There are more than 2.4 million miles of energy pipelines running through the United States, which is the largest network of oil and gas pipes in the world. This system ensures that there's enough gasoline to fill our cars and natural gas to heat our homes so we can live comfortably in our modern society. That said, comfort has a price as it costs billions of dollars per year to transport oil and gas through this network. It's a great business for pipeline operators, which get paid steady fees as these volumes flow through their systems.
While those companies use some that cash flow to maintain their pipes, they generate so much each year that they're able to send billions of dollars back to investors via dividends, which makes them excellent stocks for those seeking an additional income stream. While there are plenty of pipeline stocks to choose from, here are three top options to buy now:
Dividend Payout Ratio
Dividend Growth Forecast
Enbridge (NYSE: ENB)
10% annual dividend growth through 2020
Kinder Morgan (NYSE: KMI)
60% increase in 2018 and 25% increases in 2019 and 2020
ONEOK (NYSE: OKE)
9% to 11% annual increases through 2021
Source: Kinder Morgan, TransCanada, and ONEOK.
Image source: Getty Images.
A high growth, high-yield pipeline stock
Enbridge operates the longest and most sophisticated oil pipeline system in the world. The vital network primarily moves oil from Canada to the U.S. and currently supplies the states with 28% of its total oil imports. However, the Canadian pipeline giant is much more than just an oil pipeline company since it gets half its cash flow from other sources like natural gas pipelines, utilities, and renewable energy. Overall, those income streams have provided Enbridge with about 3.9 billion Canadian dollars ($3 billion) in cash flow from operations through the third quarter of this year. That's up from CA$2.8 billion ($2.2 billion) over the same timeframe in 2016 due to a major acquisition and recently completed growth projects.
More growth is on the way since Enbridge expects to place CA$12 billion ($9.3 billion) of expansions into service this year and a total of CA$31 billion ($24.1 billion) through 2020. Those new additions will fuel more cash into the company's coffers, giving it the visibility to increase an already generous divided by 10% annually over the next three years. Meanwhile, at the same time the company's raises its dividend, it expects to firm up its balance sheet by selling non-core assets to pay off debt and finance its massive backlog of expansion projects. This combination of an improving financial picture and visible growth prospects suggests that Enbridge's lucrative dividend is on a firm foundation.
A dirt cheap dividend growth stock
Kinder Morgan is one of the largest energy infrastructure companies on the continent, including operating the largest natural gas pipeline network. The company expects its portfolio to generate $4.6 billion in cash flow next year, which would be about 3% higher than this year. That will provide the pipeline giant with enough cash to finance $2.2 billion of expansion projects and pay a dividend that's 60% higher than 2017's rate, with about $500 million left over for share buybacks or additional growth projects.
That 60% dividend boost is worth noting because it would push the company's yield up closer to Enbridge's at 4.6%. That said, the increased payout would only consume about 40% of the company's cash flow compared to 65% at Enbridge, which means Kinder Morgan's dividend is on an even better foundation.
One other thing worth noting about Kinder Morgan is how cheaply its stock trades when compared to other pipeline companies. Given its current forecast that it will generate $2.05 per share in cash flow next year, it implies that the stock sells for just 8.4 times cash flow considering that shares were recently around $17.25 apiece. For perspective, its pipeline peers currently trade at around 14.9 times cash flow per share, suggesting that Kinder Morgan's stock is dirt cheap these days.
Image source: Getty Images.
Higher risk, but with a higher reward
ONEOK currently offers the highest yield among this trio. However, with that higher reward comes more risk since the company pays out a much larger portion of its cash flow in support of that payout. That said, it doesn't need to retain as much excess cash since it doesn't have a large pipeline of expansion projects to finance.
Instead, what will fuel ONEOK's growth will be smaller, higher-returning projects as it grows its existing asset base. For example, the company recently agreed to invest about $160 million in expanding one of its pipeline joint ventures in a project that should enter service in the third quarter of next year. That's one of roughly $500 million of expansion projects the company has secured since the middle of this year. What's worth noting about these projects is that they should earn returns in the five to seven times earnings range, which is better than the 6.8 times earnings multiple Kinder Morgan expects to make on the $10.2 billion in fee-based expansions it currently has in development.
That said, if there's one concern with ONEOK's growth prospects it's that other than those near-term projects, the company doesn't have anywhere near the visibility of Kinder Morgan and Enbridge, which have much larger backlogs. While the company has a $2.5 billion to $3.5 billion inventory of growth projects under development, there's a risk that it doesn't secure enough of those projects to fuel its planned dividend growth since it has a much smaller margin for error due to its higher payout ratio. Because of that, investors need to carefully weigh the reward of a higher payout now with the risk that it might not grow as fast as expected in future years.
Visible growth and income for years to come
Thanks to the primarily fee-based contracts underpinning their pipelines, this trio should continue generating the steady cash flow needed to keep paying out lucrative dividends. Because of that, income investors should do very well over the long-term by going with any one of these pipeline stocks. In the end, the deciding factor boils down to what level of income and risk an investor is comfortable with since ONEOK offers higher doses of both while Kinder Morgan is on the lower end of the spectrum and Enbridge is in the middle.
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Matthew DiLallo owns shares of Enbridge and Kinder Morgan and has the following options: long January 2018 $30 calls on Kinder Morgan, short December 2017 $19 puts on Kinder Morgan, and short March 2018 $17 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Enbridge, Kinder Morgan, and ONEOK. The Motley Fool has a disclosure policy.