 billion in profit. In 2010, $1.333 billion. And then 2011 was the breakout year when profits grew to $1.732 billion, which have grown every year since and are expected to approach $3 billion before the consolidation is complete.
ExxonMobil, meanwhile, saw its profits fall from $35 billion to $17 billion from 2008 to 2009. This doesn’t mean Kinder Morgan Energy is a better investment; Exxon kept buying back its stock when the price fell following the profit decline, and Exxon raised its dividend so that shareholders did just fine even as the profits experienced their greatest one-year declines of the generation.
All it means is that Kinder Morgan Energy’s business model has more consistency of profits than you’d traditionally expect from investments in the oil and natural sector gas sector. This consistency, though, partially explains why Kinder Morgan has been able to significantly increase its payouts and compound at 21% annually since 1992, turning a $15,000 investment into a little over $1,000,000 over that time frame.
What then, are the terms of the announced Kinder Morgan transaction, and what lies ahead for investors?
If you owned Kinder Morgan Management, LLC (ticker symbol KMR), then each share will become 2.4849 shares of Kinder Morgan, Inc. If you owned El Paso Pipelines Partners (ticker symbol EPB), then you will receive $4.65 in cash and .9451 shares of KMI for each EPB unit you owned.
If you owned Kinder Morgan Energy Partners (ticker symbol KMP), then you will receive 2.1931 shares of Kinder Morgan, Inc. (ticker symbol KMI) and you will also receive $10.77 in cash for every unit of Kinder Morgan Energy that you had.
This $10.77 cash payout for each share is designed to help cover the instant tax burden for those invested in Kinder Morgan Energy’s partnership units. One of the appeals of owning an energy MLP is that a substantial block of taxes are deferred—super long-term investors use these as planning tools so that they can collect MLP distributions until their death, and then their heirs and beneficiaries receive a steeped-up cost basis upon the death transfer. It lets the original investor collect lots of income during his lifetime, and then his kids or whoever can receive the units without owing a lot to the taxman.
This consolidation eliminates this possibility, and Kinder Morgan released a statement estimating that most people will owe taxes between $12.39 and $18.16 when the otherwise deferred taxes come due. The assumptions that went into this estimate are as follows: (1) passive losses haven’t already been used by the investor, and (2) KMI will trade between $36.12 and $44.44 at the moment of consolidation. So the $10.77 will cover either most or half of your tax bill, and the rest will need to come out of your pocket or through a sale of your new KMI shares to send the way of the U.S. Treasury.
If I were sitting on shares of KMI, I would continue to hold the stock indefinitely. Management has come out and said that the dividend will grow by 10% annually from 2015 to 2020, and the current dividend of $1.72 annually will be raised to $2.00 annually next year (for growth of 16%).
For long-term holders, Kinder Morgan, Inc. (KMI) seems poised to offer investors a nice starting yield with continued dividend growth going forward. Shares of Kinder Morgan are at what, $38 now? When the company pays out $2 per share next year, you’ll be collecting 5.26% on your 2014 investment. It’s a nice hybrid that, right now, combines the high yield of BP with the dividend growth rate you would expect from Chevron. With the possible exception of Philip Morris International, it’s hard for me to think of another company that offers such a high starting yield mixed with the prospect of high-single digit dividend growth over the next five to ten years.