Master of Its Universe

08/03/2009 12:00 pm EST

Focus: STOCKS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says an energy master limited partnership has steady growth prospects and pays out a fat dividend.

Kinder Morgan Energy Partners L.P. (NYSE: KMP) continues to deliver on its expectations and has made great strides in cost controls to compensate for the weak economic environment. When things turn around, it could really take off.

KMP is a master limited partnership, a pass-through vehicle for tax purposes. The company pays no corporate taxes, but pays out its income directly to you, similar to real estate investment trusts (REITs). It is best not to buy them in tax-deferred accounts, because that negates some of their tax advantages.

KMP is one of the largest and most respected pipeline and energy storage LPs in North America. It operates or [has] interests in more than 26,000 miles of pipelines and 170 terminals. Its pipelines transport crude oil, natural gas, fuels, other distillates, ethanol and [carbon dioxide]. Its terminals store petroleum products and chemicals and handle bulk materials like coal and petroleum coke.

Since MLPs distribute most of their cash flow, they periodically need to raise capital through secondary stock offerings and debt. KMP continues to have easy access to the capital markets at very attractive rates, while providing great long-term returns.

[KMP] has steadily increased its income distributions in the last five years at a compound annual rate of 8.8%. If it can continue to grow at even a 5% rate, combined with its current dividend yield of 8.1%, it will provide returns that trounce the market for the foreseeable future.

KMP, along with most publicly traded LPs of this type, tends to move in spurts. While the dividends keeps growing steadily, the demand for the stock wanes during periods when the public thinks it can make a killing buying sexier stocks with gaudy short-term growth prospects. Then, when the bloom is off the hyper-growth rose, investors gravitate back toward more reliable, steady prospects.

I think we’re entering another flight-to-quality era. We already see the strength returning to the MLPs. After the market collapses again, that trend will only accelerate. We baby boomers cannot afford another hit to our retirement funds. The entire complex of stocks with income and steady growth will benefit, and so will their owners. That will be us.

KMP had a good quarter, and remains on track for its projected payout this year. The firm is extremely well managed by one of its founders, Richard Kinder. He takes no salary, but is a large shareholder. The units are 8.5% insider-owned and its sister units that pay dividends in additional shares, rather than cash, are 14% insider-owned.

As with all MLPs and REITs, its distributions typically exceed its book income because of non-cash, non-essential depreciation and tax credits. This makes its payout ratio look high, but that’s an illusion, and its balance sheet is among the best in the business. Buy KMP up to $57. (It closed at around $53 Friday—Editor.)

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