Better Buy: Kinder Morgan vs. ONEOK

Kinder Morgan (NYSE:KMI) and ONEOK (NYSE:OKE) are among the largest pipeline companies in North America. As a result, they operate extensive energy toll roads that enable them to generate predictable cash flow, the bulk of which they return to their investors via high-yield dividends. That makes them ideal investments for income-focused investors.

Dividend investors, however, will likely only want to hold one of these pipeline giants in their portfolio. Here’s a look at which one is the better buy right now.

Pipelines going over a blue sea and with a blue sky ahead.

Image source: Getty Images.

Drilling down into their financial profile

The first thing that investors should consider when analyzing two potential investment opportunities is the strength of their financial foundation. Here’s how these two pipeline giants stack up:

Company

Dividend Yield

Credit Rating

% of Cash Flow, Fee-Based or Regulated

Debt to Adjusted EBITDA

Dividend Payout Ratio

Kinder Morgan

4.9%

BBB/Baa2

91%

4.4 times

45%

ONEOK

5.1%

BBB/Baa3

85%

4.2 times

68%

Data source: Kinder Morgan and ONEOK.

As that table shows, Kinder Morgan and ONEOK have relatively similar financial profiles. Both have solid investment-grade balance sheets backed by a decent leverage ratio. They also produce fairly stable cash flow, though Kinder Morgan’s is slightly more predictable since it gets a higher portion from steady fees. The only major difference is that ONEOK pays out a larger portion of its cash flow via its dividend, which is why it has a higher yield. It consequently retains less money to help finance expansion projects, causing its leverage ratio to rise from 3.75 times debt to EBITDA at the end of last year to its current level.

Growth prospects

The main reason ONEOK’s leverage has increased this year is that it’s in the midst of a major expansion phase. The company began the year with about $ 6 billion of growth projects under construction, including an estimated $ 4.4 billion that it expects to finish by the first quarter of next year. That sets the company up to grow its EBITDA by about 6% this year and by more than 20% in 2020. This growth rate supports the company’s view that it can increase its dividend by at least 9% per year through 2021.

Kinder Morgan, meanwhile, started this year with about $ 5.7 billion of expansions under construction. It has since completed two of its largest projects while only adding a few smaller ones to its backlog. As a result, it only had about $ 4.1 billion in projects in its backlog at the end of the third quarter. When factoring in recent asset sales, the company is on track to grow EBITDA by a low single-digit rate over the next few years. Kinder Morgan does, however, expect to increase its dividend by another 25% next year as it works to push its payout ratio above 50%, though growth beyond 2020 will likely slow to a low single-digit annual pace.

A quick peek at their valuations

Because ONEOK’s earnings are growing at a much faster rate, investors are willing to pay a premium for its stock. The company is currently trading at about 12.8 times its enterprise value (EV) to its projected EBITDA in 2020, which is the highest valuation among large pipeline companies. Kinder Morgan, in the meantime, trades near the lower end of its peer group at about 10.7 times EV to 2020 EBITDA.

ONEOK should trade at a premium multiple compared to Kinder Morgan, given its faster growth rate in 2020. However, Kinder Morgan seems to be trading at an unjustifiably low valuation. That’s evident in the price that buyers are willing to pay for its assets. The company recently sold one pipeline at a multiple of 13 times EBITDA and has received “expressions of interest” from other potential buyers willing to pay that much, if not more, for some of its other assets. Because of that, the market seems to have undervalued Kinder Morgan by quite a bit.

Verdict: Kinder Morgan is the better buy on value

While ONEOK has a sound financial profile and excellent growth prospects, the market seems to have already priced that into the company’s stock. Kinder Morgan, on the other hand, offers a similarly strong financial profile and decent growth prospects for a much lower value. Based on that valuation gap, Kinder Morgan could generate higher total returns for its investors in the coming years, which is why it looks like a better buy right now.

 

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