Tuesday, March 18, 2014

Richard Kinder: The Warren Buffett of Energy

Warren Buffett is the most successful investor in the world. If someone had put $10,000 in his partnership in 1956 and stayed with him, approximately 57 years later their stake would be worth almost $1 billion. I have been on a mission to learn as much as possible about this successful investor, and hopefully implement some of those lessons to improve my own investing. In the process of my reviews, I noticed some striking similarities between Warren Buffett and Richard Kinder, who is the CEO of Kinder Morgan Inc (KMI).

I have owned Kinder Morgan Management LLC (KMR) for a little over 5 years, and Kinder Morgan Inc (KMI) for over 3 years now. In my research of the Kinder Morgan Companies, I have uncovered striking similarities between the founder and main shareholder of Kinder Morgan and investing legend Warren Buffett. Of course, correlation is different from causation, but never the less I think it pays to pay attention to certain traits of successful CEO’s. I believe these characteristics could pay dividends for shareholders for years to come.

The first striking characteristic is that both men have the majority of their net worth in the stock of the companies they manage as CEO’s. Buffett has a 21.40% economic interest in Berkshire Hathaway, while Richard Kinder owns 23.30% of Kinder Morgan Inc. I really like to see when CEO’s have most of their net worth in the company they manage, because this shows that their interests are aligned with the interests of ordinary shareholders. What can I say, I admire investors with skin in the game.

In addition, both men take nominal salaries from the companies they manage, compared to other CEO’s. Warren Buffett earns a $100,000 annual salary from Berkshire Hathaway (BRK.B), while Richard Kinder earns a mind-boggling $1/year. Of course, they are not relying on these salaries, which are pitiful compared to the gargantuan packages that executives earn these days. Buffett has approximately 1% of his net worth in various investments, which earn him a high enough dividend income to pay a lower tax rate than his secretary. Richard Kinder on the other hand derives most of his income from dividends paid by Kinder Morgan Inc to shareholders. With over 240 million Kinder Morgan Inc (KMI) shares, Richard Kinder makes approximately $400 million in annual dividend income. You can bet that he would do anything within his control to ensure that his stream of dividends increases over time, and that his stake becomes more valuable. Because qualified dividend income has preferential tax treatment, Richard Kinder would not pay more than 23.80%.

Both Buffett and Kinder seem to be focusing their best efforts on activities they like, which are also within their circles of competence. Buffett has been a student of business and investing for almost his entire life. Richard Kinder has had a career in law, followed by working at Enron until 1996. At one time, he was one of the most likely to succeed Ken Lay to the CEO position at Enron. Unfortunately for Enron, the company did not promote Richard Kinder, which is why he left in 1996 and started his journey as the Buffett of Energy. He purchased pipeline assets from Enron, and started acquiring more pipelines and other energy gathering assets in order to gain scale. In addition, he took advantage of the master limited partnership structure for tax purposes, which was not common at the time.

The thing that really strikes a resemblance between the early days of the Buffett partnership and Richard Kinder is the smart use of leverage. For example, Warren Buffett earned as a performance fee a quarter of all partnership returns above 6% in a given year. He then plowed most of those fees back into the partnership as limited ownership stakes. Because Buffett’s investment partnership routinely made more than 6%/year, he ended up collecting millions in fees, while allowed him to end up with a high net worth by the time he wound the partnership down in 1970. Richard Kinder on the other hand owns a large stake in the general partner of Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB). The general partner earns incentive distribution rights, which essentially allow them to a greater share of incremental growth in cash flows from the limited partnerships. In addition, the general partner also owns portions of the limited partners.

Either way, my highest portfolio position is Kinder Morgan Inc (KMI), as it offers a high current yield, plus solid dividend growth. I also own a pretty size-able chunk of Kinder Morgan Management LLC (KMR), where instead of distributions I receive more shares. This is also a great way to gain exposure to MLPs in a tax-deferred account, particularly if you are afraid of the UBTI. Therefore, the growing distributions are automatically reinvested, thus further turbocharging the compounding effect there. Once I retire however, I would likely convert those shares into partnership units of KMP, so that I can live off the income. Hopefully the spread between KMR and KMP narrows by then. Otherwise, if you are a long-term investor who wants to purchase KMP units, but don’t need the cash for years, I would strongly suggest KMR instead.

