The Long Trail Back For the Energy Sector

How do markets form a major bottom?  Not when the news suddenly turns cheery and bright, but when it stops getting gloomier.

We may have finally reached that point — or at least we’re probably quite close to it — in the battered energy sector, particularly the pipeline master limited partnerships (MLPs).

I’ll caution you:  The trail back will be long and winding.  But as any hiker knows, the only way to complete an arduous trek is to put one foot in front of the other, and keep marching.

That’s what Rich Kinder and his team at Kinder Morgan (KMI) have decided to do.

Of course, I’m disappointed that KMI decided to shave its quarterly dividend by 75% (to 12.5 cents per share).

Paradoxically, though, the dividend cut will solve a major problem for KMI and — because of KMI’s standing as an industry bellwether — for the entire pipeline group.

By retaining the great majority of its projected $5 billion of distributable cash flow in 2016, KMI has stopped the market panic over the company’s balance sheet.

Moody’s immediately changed its outlook on KMI’s debt to stable (from negative) and affirmed the company’s investment-grade bond rating.  Standard & Poor’s, which previously had a stable outlook (and an investment-grade rating) on KMI’s debt, reaffirmed its position.

Kinder Morgan has also eliminated the need to raise equity capital through 2018.  Thus, the company has killed two birds with one stone:  (1) It has quashed fears that its debt might be downgraded, which could lead to a death spiral; and (2) It has spared shareholders the threat of dilutive new stock issues.

To me, those two developments suggest that KMI has taken the initial steps on the road to recovery.  On Wednesday’s conference call, the company’s executives made it clear that as KMI’s debt load eases, the board will consider boosting the dividend, buying back stock or both.

Despite the 6.9% rally in the stock, I still expect a full recovery to take several years.

How does Kinder Morgan’s radical financial surgery benefit the industry?

By showing that paths do exist for a pipeline business to heal itself from the injury caused by the oil crash.

Other players, with different strategic options available, may not need to follow KMI’s lead on the dividend.  In a speech Tuesday, CEO Greg Armstrong of Plains All American Pipeline (PAA) said: “We’re not forecasting any distribution growth in 2016, but we’re also not planning on reducing our distribution.  We don’t see any need for it.”

That’s an important signal to existing shareholders.

Outside the energy sector, a number of drug stocks in recent days have pulled back into attractive buy ranges, including Merck (MRK) and  Pfizer (PFE). Both are suitable for all investors seeking growth and income.

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