Kinder Morgan Inc: Problems for KMI Stock Still on the Horizon

For pipeline superstar Kinder Morgan Inc (NYSE:KMI), the last few years haven’t exactly been knock-it-out-of-the-park amazing. The once mighty KMI misfired on some major points and with oil/natural gas prices crashing, KMI stock was taken down hard. So hard, the income stalwart was forced to cut its former lucrative payout back in December.

Kinder Morgan Inc: Problems for KMI Stock Still on the Horizon

Under that scenario, KMI began a turnaround process to strengthen its balance sheet, boost cash flows and ultimately, return to its former glory as a pipeline kingpin.

With KMI reporting earnings yesterday, this is now the second quarter in which investors can gauge the progress of that turnaround. For Kinder Morgan, it’s so far, so good. But the results should be taken with a grain of salt.

The Positives for KMI Stock

The headline number for KMI was a 4% increase in year-over-year earnings. Total business segment earnings clocked in at 15 cents per share. As a pipeline firm, the real number that counts for KMI is its distributable cash flows. Those cash flows came in at $1.050 billion. That was roughly flat versus the $1.095 billion recorded in the year-ago quarter.

Driving those gains was a return to KMI’s bread-n-butter businesses — namely natural gas and oil pipelines. Kinder Morgan’s natural gas pipeline segment produced roughly half of the firm’s earnings, but it was the real driver of cash flows and growth. Additions to its monster Tennessee Pipeline as well as the bolt-on buy-out of Continental Resource, Inc.‘s (NYSE:CLR) Hiland Midstream added significantly to the results.

Likewise, the vast terminal and product pipeline asset-base at KMI contributed to the earnings growth. Even growth in its Canadian pipeline segment managed to see some decent numbers.

The performance health of its midstream segment is exactly what investors need to see. It goes long way to helping KMI return to its former glory days.

Kinder Morgan’s balance sheet initiatives have also helped it on its path to regain its former crown. The real onus for cutting that dividend was to reduce the firm’s massive debts. It takes a lot debt to build-out huge swaths of infrastructure and KMI was racking-up the debt in a big way — especially after it ate its master limited partnerships. Some of the firm’s excess cash flows went towards debt reduction as well as several key asset sales.

KMI received an extra $1.47 billion in cash when it sold a stake in its Southern Natural Gas pipeline system to utility Southern Co (NYSE:SO). Private equity firm Riverstone Investment Group LLC also agreed to become a partner on its Utopia Pipeline Project. Both moves were designed to help bolster cash on hand and reduce the amount of CAPEX spending on Kinder Morgan’s end.

KMI Still Has A CO2 Problem

Those positives certainly help move KMI in the right direction in its turnaround plans. So, investors were hoping that Kinder Morgan would resume its historical pace of dividend growth. Unfortunately, they have to wait another quarter.

That’s because its CO2 segment is still dragging it down. The carbon-dioxide segment moves the gas into areas of Texas for enhanced oil recovery projects. Injecting C02 into older wells helps coax more oil out of them. The problem is that with oil prices crashing, these sorts of enhanced oil recovery techniques don’t make much sense. So, the unit has been under pressure since commodity prices have crashed.

The real problem is that it’s not just other exploration and production firms that use the gas; KMI itself owns swaths of oil wells in the area. Kinder Morgan was essentially doubly screwed when oil took a dive. Pressures in this business helped KMI see a major reduction in total revenues for the quarter and hinder its earnings and potential cash flow growth.

The Bottom Line on Kinder Morgan

On one hand, Kinder Morgan is starting to deliver great performance. Its core midstream assets are humming along. And that’s why investors fell in love with KMI stock — and its multitude of MLPs — in the first place. Continued improvement here will help it become a midstream master again.

However, those looking for real, meaningful dividend growth may be disappointed for a while. The commodity sensitive portion of its businesses is still a huge drag on its bottom line. Until oil prices really move up, KMI might not be able to move its dividend higher … especially considering its new mantra of using cash flows to cover expansion projects and debt reduction.

Small token raises could be the norm for quite a while. And considering that KMI is yielding only 2.26%, those looking for a larger dividend may be better suited in a regular master limited partnership. Yields here can be had for around 7%.

KMI is moving on its turnaround plans. It is reducing its debts and its midstream assets are still producing oodles of cash flows. The problem continues to be the commodity sensitive potion of its businesses. Until it gets that act together, it could be slow going on the dividend front.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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