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Better Buy: Magellan Midstream Partners, L.P. vs. Kinder Morgan Inc.

Do you want an industry giant with a checkered past or a smaller company that's proven it is a slow and steady performer? That's the real question when you are comparing Kinder Morgan Inc. (NYSE: KMI) and Magellan Midstream Partners, L.P. (NYSE: MMP). The complicating factor here is that the giant is starting to get back on track with a plan for huge dividend growth. I'd still err on the side of caution, however, and here's why.   

The recovering giant

Kinder Morgan is one of the largest oil and natural gas midstream companies in the United States, sporting a market cap of $41 billion. Its portfolio of assets would be virtually impossible to replicate, giving it a clear advantage in the market.

Image source: Getty Images.

The problem, for me, is that Kinder cut its dividend by a painful 75% in 2016. Even worse, less than two months before that, management said it was dedicated to returning value to shareholders via a growing dividend payment. The plan, at that point, was to increase the 2016 dividend by as much as 10%, which clearly didn't happen. There's a major trust issue here.   

One of the problems that led to the dividend cut was Kinder's relatively heavy use of leverage. When oil prices cratered in mid-2014, Kinder found it lacked the financial flexibility to fund the growth projects it had lined up. It chose to sacrifice the dividend so it could keep spending. To be fair, that was probably the right decision for the company, but it was a horrible outcome for investors counting on those dividend checks.

Kinder Morgan has a new dividend policy. Image source: Kinder Morgan Inc. 

Today, however, Kinder is getting itself back on track. Leverage is lower, and it recently announced plans for a series of huge dividend increases. Between 2017 and 2020, the annual dividend will go from $0.50 a share to $1.25, assuming that it lives up to its word. I can see why investors would be interested in Kinder Morgan. But don't jump just yet, because you might find that Magellan Midstream Partners is a better option.   

Slow and steady

Magellan is much smaller than Kinder, with a far more modest $15.5 billion market cap. Magellan, though, also has notable assets that would be difficult to replace or replicate -- and its smaller size isn't necessarily a negative. The law of large numbers is a headwind to Kinder since smaller Magellan can take on acquisitions and growth projects that wouldn't move the needle at its larger peer.

Equally important, Magellan is far more conservative than Kinder. For example, Magellan's debt-to-EBITDA ratio is around 3.4 times today compared to Kinder's nearly 6.5 times EBITDA. Kinder's debt-to-EBITDA ratio is much lower than it was just a few years ago, but it's still highly leveraged compared to Magellan. If I had to guess which of these two would have an easier time raising capital in an industry downturn, my pick would still be Magellan despite the balance sheet improvements Kinder has made.   

KMI Financial Debt to EBITDA (TTM). Data by YCharts.

That said, Kinder's dividend growth over the next few years is going to trounce what you should expect from Magellan, which is targeting 8% annual distribution growth. That, however, isn't the full picture. Kinder's yield is roughly 2.7% today compared to 5.3% at Magellan. Using today's stock price, Kinder won't provide you with a comparable yield until 2019.   

You could counter that Kinder's yield in 2020 will be around 6.7% -- assuming no price appreciation. That's much higher than what you would get from Magellan today. But don't forget that Magellan will likely have provided investors with three years of 8% distribution growth by that point. And then there's the not-so-subtle issue that Magellan has increased its distribution annually for 17 years, a track record that Kinder can't match.

Go with the bird in the hand

The dividend growth potential at Kinder Morgan is certainly enticing, and the improvements it's made on its balance sheet are very encouraging. But when you compare these facts and the company's checkered dividend history to Magellan's current yield, distribution growth plans, and conservatively run business, I hope you'll hit the pause button and consider Magellan over Kinder. Magellan is a tortoise, to be sure, but sometimes tortoises make for good bets.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.