The Right Way to Buy Kinder Morgan

I’ve been a big believer in midstream master limited partnerships (MLPs) for a long time.  The U.S. domestic energy revolution has created massive new demand for pipeline infrastructure, and a lack of attractive income options elsewhere makes them doubly attractive to individual investors.

As an asset class, MLPs are off to a great start in 2013.  The JP Morgan Alerian MLP Index ETN (NYSE:$AMJ), which is a good proxy for MLPs as a whole, is already up 12% this year, not including distributions.  Not bad, given that the S&P 500 is only up 8%.

Kinder Morgan Energy Partners (NYSE:$KMP) is one of the oldest and most popular MLPs and along with Enterprise Products Partners (NYSE:$EPD) is what I would consider the bluest blue chip of the group.

But KMP is a terrible choice for most investors given that you can buy its sister security at a discount while also dealing with far less headache at tax time.

Kinder Morgan Management (NYSE:$KMR) is a hybrid security that pays its distribution in stock rather than cash. It’s also “IRA friendly” and doesn’t generate a cumbersome K-1.  It’s everything great about KMP but without the headache.

For this added convenience, you might expect to pay a premium. But at current prices, KMR trades for nearly a 5% discount to KMP.  Given your choice here, you’d be a fool to buy KMP.

There is one other option as well: Kinder Morgan Inc (NYSE:$KMI).  Kinder Morgan Inc. is the general partner that manages KMP and KMR.  It’s taxable as a corporation and pays a lower dividend at 4%.  But if you believe in the growth of the industry, it’s likely to be the most profitable of the lot. Due to the way that LP distributions are paid, the general partner can be thought of as a leveraged play on the underlying MLP.

Frankly, in an MLP bull market you can’t lose with any of these options.  But for an investment in Kinder, I would recommend something along the lines of 2/3 in KMR and 1/3 in KMI.

Disclosures: Sizemore Capital is long KMR and KMI.  This post first appeared on TraderPlanet.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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