Want $1,000 in Passive Income? Invest $3,000 in This High-Yield Energy Stock and Wait 6 Years.

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This pipeline giant just hit a four-year high and sports a 5.8% dividend yield.

High-yield dividend stocks can be an investor’s best friend when the market is selling off. But even a high yield is no match for big gains in the broader indexes — as we saw in 2023 and so far this year.

However, long-term income investors know that dividend investing isn’t about outperforming the market in a given year but collecting a steady stream of predictable passive income that can be useful for financial planning or supplementing income in retirement.

Pipeline and energy infrastructure giant Kinder Morgan (KMI 0.55%) is hovering around a four-year high. With a 5.8% yield, investing $3,000 in Kinder Morgan and waiting six years should produce at least $1,000 in passive income. Here’s why Kinder Morgan is an excellent dividend stock to buy now.

Image source: Getty Images.

An effective business model

Kinder Morgan generates stable cash flows. Around 75% of its natural gas pipeline business is supported by take-or-pay contracts where customers must either take the product or pay Kinder Morgan a penalty.

Kinder Morgan also generates a sizable amount of cash flow from fixed-fee contracts that can help offset the volatility of natural gas and oil prices. “Although natural gas prices are expected to be significantly below budget for the full year, given that we have modest direct commodity price exposure and have seen strong execution across our businesses, there’s no change to our full year budget guidance,” Kinder Morgan CEO Kimberly Dang stated in the company’s Q1 2024 earnings release.

The decision to reaffirm guidance despite weak commodity prices is a testament to the consistency of Kinder Morgan’s pricing model.

According to the Energy Information Administration, Henry Hub natural gas prices reached a four-year low in February 2024. Prices have recovered somewhat since then but are still relatively low compared to historical levels.

While Kinder Morgan isn’t as impacted by near-term price swings in natural gas, it does depend on the growing demand for natural gas to justify capital-intensive projects. For example, suppose Kinder Morgan wants to build a new pipeline from a production region like the Permian Basin to the Gulf Coast for processing or export overseas. In that case, exploration and production companies must invest in producing more natural gas so that there’s a clear path toward increased domestic consumption or export.

Liquefied natural gas has been a key driver in helping the U.S. energy industry increase its global reach. Through pipelines and storage facilities, Kinder Morgan has been front and center in this growing market.

Another trend that could lead to higher natural gas demand is energy demand from data centers. Artificial intelligence is driving higher electricity demand with an emphasis on reliability. The impact of this trend could take years to play out, but it’s worth following and certainly a potential catalyst for growth for Kinder Morgan.

One of the biggest long-term concerns with a company like Kinder Morgan is its position in the energy transition. While natural gas is considered a bridge fuel, methane is a harmful greenhouse gas. However, it is cleaner than oil and coal, which could help natural gas projects coexist with renewables decades from now.

Kinder Morgan has addressed sustainability in biofuels such as renewable diesel and renewable natural gas (RNG). Unlike fossil natal gas, RNG is produced from landfills, wastewater, cow manure, and other sources. It provides a way to create natural gas from industrial processes and the agriculture sector. However, the industry is heavily dependent on federal credits.

Building around dividend growth and financial health

Kinder Morgan may have a high yield, but that doesn’t mean it has been a good investment. Even after its recent run-up, Kinder Morgan’s stock price is down over the last five years. However, once factoring in dividends, the investment has produced a 30% total return over the last five years — which is a lot better than a risk-free asset like a certificate of deposit. Still, it’s a far cry from the 103% total return the S&P 500 has notched in that time frame.

The good news is that Kinder Morgan is a better business today than in years past. The company has been reducing its dependence on debt and has plans to reduce its leverage even further. Kinder Morgan’s net debt position is down significantly from its peak before the oil and gas crash of 2015. As you can see in the chart, Kinder Morgan slashed its dividend by 75% in response to that downturn but has since raised its dividend every year since 2018.

KMI Net Total Long Term Debt (Quarterly) data by YCharts.

The company prioritizes capital discipline and dividend growth and has a clear path toward growing the dividend for years to come. Its earnings before interest, taxes, depreciation, and amortization (EBITDA) and operating cash flow have been growing in recent years, which has helped support dividend growth and pay down debt.

KMI EBITDA (TTM) data by YCharts. EBITDA = earnings before interest, taxes, depreciation, and amortization. TTM = trailing 12 months.

Kinder Morgan is guiding for $1.22 in 2024 earnings per share, a 15% increase compared to 2023. It expects to pay $1.15 in dividends per share in 2024. While the payout ratio is high, it’s worth noting that using operating cash flow or free cash flow is a better metric than net income to gauge the affordability of Kinder Morgan’s dividend since the timing of its investment cycle and asset sales/write-downs can heavily impact net income. Kinder Morgan’s free cash flow is hovering around its highest level in 10 years, suggesting the company is generating plenty of cash to fund its dividend, invest in growth, and continue improving the balance sheet

A worthy passive income play

Kinder Morgan isn’t the flashiest company, but it has made the necessary improvements to become a solid dividend stock that combines a high yield with reliability. The company benefits from increased natural gas consumption and the U.S. export of natural gas in liquid form. Although the energy transition is an ongoing concern, there does seem to be enough demand drivers for increased domestic use and export to justify new infrastructure projects.

Despite making some notable acquisitions in recent years, Kinder Morgan has kept a tight lid on its balance sheet and continues to stress the importance of financial health and a growing dividend.

Add it all up, and Kinder Morgan stands out as a good buy for investors whose financial goals are centered around passive income generation rather than potential capital gains.