My Thoughts on Kinder Morgan

Kinder Morgan has been a core holding for a lot of dividend growth investors and I have received a lot of questions from readers about my thoughts on the company and the future prospects.

Kinder Morgan has had a spectacular fall from its peak from $44.71/share in Apr 2015 to $15.82 today (Nov 07 2015). In a way, this shouldn’t have come as a shock – Kinder Morgan has been on a debt binge (just like a lot of other companies out there – so look out for similar outcomes in other companies!) and is now close to $43B in long term debt fueling its growth and investments. The recent ratings downgrade from Moody’s with a negative outlook was a wakeup call for a lot of investors and traders have jumped in to short the stock.

The following from Bloomberg summarizes the basic math of Kinder Morgan.

KMI-Blmbrg1

At this point, it boils down to minimizing the damage and looking towards the future for Kinder Morgan.

  1. Kinder Morgan would be making a catastrophic mistake if it sticks to its previous guidance of raising dividends by 6-10% – as summarized from Bloomberg above. Distribution of all cash flow and leaving a $100M in cash will leave the company with nothing to invest in and will need to tap into the debt markets (again) to fund growth. This would no doubt result in more downgrades in its credit ratings. I think management will try to avoid this step at all cost. Chances of this happening are extremely low if not nil.
  2. A dividend freeze will also leave minimal amount of cash in its coffers – about $220M – not enough to fund any growth. Chances of this are also very low although a bit higher than #1.
  3. A cut in dividend is almost imminent. The market is pricing it in with its current yield well north of 12%. With a dividend cut, the company can regroup and rebuild. But the more important question is – how much will it cut?
    1. Cutting the dividend by 33% will leave $1.5B in cash flow for KMI. Chances are pretty good that it might cut up to this amount. Yield on the stock will then be ~8%.
    2. Cutting the dividend by 50% will leave $2B in cash flow and KMI has indicated that it wants to invest approx $2B in order meet its growth objectives. Again, a very high likelihood that we can see a 50% cut. Yield on the stock will then be ~6%.
    3. Suspending all dividends – chances of this are low, although its not completely out of question.

All in all, its a complete mess. The company leveraged too much and investors are now paying the price, including yours truly. With the question of a dividend cut imminent, the question now is what action to take?

  • Sell? We have experienced most of the pain that was to come. Is there a point in selling the stock now? Unless Kinder Morgan completely suspends dividends (or alternatively, actually goes completely bonkers – and raises dividends instead), I may consider selling and exiting.
  • Hold? This is my default position and I constantly re-evaluate based on more incoming data.
  • Buy? A massive infrastructure company with 84,000 miles of pipelines and 165 terminals selling at book value seems pretty enticing. The enterprise value of the company is $81B, but the market is trading it at $38B – that is quite a discount. There is definitely blood on the streets, so to speak. Buying more shares in this company is back on table considering the valuation. A dividend cut will drive more investors away from the company and the stock is also seeing year end tax-loss selling, so case for new purchases can definitely be made.

KMI-InfrastructureMap

More importantly what’s the big lesson for all investors? Diversify, diversify, diversify! I have written about diversification in the past (part1, part2, and part3) and problems like these illustrate why each investor should always hedge their bets and not put all eggs in one basket, no matter how attractive an investment looks. Kinder Morgan has an immensely critical infrastructure across N.America and it was really hard to argue against their long term growth plans. But mismanagement and overleveraging will result in the best of companies to stumble. Due to a diversified portfolio, my overall impact has been limited. Hope yours is too.

27 thoughts on “My Thoughts on Kinder Morgan

  1. JC says:

    Watching this play out has been pretty crazy. Personally I’d be fine with a dividend cut, was hoping a dividend freeze would sure things up but according to Bloomberg it won’t. I won’t be adding more shares due to it’s already outsized weighting for dividends but I expect to hold despite a likely dividend cut and most likely continue holding. However, KMI will definitely be much more closely monitored going forward, especially the debt levels. All the more reason to diversify.

    • I hear you, JC. I remember you had a big chunk of KMI in your portfolio…im sure the dividends will resume or rise after a cut – so its a matter of patience and closely looking for critical errors at this point.

      Thanks for sharing your take on things
      R2R

  2. The Broke Dividend Investor says:

    RM2R,

    I sold KMI today and took the tax credit. I might buy KMI back 30 days from now but I expect it to be a much much cheaper stock than it is right now. My target price is 8-10.

    I did some rough math over the weekend. With 5 billion est revenue coming in next year there is no way for them to pay their maturing debt, work on their backlog, and pay their current dividends. I predict KMI to freeze its next dividend and then cut on the following quarter (25-50%). The only way I see KMI maintaining its dividend is for the US to enter into a full war with ISIS. Bombing refineries, pipelines, upstream, and downstream to such an extent as to cause oil to skyrocket. But i highly doubt obama will put boots on the ground as that is an unpopular position at the moment.

    Oh the flip side there are still some bargains in the market. OHI is still down with a 6%. CMI is down with a 4%. and EMR is going back down. Plus December 16 will ruffle some feathers.

    • Hey BDI,
      Possibility of war definitely exists – so, that might take oil on a wild ride. My shares are in a tax-sheltered account and tax-loss selling does not apply – nor does it appeal to my investing style. I will continue to hold and closely monitor this scenario.

      Best
      R2R

  3. It seems many energy companies had a rough ride this year and the prices of their goods are still going down. I suposse that the companies with lots of debt will get in troubles sooner or later if the prices stay this low. But the big companies will probably use this to acquire new assets cheaply. From what I see my guess is that they will go for a 50% cut so they can still invest in growht. I don’t have KMI myself in my portfolio.

