Kinder Morgan Inc: A High-Yield Stock Hiding in Plain Sight

At first glance, Kinder Morgan Inc (NYSE: KMI) doesn't look like an appealing stock for many income seekers. While its current yield of around 3.1% is above the 1.8% average of the S&P 500, it's well below what other pipeline stocks currently offer. ONEOK (NYSE: OKE), for example, yields 5.5%, while TransCanada (NYSE: TRP) pays 5.1%. That said, Kinder Morgan's current yield doesn't tell the whole story, because the company is about to significantly boost that payout and continue growing it at an above-average rate for the next few years. That growth will transform the natural gas pipeline giant into a much higher-yielding stock.

Nearly as high this year but much safer

After spending the past few years shoring up its financial situation, Kinder Morgan is in the position where it can return much more cash to investors this year. In fact, the company has already promised to increase its payout 60% in 2018. This expected increase implies that investors who buy today are locking in a forward yield of 5%. That puts the payout much closer to the levels of ONEOK and TransCanada. That said, what's important to note about Kinder Morgan's higher dividend level is that it only represents about 40% of the company's anticipated cash flow for this year. For comparison's sake, TransCanada's payout will consume about 65% of its cash flow while ONEOK's will eat up roughly 80% of its expected cash flow.

What those numbers tell us is that Kinder Morgan's dividend yield will soon rival its peers' while consuming a much smaller percentage of its cash flow, putting it on a stronger foundation. In fact, Kinder Morgan will generate enough excess cash this year above the dividend to fully finance the expansion projects it has under way with room to spare, leaving it with some extra money to potentially repurchase more of its shares. TransCanada and ONEOK, on the other hand, aren't generating enough cash to both finance the dividend and their capital program. As a result, both have had to issue more stock to finance expansion projects. The added dilution from those new shares held back TransCanada's ability to grow cash flow on a per-share basis last quarter. Kinder Morgan, on the other hand, is on pace to deliver per-share cash flow growth this year, which could get a further boost from its stock repurchase program.

Putting its peers to shame

That said, while this year's dividend yield will still be a bit below its peers, Kinder Morgan is on pace to deliver a much higher one in the years to come. The company currently plans to boost its payout 25% next year and by that same rate in 2020. Supporting that forecast is the nearly $12 billion of expansion projects the company has under way and its ability to increase the payout ratio from 40% this year to around 50% in 2020. This forecast implies that investors who buy today could collect an attractive 7.7% yield in just three years.

TransCanada and ONEOK also expect to deliver fast-paced dividend growth over the next three years. TransCanada has already increased its dividend 10.4% for 2018 and planned to raise the payout at the upper end of its 8% to 10% annual target range through 2020. However, even if the Canadian pipeline giant hits that goal, its yield would only increase to about 6.1% for those buying today. Meanwhile, ONEOK expects to increase its payout at a 9% to 11% annual rate through 2021. But even if it hit the upper end of that range through 2020, its yield would only reach 7.2% for those buying today, and that payout would consume about 80% of its annual cash flow.

A hidden gem for patient income seekers

Kinder Morgan might not look like an appealing income stock at first glance, but that's about to change. With rapid dividend growth coming down the pipeline, Kinder Morgan's yield will expand over the next couple of years, even as it remains conservative by paying out a significantly lower percentage of its cash flow than its peers. That forecast makes Kinder Morgan look like a hidden gem for income investors who have the patience to wait for the company to deliver on its dividend growth plan.

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Matthew DiLallo owns shares of Kinder Morgan and has the following options: short March 2018 $17 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan and ONEOK. The Motley Fool has a disclosure policy.