Pipeline giant Kinder Morgan Inc (KMI) is what I would call a “battleground” stock. Every company has its bulls and bears, but with some stocks, the normal tug-o-war gets a lot more intense. KMI stock is one of those.
Barron’s has been skeptical or downright bearish on the stock for years, and Hedgeye analyst Kevin Kaiser essentially made his career by loudly panning KMI. But Kinder Morgan was wildly popular with many long-time dividend investors … not the least of which was the company founder and chairman himself.
Responding to some high-profile Kinder Morgan bears in a 2014 conference call, Chairman Richard Kinder famously and smugly said, “You sell; I’ll buy. We’ll see who comes out best in the long run.”
KMI Stock: The “Long Run” Can Be a Really Long Time
Well, the bears came out on top in this battle. I think Mr. Kinder will be right … eventually. But the “long run” can really be a long time, and after the drubbing KMI stock has taken over the past year, it would need to roughly double from today’s prices just to get back to its price at the time of Mr. Kinder’s chest-thumping challenge to the bears.
For most of its life as a public company, Kinder Morgan was an aggressive dividend raiser that minted money for its investors, which had a way of making them fiercely loyal. But starting around this time last year, it all started to go south.
The bond ratings agencies really started to question Kinder Morgan’s debt load for the first time, and the bears in the chain reaction that followed KMI stock lost about three quarters of its value … and slashed its dividend by 75%.
But for most of 2016, Kinder Morgan stock has been slowly clawing its way higher and is now up more than 60% from its lows for the year. Of course, it helped when it was announced back in February that David Tepper and Warren Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B) both took significant new positions in the stock.
So, now that we’re approaching the halfway point of the year, how are things looking for Kinder Morgan? After a fantastic run in 2016, should we expect more to come? Or is the profit pipeline about to run dry?
Let’s start with valuation. At sub-$12 per share, KMI stock was ludicrously cheap. But at the same time, a price only $40 per share really only made sense if you valued Kinder Morgan based on its dividend yield and dividend growth rate.
By most other metrics, KMI was an expensive stock. But at today’s prices, Kinder Morgan is still very reasonably valued. KMI trades for 2.9 times sales, which is more or less in line with the stodgy utilities sector, and at just 1.2 times book value.
Post dividend cut, Kinder Morgan is a more conservative company that finances its growth primarily through internally generated cash flows rather than from external financing. A more conservative Kinder Morgan is a slower-growing Kinder Morgan.
But importantly, it is also a safer KMI, and that safety deserves a premium. Given the “bond-like” nature of Kinder Morgan’s cash flows and the fact that it no longer depends on external financing for a significant portion of its growth needs, I would consider KMI’s risk of default over the next 3 to 5 years at essentially zero. I would certainly consider it no more risky than a blue-chip utility stock.
At current prices, KMI stock yields 2.7%. While that’s a far cry from the 5%-plus yields we grew accustomed to, it still makes Kinder Morgan one of the higher-yielding large cap stocks in America. And within another 18 months, I expect KMI to get back to what it does best: raising that dividend for the benefit of its long-term shareholders.
So, with Kinder Morgan today, you get a current yield that is a little higher than the yield on an A-rated 10-year corporate bond with the potential for very robust dividend growth in the not-too-distant future.
That’s not a bad deal.
Meanwhile, even with oil and gas prices still very low, Kinder Morgan is finding fantastic growth opportunities. KMI was just given authorization to move forward with a major LNG exportation project, which should be operational by 2018.
As I’m writing this, KMI stock trades for about $18.45 per share. I expect it to be in the mid-to-high $20s within the next 1 to 2 years. While that’s not the kind of share price appreciation we’ve enjoyed in 2016, it’s still very attractive in an otherwise expensive U.S. market.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long KMI.