Pipeline Potential

08/19/2005 12:00 am EST

Focus:

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

An expert on Canadian stocks, Gordon Pape looks to a US pipeline operator as the latest addition to his buy list. Here, he reviews Kinder Morgan, which recently made a Canadian acquisition that he believes has created an opportunity both north and south of the border.

"Many Canadians may have found themselves muttering 'Who?' when the news was announced that Kinder Morgan (KMI NYSE) of Houston is taking over Terasen for $6.9 billion. KMI is not well-known in Canada but it is a major player in the US pipeline sector, operating more than 35,000 miles of gas and products pipelines. It is also involved in natural gas retail distribution and, to a limited extent, in natural gas fired electrical generation.

"Kinder Morgan was originally founded in 1936 as the Kansas Pipeline and Gas Company. Its current structure dates from the 1999 merger with KN Energy. KMI owns the general partner of Kinder Morgan Energy Partners LP, one of the largest pipeline master limited partnerships in the US. It also owns the Natural Gas Pipeline Company of America, which operates a 9,800 mile pipeline that serves Chicago and several mid-western states from Wisconsin to Texas.

"Once the Terasen acquisition closes, expected before year-end, KMI will control about 40,000 of natural gas and petroleum pipelines and have more than 1.1 million natural gas distribution customers. It will also place KMI in a position to be able to supply output from the Alberta oil sands to the US market, which is expected to dramatically increase its reliance on Canadian oil in coming years. In announcing the Terasen acquisition, KMI’s chairman and CEO Richard Kinder indicated the firm is prepared to invest heavily in expanding this capacity going forward.

"There is another potential bonus for shareholders in KMI’s entry into Canada. The company is the leading supplier of carbon dioxide for use in oil recovery in the US. The gas is gaining favor as a way to increase yields from the Alberta oil sands and KMI will now be well-positioned to grab a share of that business. The company is currently generating strong financial results. For the first six months, earnings per share were $2.11 compared to $1.85 in 2004. Target for the year is $4.22 a share which the company says it expects to 'meet or exceed.'

"The company’s balance sheet showed long-term debt of $2.9 billion as of June 30. However, the debt to capital ratio is a very good 38.2%. The company has a BBB credit rating from S&P although it is on negative watch at present. In announcing the second-quarter results, the company said it is increasing its quarterly dividend for the second time this year, to 75 cents a share ($3 a year). This is the sixth dividend increase since the second quarter of 2002, when it stood at 5 cents a share, and according to Kinder, there are likely more to come. At the quarterly rate of 75 cents, the stock yields 3.2%.

"Much of KMI’s operations are regulated, which gives the company many of the same pluses and minuses. But there is a lot more growth potential here. If the oil sands do become a major source of energy for the States as expected, KMI has put itself in an excellent position to benefit and shareholders will reap the rewards for years to come. Higher interest rates may create a drag on the stock price. But the long-term prospects are exciting and the dividend is very attractive. We rate KMI a buy."

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