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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Kinder Morgan

July 11th 2012 Kinder Morgan
NYSE Symbol: KMP
Industry: Master Limited Partners
Price as of 7/11: $83.34

A great end to the second quarter has followed through to the first two weeks of the third quarter. Countries like China, Brazil, the US, and especially Europe are cutting interest rates to try and fuel growth with limited success so far. The weaker than expected employment data out last Friday indicates the US still needs more quantitative easing as well. The second quarter earnings season will start next week giving us a view into the growth prospects for the rest of the year. The weakest sectors in the market remain energy, materials and industrials, sectors that rely on foreign sales. Engine maker, Cummins dropped 10% yesterday causing a broad based sell off. The oil and natural gas plays have all come under pressure with slowing global growth dragging with it the master limited partners or MLPs. The MLPs have performed well the last several years as investors seek out yield, however most of the major MLPs are still in the red for 2012. This week we'll highlight the largest US midstream MLP, Kinder Morgan yielding 5.9%. Investors have been drawn to the MLPs for their diversification, tax advantages and the fact they typically move independent of other asset classes such as stocks, bonds and commodities. An MLP may be a good way for investors to avoid the market volatility, get more income, while also diversifying their portfolio away from the more traditional income plays.

MLPS or master limited partnerships are the backbone of the energy infrastructure in the US, offering a play on domestic energy with less volatility than exploration and production operations, which are exposed to fluc¬tuating commodity prices. Midstream MLPs are the toll takers of the energy industry getting paid on the volume of commodity product moved, rather than the price of the commodity produced. This makes for smoother revenue, while still providing exposure to energy produc¬tion. As mentioned, Kinder Morgan is the largest midstream company in North America with 75,000 miles of pipelines transporting crude oil, natural gas, carbon dioxide, refined petroleum products and other products. Their 180 terminals store chemicals and petroleum products, and handle products like ethanol, petroleum, coke, coal and steel.

One of the best features for investors in MLPs is the tax advantages. MLPs combine the tax benefits of a limited partnership with the liquidity of publicly traded securities. As opposed to a corporation, a MLP is considered to be the aggregate of its partners rather than a separate entity. MLPs provide for pass-through income, thus they are not subject to income taxes at the corporate level. Owners of an MLP are responsible for paying taxes on their percentage of the MLP's income. This eliminates the double taxation typically applied to corporations. Because of this tax advantage and the accounting rules for MLPs, Kinder Morgan does not trade on traditional valuations. For example Kinder Morgan trades for 35 times earnings and pays out more in dividends at around $4.55 a share verse earnings which are estimated at $2.35 a share. This is due to accounting rules which allow MLPS to depreciation expenses for long term assets like the pipelines over their useful life. This depreciation expense is an non-cash evident which suppresses earnings per share while not effecting cash due to the low maintenance of the pipelines. Hence Kinder Morgan can pay out a very high level of cash flow without hurting the long term earnings potential for the business. The one hitch that many investors dislike about MLPs is the K-1 filings that come sometimes later in the tax reporting season than traditional 1099s. But most investors would concede that the K-1 filing is worth the tax advantages that MLPs provide.

Bottom line, MLPs like Kinder Morgan are great dividend paying stocks yielding 5.9% with tax advantages and less price volatility (beta 0.51) than traditional stocks and the broader market.