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Better Buy: Kinder Morgan vs. TerraForm Power

Energy companies Kinder Morgan and TerraForm Power both cater to dividend-focused investors. They each currently yield around 5% and expect to increase their payouts in the coming years. Because of that, either one would be an ideal option for those seeking income.

However, not all investors likely want to own more than one energy-focused company in their portfolio, even though Kinder Morgan operates in the midstream segment while TerraForm Power focuses on renewable energy. Here's a closer look at which one of these two is the better buy right now.

A hand drawing a scale with the words price and value on it.

Image source: Getty Images.

A closer look at their financial profiles

One of the first things investors should analyze when considering two income-focused investment options is their financial profiles. Here's how Kinder Morgan and TerraForm Power stack up against each other.

Company Dividend Yield Credit Rating % of Cash Flow Fee-Based or Regulated Dividend Payout Ratio
Kinder Morgan (NYSE: KMI) 5% BBB/Baa2 91% 45%
TerraForm Power (NASDAQ: TERP) 5.1% Ba3/BB- 95% 85%

Data source: Company investor presentations.

Let's start with the similarities. Both companies generate very stable cash flow since fees or other predictable sources supply more than 90% of their annual earnings. Meanwhile, they each pay a similar yielding dividend. However, TerraForm Power pays out a much greater percentage of its cash flow to support its payout and has a lower credit rating. Because of that, it doesn't have as strong a financial profile as Kinder Morgan.

However, it's worth noting that TerraForm's payout ratio is within its target range. Further, the company recently made some moves to bolster its balance sheet. Because of that, it has a solid financial profile, even if it might not be as strong as Kinder Morgan's.

A look at their growth prospects

Kinder Morgan and TerraForm Power both expect to grow their dividends in the coming years. However, they have completely different plans to power their strategies. Kinder Morgan's primary fuel source is investing in organic expansion projects. The midstream-focused company currently has $4.1 billion of pipelines and other similar assets under construction, which will drive growth in the coming years. In the company's view, it can invest between $2 billion and $3 billion per year on organic expansions, which at a minimum will grow its earnings by a 4% annual rate.

That need to fund expansion projects is why the company has a much lower dividend payout ratio, as it retains that cash and uses it to finance construction. Kinder Morgan, however, does plan to boost its payout ratio next year, given its previously announced intention to increase its dividend by another 25% for 2020. Its dividend growth rate will likely moderate after that, probably to a mid-single-digit annual pace.

TerraForm Power, on the other hand, grows primarily through acquisitions, which it funds by selling more stock and noncore assets, and issuing new debt. The company bought a Spanish wind and solar power company in 2018 for $1.2 billion. Meanwhile, it recently purchased a portfolio of solar assets in the U.S. for $720 million. It's also working on another deal to invest more than $150 million to acquire additional solar assets in Spain. These transactions, as well as its initiatives to improve the profitability of its legacy assets, should give it the power to grow its dividend by 5% to 8% per year through 2022.

A quick peek at their valuations

The final thing that investors should look at when comparing two investment options is value. In Kinder Morgan's case, it currently expects to generate about $2.20 per share in cash this year. With its stock recently trading at $20 apiece, it sells for about nine times cash flow. TerraForm Power, meanwhile, is on track to generate about $1.10 per share in cash flow this year. With its stock recently around $16 apiece, it trades at about 14.5 times cash flow. That higher valuation is why it has a similar yield as Kinder Morgan, even though it has a higher payout ratio.

Verdict: Kinder Morgan is the better buy for income-seekers right now

While both companies offer yield-focused investors a similar payout, those investors are paying a much higher price for TerraForm Power's dividend. That's because the market has undervalued Kinder Morgan even though it has a strong balance sheet and solid growth prospects. Because of that value disconnect, it could potentially generate higher total returns in the coming years, making it the better buy right now.

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Matthew DiLallo owns shares of Kinder Morgan and TerraForm Power. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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