What do natural gas pipelines have in common with tech giants eBay and Facebook? They all have an iron grip on the markets they serve. And market dominance is one of the key signs of likely long-term success for a stock.
Companies can take control of their markets in one of two ways. Like Apple today or IBM 40 years ago, technology companies can set the standard for innovation in a rapidly developing industry. Once established, this kind of dominance lasts as long as the company can stay out in front – and often until the technology undergoes a fundamental change.
IBM, for example, was computer king from the early 1960s until the mid-’80s, when the company’s dominance was broken by the shift from mainframes to desktops. Microsoft is already facing similar threats, including the spread of diverse operating systems, such as Linux; the popularity of smartphones and other hand-held computing devices; and the potential of cloud computing. [time-link title=”(See photos of life inside Facebook’s headquarters)” url=http://www.time.com/time/photogallery/0,29307,2036832,00.html]
There is another kind of dominance, however, that may well be longer lasting – control of a market where there are barriers to entry. In such cases, there are legal or practical limitations for any newcomer who wants to start competing with well-established companies.
For example, there are a limited number of frequencies available for mobile phone calls and smart-phone data transmission. AT&T and Verizon have a lot of those frequencies locked up. And that gives them an edge against other phone company competitors.
But when it comes to industries with such barriers to entry, one market looks especially interesting to me – natural gas pipelines. Environmental and zoning restrictions make building new pipelines a practical impossibility, even though gas usage seems almost certain to rise over the long term.
Indeed, the case for natural gas is compelling. The U.S. has more natural gas than oil, and gas reserves are growing. Gas burns cleaner and produces less carbon dioxide than either oil or coal. Moreover, gas is generally cheaper than oil and much cheaper than normal today, relative to the current oil price of more than $100 a barrel.
But if natural gas is so great, why don’t we use it more? The answer is that the easiest switchovers to natural gas have already been made. Greater use of gas now depends on the capacity of pipelines to move it from the fields where it’s produced to additional places where it could be used effectively.
Trouble is, nobody wants a new pipeline going up near their house. The potential dangers are obvious and, even in a best-case scenario, gas pipelines and storage facilities make for ugly industrial landscapes. [time-link title=”(See photos of crabbing in the Gulf after the BP oil disaster)” url=http://www.time.com/time/photogallery/0,29307,2007182,00.html]
What that means is that there will always be barriers to entry for new pipelines. And those that already have a dominant position will continue to enjoy a partial monopoly in their service areas.
There are a limited number of mega-pipelines in the U.S. And I own two stocks that each control a major pipeline and also pay above-average dividend yields.
NiSource (NI), a utility based in Indiana, owns Columbia Gas Transmission, one of the largest pipeline networks in the U.S. With 12,000 miles of pipe, Columbia transports massive amounts of natural gas from Texas, Louisiana and the Gulf of Mexico to the northeastern and midwestern U.S. The shares trade at less than 14 times estimated earnings for the coming year and pay a 4.6% annual yield. [time-link title=”(See photos of how cities are powered)” url=http://www.time.com/time/photogallery/0,29307,2026653,00.html]
Spectra Energy (SE) in Houston, owns Texas Eastern transmission, with 9,200 miles of pipe. Along with other pipelines that raise the total to 13,000 miles, Spectra brings gas to large areas of the Eastern and Southeastern U.S. The shares trade at less than 15 times estimated earnings for the coming year and pay a 3.8% yield.
These pipeline giants will be around, cranking out their superior yields, for a long, long time. And unlike Facebook, they’ll never have to worry about being unfriended.