AMLP - Recession-Resistant High Yields: Kinder Morgan Vs. ONEOK

2023-10-24 08:00:00 ET

Summary

• Kinder Morgan and ONEOK are recession-resistant midstream businesses with high-quality energy infrastructure portfolios.
• Both companies generate stable cash flows and have solid balance sheets, with BBB credit ratings from S&P.
• We compare them side-by-side and offer our take on which is the better buy right now.

Kinder Morgan ( KMI ) and ONEOK ( OKE ) are two recession-resistant high-yielding midstream businesses that own high-quality midstream energy infrastructure portfolios. That being said, both have considerably lagged the total returns of the broader midstream sector ( AMLP ) so far this year:

In this article, we will compare them side-by-side and offer our take on which is the better buy right now.

KMI Stock Vs. OKE Stock: Business Model

KMI is a major player in the North American energy infrastructure industry, and as such boasts a diverse and large portfolio that includes natural gas, natural gas liquids, oil, and liquefied natural gas ((LNG)) assets. The company's U.S. gas pipeline business is particularly important, with a daily capacity equivalent to 40% of the average U.S. gas consumption. It also and a dominant position in the LNG market, servicing 50% of the U.S. market.

Additionally, KMI's extensive asset footprint provides numerous investment opportunities, and KMI is also moving to reduce its carbon footprint with over 80% of its backlog comprising low-carbon investments and a recently formed energy transitions group tasked to explore renewable natural gas, biofuels, and carbon capture projects.

~93% of its cash flow is contracted with take-or-pay or fee-based terms, providing substantial stability for the company's bottom line. Additionally, over 70% of its customers are end users, ensuring consistent demand. As a result, the business is built to weather energy price and macroeconomic volatility quite well and with insiders owning ~13% of the common equity, management interests should be well-aligned with shareholders.

Meanwhile, OKE is also an increasingly prominent player in the energy industry, especially after its recently agreed-upon acquisition of Magellan Midstream Partners ( MMP ). Like KMI, ~90% of its earnings come from fee-based sources with strong counterparties and low exposure to commodity price fluctuations. The recent acquisition of Magellan's refined product assets further solidifies its position and creates new investment avenues.

OKE has strong growth potential in its Rockies and Williston Basin assets while its acquisition of MMP should also give it growth investment opportunities in the Permian Basin as well as in hydrogen and renewable fuels.

In summary, both of these businesses generate very stable and defensive cash flows from a well-diversified set of assets, geographies, and energy commodities, making them good sources of stable income during a period of significant macroeconomic and geopolitical instability.

KMI Stock Vs. OKE Stock: Balance Sheet

KMI and OKE both have solid balance sheets as evidenced by their BBB credit ratings from S&P. Both OKE and KMI anticipate closing out 2023 with a net debt to adjusted EBITDA ratio of 4.0x.

That said, OKE expects to bring its leverage ratio down to below 3.5x by the end of 2026 whereas KMI sees itself as being in an excellent financial position already with a long-term leverage target of 4.5x. With well-laddered debt maturities, strong free cash flow profiles, and plenty of liquidity, both OKE and KMI are in sound financial condition.

KMI Stock Vs. OKE Stock: Distribution Outlook

Neither KMI nor OKE have delivered particularly exciting dividend growth in recent years as both businesses have been focused on capital spending and improving their balance sheets:

Moving forward, it is unlikely that growth will dramatically improve, though it is expected to improve some. KMI is projected by analysts to post a dividend compound annual growth rate of 2.9% through 2027 underpinned by an anticipated 3.7% CAGR in distributable cash flow per share during the same period. Meanwhile, its 2023 dividend coverage is expected to be quite conservative at 1.9x on a DCF basis, indicating a very safe payout and room to grow it in the coming years.

Meanwhile, OKE is poised to achieve a dividend coverage ratio of 1.79x in 2024 on a DCF basis, which marks its first full year following its acquisition of MMP. As a result, OKE is also well-positioned to increase its dividend in the coming years even as it also focuses on continuing to deleverage its balance sheet. Analysts currently forecast a 5.7% dividend CAGR for OKE through 2027.

Both companies' dividend payments currently appear to be on solid ground and are likely to increase at a pace that keeps pace with or surpasses inflation for the foreseeable future. Overall, we give OKE the slight edge here.

KMI Stock Vs. OKE Stock: Valuation

As the table below illustrates, KMI is quite a bit cheaper than OKE across both the EV/EBITDA and dividend yield metrics, though OKE appears cheaper relative to its historical average EV/EBITDA than KMI does:

KMI Stock Vs. OKE Stock: Investor Takeaway

Both businesses appear to be quite strong and positioned to weather an economic downturn and/or stormy seas for the energy sector. Moreover, both are trading at clear discounts to their historical average valuation metrics despite energy prices being fairly elevated in recent years as rising interest rates have weighed on them. Moreover, both offer attractive, well-covered, and growing dividends.

That being said, neither is without risks. OKE is paying a pretty hefty premium for MMP despite the fact that MMP was already trading at a pretty substantial premium to most of its midstream peers at the time that the deal was struck. OKE is justifying the acquisition by claiming that it will generate hundreds of millions of dollars in annualized synergies by the combination of the two companies. However, actually realizing these synergies is uncertain, so there will remain a degree of risk involved in the full integration of this substantial acquisition until it is successfully executed.

Meanwhile, KMI has a past history of destroying shareholder value and deeply slashing its dividend. Moreover, despite generating a lot of excess cash flow above its dividend payouts in recent years, KMI has failed to grow its dividend very much and its buybacks have been relatively immaterial. As a result, KMI has significantly underperformed the broader midstream sector over the past three years:

Moreover, it is uncertain what catalyst the company would be able to enjoy in the future that would drive a significant upside in the stock as the dividend is good, but not great, especially relative to current long-term interest rates. Moreover, the dividend growth rate is pretty anemic and unlikely to materially improve for the foreseeable future. Finally, KMI recently announced a mixed shelf, which includes the potential for it to issue additional common stock. There is certainly a risk that this offering may end up diluting shareholder value over the long term.

Overall, we like both of these businesses and think that they should prove to be solid dividend payers for years to come. If we had to pick one of these, we would choose OKE simply because we think it has great valuation upside potential and its leverage ratio is likely going to be lower than KMI's in the coming years. We also see it having stronger growth potential than KMI in the near term at least. That said, we rate both as Buys and relatively low risk investments.

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