Pipeline companies typically offer investors enticing dividend yields. Fueling those payouts is the relatively predictable cash flow these companies generate from their predominantly fee-based assets. That said, while investors can collect a high yield on almost any pipeline stock, some are much better than others.
That's certainly the case when comparing the top five pure-play pipeline companies, which as the following table shows, have wildly different financial metrics:
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When we compare these companies on the merits of their financial situation with the visibility of their growth prospects, one stands above the rest.
Giving credit where credit is due
A crucial factor for income investors to consider when comparing pipeline stocks is the underlying strength of their financial situation. As the previous table showed, TransCanada had the highest credit rating while Targa Resources has a junk rating. One thing that's surprising about this is that Targa has a much lower leverage ratio. What this shows is that while leverage plays a role the soundness of a company's balance sheet, it's not the only factor. The rating agencies also placed a high value on a company's dividend coverage and cash flow stability. These factors should also be important to dividend investors because they'll increase a company's ability to sustain its dividend through the tough times.
Take Kinder Morgan, for example. While it currently has the best dividend coverage of the group, that wasn't always the case. The company used to pay out nearly all its cash flow to investors, which resulted in razor-thin dividend coverage similar to where Targa Resources is today. That came back to bite the company when credit started to tighten in the industry as a result of the deepening of the downturn in the oil market. Consequently, it slashed its dividend to free up cash to help finance growth projects.
A future dividend cut isn't a worry at TransCanada and Enbridge because both generate extremely predictable earnings and retain a significant portion of their cash flow to help finance growth projects. Meanwhile, Targa Resources' payout appears to be at risk of getting reduced due to its microscopic margin for error, since it's currently paying out more than it's bringing in and 30% of its cash flow has direct exposure to volatile commodity prices.
Given the importance of these factors, here's how I'd rank the dividend safety of these five pipeline stocks:
- Kinder Morgan
- Targa Resources
The best of both worlds
While many investors choose an income stock based on its current yield, it's even more important to consider a company's ability to increase that payout because it could enable an investor to collect an even greater income stream in the future. Here's how this group compares:
As that table shows, on yield alone, Targa Resources stands out. Even if the company doesn't increase its dividend over the next few years, Targa could still have the highest yield in 2020. That said, given its tight coverage ratio and elevated exposure to commodity prices, there's a high risk that the company might reduce its payout.
Meanwhile, the rest of the companies anticipate increasing their payouts by robust rates in the coming years. Backing those projections are massive backlogs of primarily fee-based expansion projects. Enbridge, for example, currently has 31 billion Canadian dollars' ($25 billion) worth of projects under construction. Meanwhile, Kinder Morgan has more than $12 billion of projects under development. Those expansions, when combined with the company's decision to increase its payout ratio from 25% of cash flow up to 50% are what supports its recently announced plans for a massive dividend increase next year, followed by significant increases in both 2019 and 2020.
One other company that stands out on this list is ONEOK. It's on pace to have the second highest-yielding payout in 2020. However, one of the drivers is that ONEOK only expects dividend coverage to be 1.2 times, which is much tighter than the 2.0 times coverage forecast of Kinder Morgan, Enbridge, and TransCanada. That makes ONEOK's payout a bit higher risk.
When factoring in the projections and risk factors, here's how I'd rank the income and growth prospects of this group:
- Kinder Morgan
- Targa Resources
This one checks all the boxes
This race is a very tight since Kinder Morgan and Enbridge are neck and neck. However, for investors who need a higher level of income in the near term, with a high probability of growth over the next several years, Enbridge rises to the top. The company offers a well-supported high yield today that it should have no problem growing at a rapid rate over the coming years.
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Matthew DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan, long January 2018 $30 calls on Kinder Morgan, and short December 2017 $19 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Enbridge, Kinder Morgan, and ONEOK. The Motley Fool has a disclosure policy.