It’s been a stressful couple of years for investors in Kinder Morgan Inc (NYSE:KMI). In 2014, the company appeared to be riding high, with KMI stock pushing to new heights. A huge merger promised massive tax savings. But the crash in oil prices crashed Kinder’s plans. The downturn culminated in Kinder Morgan shares losing as much as 75% of their value, and KMI’s previously sacred dividend payment was gutted.
However, since KMI stock bottomed at $11 last year, the company’s fortunes improved. Oil and natural gas prices have rebounded, and investors moved back into the energy sector. Kinder Morgan has doubled off the low. It’s a far cry from the $45 level achieved in 2014, but things appear to be on the mend.
Let’s take a deeper look at the business, and at whether you should own Kinder Morgan stock.
Breaking Down The Business
Houston-based Kinder Morgan is one of North America’s leading energy companies. Specifically, it is the leading oil and gas pipeline owner and operator. With a $48 billion market cap, Kinder Morgan leads its closest rivals — Canadian firms Enbridge Inc (USA) (NYSE:ENB), and TransCanada Corporation (USA) (NYSE:TRP) — by more than $10 billion each in equity valuation.
The company owns and/or operates more than 80,000 miles of pipelines, along with almost 200 product terminals. Its facilities account for almost 40% of overall U.S. natural gas transportation, along with smaller shares in other product markets.
Financial Performance
Kinder Morgan has struggled mightily during the energy downturn, and the second quarter’s results showed little indication that this has changed. KMI’s revenues fell more than 9% versus the same period last year. The company’s carbon dioxide unit — highly vulnerable to falling oil prices — caused much of the decline.
The company is largely a toll taker, but it’s not immune to weakening industry conditions.
Kinder’s distributable cash flow (DCF) fell to 47 cents this quarter, down from 58 cents last quarter and 50 cents in the same quarter last year. DCF, instead of earnings, is arguably a more useful measure of economic earnings than normal earnings per share for many energy transportation firms.
DCF also generally guided Kinder Morgan’s dividend in the past … prior to the large dividend cut.
That discussion of DCF also carries importance when discussing Kinder Morgan’s balance sheet.
Kinder Morgan Balance Sheet
Previously, many folks purchased KMI stock for its large dividend. The company used to yield around 5%. On top of that, management had promised 10% dividend growth for several years following the large Kinder Morgan merger a couple years ago.
These plans fell apart as the energy market tanked.
Kinder Morgan’s carbon dioxide unit saw dramatic declines in profitability. And the market turned hostile, becoming much less willing to finance Kinder Morgan’s aggressive expansion plans. The company’s debt load surged to as high as $43 billion, well in excess of the company’s equity at last year’s lower KMI stock prices. Credit rating agencies threatened to downgrade the firm to junk status.
This forced Kinder Morgan to change directions, abandoning aggressive expansion plans. Instead, they slashed the dividend, cut back on growth plans and began selling assets.
Most recently, they sold a 50% stake in a pipeline venture to Southern Co (NYSE:SO) for a cool $1.5 billion. Moody’s, one of the major credit ratings agencies, praised the move. They reaffirmed Kinder Morgan’s all-important investment grade credit rating and suggested the asset sale is a small but helpful step toward shoring up the balance sheet.
With oil prices still low, Kinder Morgan needs to stay in defensive mode for the time being. But the combination of asset sales and defensive positioning should give the company more breathing room coming into 2017. KMI tried to grow too aggressively, and it paid the price.
But current moves are bolstering the company’s financial strength, and should allow dividend increases, starting next year.
KMI Stock: A Good Value?
Let’s be clear; most people that own KMI stock are there for the dividend. At the current share price and dividend, Kinder Morgan yields a pedestrian 2.2% annually. You could buy Exxon Mobil Corporation (NYSE:XOM) and get almost double that.
To put it bluntly, the current dividend isn’t that attractive.
However, think back to the DCF figure that we discussed earlier. Kinder Morgan is generating close to 50 cents per quarter of distributable cash flow. Previously, the company paid close to 100% of that out to shareholders. Annualize that 50-cent figure, and you’re looking at $2 per year. On a $22 stock, that’s close to a 10% dividend yield.
Kinder Morgan can’t pay that DCF out as dividends right now thanks to the tough situation in the energy market. However, at some future point, when conditions improve, it could return to paying out almost all of DCF as dividends. If and when it does so, you’ll receive a huge dividend compared to today’s current stock price.
All that said, Kinder still has a massive amount of debt. Even with the asset sales, KMI has a huge amount of leverage. Any further downturn in the prospects for the American energy industry would hit this company hard.
Kinder Morgan is a high-risk, high-reward bet on the energy sector finding renewed strength. If things succeed, KMI stock will likely (in a few years) pay a 10% annual dividend (at least based on the current $22 stock price). But if things go wrong, the company is so heavily indebted that the common shares could face almost complete wipeout.
Verdict
In retrospect, I should have purchased KMI stock last year when it was trading under $15. I regret not doing so. At $22, however, the risk and reward seem fairly balanced.
If the energy market turns higher, things will turn out well. Particularly if the market is able to regain confidence in Kinder Morgan’s management team, it isn’t hard to imagine KMI stock trading at $40 and paying a $2 annual dividend five years from now.
On the other hand, a renewed drop in oil and natural gas, along with bankruptcies of a few of Kinder Morgan’s customers, would leave the company in a tight spot.
KMI stock has doubled off last year’s lows. And, to be honest, that’s a bit aggressive, given the relatively weak ongoing conditions for American oil and gas producers. Kinder Morgan stock offers some strong upside potential, but I’d feel a lot safer paying $18 per share or less. At current prices, the potential upside is equally balanced against the risk that the energy sector turns lower again.
For now, Kinder Morgan stock is worth watching, but I don’t see it as a buy here.
As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
