Kinder Morgan (NYSE:KMI) offers investors a fat 7.1% dividend yield. Enterprise Products Partners (NYSE:EPD) has an even more enticing 8.3% distribution yield. But there’s a lot more to understand here before picking one of these two North American midstream giants. Here are some things you need to know.
1. Tax treatment: Dividends vs distributions
Perhaps one of the first issues dividend-focused investors need to consider here is corporate structure. Kinder Morgan is pretty simple to understand since it is just a typical company and pays normal dividends. Enterprise is different, because it is structured as a Master Limited Partnership (MLP) and pays distributions. That’s not the end of the world, but it does complicate things.
For starters, investors are considered part owners of an MLP and are called unitholders. Come tax time, unitholders get a K-1 form that outlines their piece of the partnership’s annual results. It can really complicate your taxes, and it’s probably a good idea to consult a tax professional here. That said, there are benefits to this — some of the distribution will likely receive favorable tax treatment thanks to the unitholder being allocated a portion of the MLP’s depreciation, among other things. For some investors the tax benefit might be worth the extra effort of dealing with a K-1.
But there’s one more issue: MLPs don’t play well with tax-advantaged retirement accounts. So it is best to only own Enterprise in a taxable account, which may or may not be where you have cash to invest. Basically, if you want to keep things simple, Kinder Morgan is probably the better option.
2. Trust is a fickle thing
The next big problem here is a bit harder to define. Enterprise Products Partners has a long history of rewarding unitholders with a steadily growing distribution. It has increased its distribution for an impressive 23 years at this point, with the most recent hike being announced in January. Though that increase was a token $0.005 per share per quarter, given the downturn in the energy sector such a small increase is probably appropriate. It was the statement that management understands the importance of the distribution to unitholders that mattered most.
Kinder Morgan’s history isn’t nearly as good. In 2016 the company cut the dividend 75% after telling investors just a few months earlier that it was expecting to enact an increase of up to 10%. Since that point, the company has gotten back on the dividend growth track. But it failed to live up to its promises again in 2020, when it increased the dividend by just 5%. To be fair, that’s much better than a cut, but management had laid out a multi-year plan that included a 25% increase in 2020. The energy industry downturn got in the way, but it isn’t exactly a great thing that management chose to go back on its word again. Conservative investors will probably want to be cautious here, giving Enterprise a sizable edge on the trust issue.
3. Dividend/distribution safety
That brings us to a key final point. Enterprise Products Partners covered its distribution 1.6 times over in 2020. And it has among the lowest levels of leverage in the midstream sector, with a financial debt to EBITA ratio of around 3.6 times. The distribution seems pretty safe as well, with ample wiggle room to deal with further industry headwinds on both the coverage front and the balance sheet.
Kinder Morgan’s covered its distribution by an even more impressive 1.9 times in 2020. However, the midstream giant’s financial debt to EBITDA ratio is among the highest in the sector at 7.1 times. To be fair, Kinder Morgan has long made more aggressive use of its balance sheet, but this was part of the reason for the dividend cut in 2016 when capital markets were hard to access and the company needed cash for capital projects. Once again, more conservative investors will probably want to err on the side of caution and stick with more conservatively financed Enterprise.
The final call
Although this sounds like a strong call for Enterprise, the truth is that buying Kinder Morgan wouldn’t exactly be a mistake. Both of these midstream giants are well-run and are highly likely to survive the current energy industry downturn. However, for more conservative types, there is a difference here — and that should lead to a heavy lean toward Enterprise, assuming that its MLP structure doesn’t trip you up.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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