Full Disclosure: Long KMI, KMR, BRK/B

Relevant Articles:

The Importance of Corporate Governance for Successful Dividend Investing
Your best ideas might already be in your circle of competence
I admire Investors with Skin in the Game
Do not become a victim of fear in your dividend investing
Warren Buffett Investing Resource Page
Buffett Partnership Letters

14 comments:

  1. I own KMP in a tax deferred account. I have owned large positions in other MLPs as well. Chas Schwab manages the tax deferred accounts for me, and does the tax returns for these positions.

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  2. Which one of these is best for a normal taxable investment account - KMI, KMR or KMP ?
    Or is it all complicated ? I have not invested in any LPs and I have stayed so far with only pure american dividend distributing company equities in the taxable account.

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  3. Would converting KMR to KMP be an untaxed event ?

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  4. But are the pe ration for KMI and KMR too high right now to start building a position?

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  5. DGI,

    It looks like KMI is at about 27x P/E, which seems a bit high. However, the stock is about at a 52-week low point around $31.70. I'm conflicted on whether this is a time to buy since I'm skeptical of buying anything above a 20 P/E. Thoughts?

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  6. KMI's dividend seems to be 1.64 but EPS is only 1.15. How can that be?

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  7. Actually what he has in common with Warren is that Warren runs a diversified hedge fund and the Kinder Companies are set up like a non-diversified Hedge fund.

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  8. Toss if you convet the wronge way like that you will reduce your income by about ten percent, lose control of how much to spend and how much to keep, and convert your capital gain income to ordinary income.

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  9. SG Kmr is the best, you will get more shares, probably about a 10% larger claim on assets and income.

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  10. The IRA is a good way to get around the K-1 but it does not compensate you for the 10% fewer shares your money bought than if you knew what you were doing when you got in and bought Kmr instead.

    See.. Dividend growth: http://kinderflow.blogspot.com/2013/12/quarterly-payout-from-one-original-share.html

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  11. Converting KMR to KMP isn't my idea, it's in the article. I was wondering if there was a mechanism in place at Kinder to convert and asked the author if doing so would be considered some sort of wash that isn't taxed.

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  12. KMI is slightly different to analyze than a JNJ or WMT, since it distributes a large portion of cash flows to shareholders. Thus, I simply look at its current dividend, estimates for future dividend etc. I think that any yield above 4% compensates me for holding KMI. I also like the leverage off KMP through IDR's.

    A metric KMI uses is called "Cash available to pay dividends" To determine coverage, you can find it in on page 4 http://www.kindermorgan.com/investor/4Q_2013_KMI_Earnings.pdf

    I cannot provide individual tax or investment advise to anyone on this site. Everyone's situation is different, so it is up to each individual to determine what is best for them. I merely share my thoughts on companies I am looking at, nothing else, nothing more.

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  13. If that tax disclaimer is aimed at my question then I'm not asking for tax advice. Rather I was struck by the expressed intent to "convert" KMR to KMP at some point. I was wondering how that might be done (is it an otion Kinder provides for or would it just be selling KMR and buying KMP) and wouldn't it be particularly couterproductive if it is a taxed event. --For my part, I own both. I bought the KMR first and now feel it was the less troublesome investment; I wish I'd just stuck with the KMR. Now I'm transitioning to KMI.

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  14. Toss,

    I don't think there is a mechanism to "convert" KMP to KMR or vice - versa. The only way would be to sell KMR and buy KMP. This would create a taxable event. That's what I meant. At some point the spread between the two will probably narrow, which might make this an advantageous conversion.

    Cheers!

    DGI

    ReplyDelete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

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