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