    Cheers,
    Geblin

    • Thats a good summary, Geblin. Oil and energy companies are taking quite a beating. The midstreams survived the initial downturn last year, but things are finally catching up after almost a year. Probably better to watch it from the sidelines.

      cheers
      R2R

  4. I’ll continue to hold and monitor the stock. It’s getting pretty ugly that’s for sure. It’s probably in its best interests to either freeze the dividend or cut it slightly.

    • Same here, Tawcan. I continue to hold. The high debt load sure is making the company think twice about its ways of conducting business. This is not the only company imo, or even the only industry. We will probably see more problems in the future.

      Best
      R2R

  5. Nice write up R2R. I was/am grateful and fortunate to miss out on this one. It was mostly luck, but I saw two huge warning signs. Initially, CEO Richard Kinder was buying huge slugs of stock on the open market……which went on for an extended time. Then, as the share price plunged, he quit buying.

    The second, was the massive expansion of debt. While I don’t study the company closely, I couldn’t figure out what they were going to do with all the fresh capital. Apparently, management wanted to fund this latest acquisition. Some say the price they paid was too high, but I can’t speak to that. It sure looks like a poorly timed acquisition. My guess at this point is a 25-33% dividend cut. Management will lick their wounds….and the company will go on.
    -Bryan

    • Hey Bryan,
      Its good that youve missed this boat and simply watching from teh sidelines. I remember you mentioning a couple of times about the fact that the company was taking on too much debt and the insider buying. Good picks on that. The company sure has been extremely aggressive and is now paying the price.

      Looking forward to see what happens.
      R2R

  6. I am holding (not willing to take a loss) and even adding more shares of KMI. Even if they suspend the dividend, it will not be for a long time. At some point in the future they will reinstate it and the company will grow again, so I will capture capital gains and future dividends. As of now it is about cost averaging. Since all my stock investments are in ROTH IRA I do not need tax harvesting and because I am invested for the next 20 years, I consider this a blip. I am staying and moving on with this stock.

    • Same here, Martin. I am holding through this painful time. I will be looking for more data – and may consider buying at a great valuation. The pipeline infrastructure is essential and dividends will continue flowing and growing once teh company is a bit deleveraged.

      R2R

    • Well said, Tyler.
      Its testing my patience though and for now, we’ve taken quite a bit of paper loss…which doesnt really mean anything. The dividend move will be telling.

      cheers
      R2R

  7. I have sold my KMI to tax loss harvest on my KMI. The majority of my tax loss harvesting was from KMI this year.
    This year I will claim $3000 in tax loss harvest which I will deduct from my W-2 earnings. That will allow me to get $1000 back in February-March which I will use to invest back into stocks.

    Best of luck to all KMI holders.
    Those with a diversified portfolio should be okay, since KMI will only be a smart % of their overall holdings, as was the case in my portfolio.

    • Thats what the market appears to be pricing-in. Hopefully we will get some more visibility in the coming days. Management is also avoiding media spotlight and just skipped their Wells Fargo Energy symposium appearance today.

      R2R

  8. Thanks for the analysis. I don’t currently own any KMI, but at this price I am considering buying some. Even if the dividend is cut 50%, the yield is still 6.4% at today’s price! That should leave them with enough retained earnings to fix their issues.

    KMI own lots of infrastructure that is essential and difficult to replace. I’m pretty sure they will be around for a long time.

    Take care.

    • This could be a great time to initiate if you dont have a position. Theres a lot of panic in the industry and shares are trading at quite a discount. As you mentioned, the infrastructure is essential and difficult to replace – that would be quite a bargain.

      Best wishes
      R2R

  9. fyi…

    “Kinder Morgan, Inc. (NYSE: KMI) today announced that its Board of Directors has approved a plan pursuant to which it expects to pay quarterly dividends of $.125 per share to its common stockholders ($.50 annually), down from its current quarterly level of $.51, beginning with the fourth quarter 2015 dividend payable in February 2016. This dividend enables the company to use a significant portion of its large cash flow to fund the equity portion of its expansion capital requirements, eliminate any need to access the equity market for the foreseeable future and maintain a solid investment grade credit rating. KMI anticipates enough retained internally generated cash flow to fund all of the required equity contribution projected for 2016 and a significant portion of its debt requirements. The company has reviewed its expected investments in 2017 and 2018 and believes that its stable and growing internally generated cash flow will allow it to continue to fund the equity portion of its capital budget without the need to access the equity market. It anticipates meeting all of the rating agencies’ requirements to remain investment grade, and expects a net debt/EBITDA ratio of 5.5 for 2016 and anticipates reducing that ratio in subsequent years.”

    http://web.tmxmoney.com/article.php?newsid=81110639&qm_symbol=KMI:US

    Mark

  10. Part of my portfolio is what I call “play money”. Within this portfolio, I have bought KMI 2 times already. Once when I thought the rebound started (right after the dividend cut). I turned out to be a little spike only. I got in a little later again.

    I support the idea that in the long run, the company should be able to clear up its high debt by reducing dividend for a few years. After that, They can start to be a great dividend company.

    I also lower my investment cost by selling calls against my positions. It will lock down my max profit, but generates some cash in the mean time.

    • I was tempted to pick up after the cut as well, but decided to hold off to let the intense trading and excitement settle before making a move. Now that it is closer to $15, it looks tempting…although Ive seen some analysts suggest that the real value might be closer to $13 instead. Good idea to write covered calls, I am thinking about that approach too – still havent decided if I should.

      cheers
      R2R

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