Income Investing: High Yield Bets on Natural Gas Transportation

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The topic of domestic energy production served as a highlight of the recent Presidential election, with both candidates presenting strong opinions on the matter. Governor Romney spoke aggressively about the importance of increasing offshore oil production, including drilling in the mid-Atlantic, as well as greater coal production. In contrast to Romney, President Obama spent most of his time on the defensive, citing an increase in domestic oil production during his first term, despite the fact that he cut the number of drilling permits on federal land by nearly half.

While natural gas received honorable mention, neither candidate stressed the significance of this clean fossil fuel, which is low-cost and abundant. In fact, natural gas continues to replace coal as the primary driver of electric power generation. Previously thought of as a “bridge” fuel, natural gas is now becoming a “destination” fuel as coal usage continues to decline based on new EPA regulations.

In my home state of Ohio, thousands of jobs are being created along the Utica shale, as companies are realizing that demand for natural gas is increasing as the power-generation landscape changes. Here are my favorite investment ideas to participate in the transportation and storage of this important commodity within the United States.

Boardwalk Pipeline Partners (NYSE: BWP). This Houston, Texas based limited partnership is a leader in the transportation and storage of natural gas. The Company owns and operates approximately 14,300 miles of interconnected natural gas pipelines through its six subsidiaries.

Unlike a natural gas exploration and production company, Boardwalk Pipeline’s operating results are only moderately affected by the underlying price of natural gas. Furthermore, the Company has a history of consistent earnings growth in a volatile natural gas price environment. Consider the purpose of an interstate toll road, where the toll operator collects a fee for every vehicle that drives on the interstate. The toll operator isn’t affected by the price of gasoline that’s inside the car, the only revenue factor for the operator is the number of miles driven on the toll road.

Here are four reasons why Boardwalk is priced attractively for long-term buy-and-hold investors:

  • The Company successfully completed a secondary offering of 10 million common units in early October at a price of $26.99 per unit. The partnership received net proceeds of $266.1 million from the offering. Management stated it would use the proceeds to repay borrowings under its credit facility, deleveraging its balance sheet.
  • On October 15, the Company announced it would be purchasing the remaining 65% interest in PL Midstream from the Loews Corporation (NYSE: L), which gives unitholders exposure to the transportation of petrochemicals and natural gas liquids within the Gulf Coast region.
  • Boardwalk maintains a highly desirable pipeline system that originates in the Gulf Coast region and extends north and east throughout the Midwestern states of Tennessee, Kentucky, Illinois, Indiana, and Ohio. Furthermore, Boardwalk’s pipelines are centrally located near the most abundant sources of natural gas in the United States, ensuring its business viability many decades into the future.
  • Loews, controlled by the notable Tisch business family, is the majority unitholder of Boardwalk maintaining a 2% General Partner interest and 53% Limited Partner interest. In addition to natural gas pipeline, Loews has businesses in energy exploration, insurance, and luxury hotels. The company recently announced on Dec. 3 it would be purchasing the iconic Madison Hotel in Washington, D.C. This level of diversity—similar to a Berkshire Hathaway—is important when considering investment in Boardwalk, as it indicates the Loews Corporation is well-capitalized and can stand behind Boardwalk in the event of economic need.

Boardwalk pays an enormous 8.26% dividend distribution, which is a function of its Master Limited Partnership (MLP) tax structure. Most MLPs are exempt from corporate taxation at both the federal and state level, and profits flow through to limited partners (LPs). The Company has increased its distribution amount by approximately 3.86% annually over the last 3 years.

<table> <tbody> <tr> <td> </td> <td><strong>Boardwalk Pipeline Partners LP</strong></td> <td><strong>Kinder Morgan Energy Partners LP</strong></td> <td><strong>Kinder Morgan Inc.</strong></td> <td><strong>Loews Corp.</strong></td> </tr> <tr> <td><strong>Market Capitalization</strong><span> ($)</span></td> <td>5.9 B</td> <td>29.0 B</td> <td>34.9 B</td> <td>16.3 B</td> </tr> <tr> <td><strong>EPS</strong><span> (TTM)</span></td> <td>1.25</td> <td>1.55</td> <td>0.98</td> <td>2.19</td> </tr> <tr> <td><strong>P/E Ratio</strong></td> <td>20.65x</td> <td>51.27x</td> <td>34.49x</td> <td>18.77x</td> </tr> <tr> <td><strong>Ann. Dividend/Yield</strong></td> <td>$2.13/8.26%</td> <td>$5.04/6.35%</td> <td>$1.44/4.28%</td> <td>$0.25/0.61%</td> </tr> <tr> <td><strong>Beta</strong></td> <td>0.3</td> <td>0.4</td> <td>0.7</td> <td>1.2</td> </tr> </tbody> </table>

When I want to gain exposure to a certain sector of the market, as a general approach I identify one or more companies within the sector that are best positioned for outperformance. The main reason for considering multiple companies that operate in similar lines of business is to reduce company-specific risk. I feel this rule is especially important for income-producing investments, as readers who desire current income tend to be approaching retirement or already meet retirement age.

On the above basis, let’s consider a second company involved within energy transportation and storage. Here are four reasons why Kinder Morgan Energy Partners LP (NYSE: KMP) is an attractive investment:

  • On December 4, Kinder Morgan provided preliminary guidance to limited partners for fiscal year 2013. Management expects to declare cash distributions of $5.28 per unit for 2013, an increase of 6% over the 2012 target of $4.98 per unit. This gives the stock nearly a 7% forward yield.
  • On October 16, the company announced a raise in its quarterly distribution to $1.26 per unit, representing a $0.03 increase from the third-quarter distribution of $1.26. Kinder Morgan’s management has increased the size of the quarterly distribution payment 45 times since February 1997.
  • Kinder Morgan’s pipelines transportation business is the most diverse in the industry. In addition to the transportation of natural gas, KMP is a leader in the transport of refined petroleum products, crude oil, and carbon dioxide (CO2). The company owns the rights to approximately 29,000 miles of pipelines and 180 terminals.
  • The company’s executive team is awarded a greater amount of stock than cash, aligning management’s interests with shareholder interests. Kinder Morgan has a motto of “being run by shareholders for shareholders.” The stewardship model seems to be paying off, as the company has delivered an average annual compound return of 25% per year to shareholders since 1997.

If you are interested in Kinder Morgan Energy Partners and would like to reinvest distributions in the form of additional shares, you should consider Kinder Morgan Management (NYSE: KMR). Otherwise, profits from KMP will be distributed into your brokerage account as cash. Reference the following letter to shareholders for more information on KMP and KMR.

Foolish Bottom Line

Energy transportation and storage companies have a long history of outperformance, and the future appears no different based on strong fundamentals for the group.  However, keep in mind the unique tax implications that accompany your ownership interest as a limited partner. Profits flow through the partnership to the LP, untaxed, meaning you will receive an IRS Schedule K-1 in the mail each year. Please consult your tax accountant for formal advice, especially when considering investment in a 401(k).

Although I am confident Fool readers will find advantages in MLP investing, you can still have exposure to natural gas transportation and storage outside the MLP structure. For one, consider Kinder Morgan Inc. (NYSE: KMI), which is the general partner of both Kinder Morgan Energy Partners and El Paso Pipeline Partners, a third choice in the natural gas pipeline space.

Thanks for reading, and consider subscribing to my posts for more Fool ideas on outperforming the market.

johnmacris has no positions in the stocks mentioned above. The Motley Fool owns shares of Kinder Morgan. Motley Fool newsletter services recommend Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus