Dividends and pipeline juggernaut Kinder Morgan (KMI) go hand in hand.
Born from the good remnants of defunct Enron, the firm pioneered and popularized the master limited partnership to help it expand and grow into an energy logistics behemoth. Along the way, KMI has managed to push plenty of the cash flows from its pipelines, terminals and other midstream assets back into the hands of its investors.
And then things got weird. Not actually weird per se, but still a tad strange.
Kinder isn’t acting much like the KMI of old. Several recent moves by the firm are a tad bit puzzling and could potentially signal that cracks are starting to form in the largest midstream firm’s armor.
While calling KMI a “loser” is still a bit of stretch, there plenty of concerns that investors need to be thinking about.
A Few Issues at KMI
With 84,000 miles worth of pipelines, numerous storage, 165 terminaling and processing assets, KMI is certainly in a league of its own. And that is part of the problem. In order to keep growing your cash flows at a firm the size of Kinder Morgan, you really need to develop projects that move the needle. Tacking on a smaller 200-mile gathering lien really isn’t going to cut it.
The problem is big projects cost big bucks to build. MLPs are constantly doing secondary offerings or tapping the debt markets to finance “drop downs” from their general partner parents. Financing became expensive at Kinder Morgan’s MLP, and in surprise move Kinder Morgan actually decided to buy out its MLP and merge the firm back into KMI stock.
The basis for deal was that it would lower Kinder Morgan’s cost of capital as it could now issue shares of KMI as a cheap way to keep building/buying the projects it needs to grow its cash flows and, ultimately, its dividend.
The wrench in all of this was that KMI stock has tanked hard. The duel threat of rising interest rates and collapsing crude oil/natural gas prices have hurt shares. That has made the “shares as currency” idea a pretty expensive proposition in its own right. Debt is also expensive and perhaps out of reach, given that KMI is already holding roughly $50 billion in debt on its balance sheet and carries a near-junk credit rating.
To that end, KMI did some financial engineering and decided to do a convertible bond offering — allowing it to benefit from a rising share price later while getting the cash it needs today — at a potentially cheaper rate. The issue here is that KMI launched the new debt at a coupon of 9%. Paying that much says that no institutional investor wants our stock, so we are willing to pay through the nose to get needed cash.
Now with higher debt expenses, KMI has reconsidered the pace of dividend growth as well.
One of the major selling points of the KMI deal for its two MLPs was that dividend growth would make up for the lost yield on the two master limited partnerships. Originally, Kinder Morgan guided to more than 10% dividend growth through 2020 post combination. With its latest earnings release, KMI announced that number should be in the 6% to 10% range for 2016.
Historically, KMI has done what it takes to pay to its guided dividend. So the fact that its willing to cut that guidance might actually signal trouble is a brewing for the midstream giant. Even more so, given how confident Kinder’s management has been on its ability to achieve that previously set robust dividend growth rate.
Not Bailing on KMI Just Yet
So is Kinder Morgan and KMI a lost cause? Not exactly. The firm’s massive array of assets do throw off plenty of cash flows and its coverage ratio is basically 1 — meaning that cash flows cover its current payout.
Going forward, however, things may not be as rosy for Kinder as planned. Being forced to use relatively expensive methods of raising cash defeats the whole purpose of swallowing its MLPs in the first place.
Basically, that says that for the near-term, financing much needed projects is going to be expensive either way. KMI needs those projects to grow its dividend, but the new higher expense of funding those projects will take a bigger bit of their cash flows.
All in all, there might not be much money in the kitty to fund big time dividend increases that investors in KMI have grown accustomed to.
With that in mind, it may be time to start trimming back a position in KMI and focusing on some other smaller MLPs that don’t need the elephant-sized deals to get the job done.
Holding some KMI still could make sense as it still is midstream royalty. It’s just that it may not act like the king for much longer.
As of this writing, Aaron Levitt was long KMI, but has started trimming his position since KMI’s earnings report.