Warren Buffett Is Bullish on KMI Stock

This firm is my favorite way to invest in oil. Now, even Warren Buffett agrees with me. I’m talking, of course, about Kinder Morgan Inc (NYSE:KMI) stock.

On Tuesday, the billionaire disclosed a new investment in pipeline operator Kinder Morgan. According to a Securities and Exchange Commission (SEC) filing, Buffett’s holding company, Berkshire Hathaway, owns 26.5 million shares of KMI stock worth $395.9 million. (Source: “Berkshire Hathaway 13-F Filing,” SEC, February 16, 2016.)

The bet is unusual. While pipelines are usually a boring business, shares have been crushed. KMI stock has been cut in half since April.

The industry is in trouble. Investors are running for the hills. What could Warren Buffett see in this stock?




Here’s Why Warren Buffett Is Buying

Kinder Morgan owns oil pipelines and terminals across North America. If you follow the news, you know these things are a hassle to build. But once they’re up and running, there’s no better business around—especially if you like dividends.

Pipelines act like the “toll booths” of the oil patch. Drillers are always searching for a big score, hoping to strike it rich on the next gusher. Pipelines, in contrast, collect fees delivering oil to customers. They are content to earn a “toll” on each barrel shipped.

As a result, pipeline profits are immune from wars and recessions. While energy prices can be volatile, the actual volume of crude is steady from year to year. Buried deep underground, your investment is perfectly safe.

And while pipelines are costly to build, they’re not that expensive to maintain. Once laid, a pipeline just sits there, delivering oil to customers. Ongoing costs are only a small fraction of sales. The rest is paid out to shareholders.

Best of all, there’s almost no competition.

Trucks and rail can’t compete once a pipeline is in place. A second line can cost billions to construct. Even if you have the money, governments are hesitant to grant the right-of-ways to build a new one.

Buffett calls this advantage an “economic moat.” In the old days, castles were fortified by trenches called moats. The wider the moat, the easier it was to defend the castle.

The same is true in business. If a castle represents profits, then the moat represents a company’s competitive advantage. You want a broad and deep trench to fend off rivals.

Kinder Morgan’s moat is more than a mile wide and filled with angry mutant sharks. Good news for shareholders. The firm is able to earn huge profits year after year without the fear of rivals eating into margins.

Needless to say, Kinder Morgan qualifies as a wonderful business in the Buffett sense. The problem is that investors tend to bid up the price of these stocks. You can always find great companies, but they’re almost never on sale.

Consider stocks like Coca-Cola, Kraft Heinz, or Procter & Gamble. They are all top-notch businesses to be sure, but you can never buy them at a reasonable price. Kinder Morgan is no exception.

Or at least, that used to be the case.

Turmoil in the oil patch has sent investors reeling. Low energy prices have crushed drilling stocks, with dividends being cut left and right. Even safe pipeline names have been scathed.

KMI stock has been hit, too. With the downturn in the energy market, Kinder Morgan lost access to capital. To conserve cash, the firm slashed its dividend in December.

Cutting your dividend is a bit like wearing a New York Yankees hat around Boston. Sure, you can do it, but don’t expect a warm reception. Investors punished KMI stock afterward, sending shares down another 25% in the following weeks.

Chart courtesy of www.StockCharts.com

The situation has created a once-in-a-generation opportunity. Today, KMI trades at a discount on several metrics to its average historical valuation. Mr. Market, in his irritable mood, is throwing a fire sale.

With the dividend cut out of the way, there are many reasons to be hopeful. The threat of a credit rating downgrade is now off the table. Better yet, Kinder Morgan will be able to fund its expansion with internal profits; no need to dilute investors by issuing shares.

The Bottom Line on KMI Stock

Kinder Morgan is a wonderful business. No, shareholders won’t get rich quick. But given most of the issues are resolved, there has never been a better time to check out KMI stock on the cheap.

No wonder Warren Buffett is backing up the truck.