Kinder Morgan: Share Price Slump Provides Income Boost (NYSE:KMI) - Seeking Alpha

Kinder Morgan: Share Price Slump Provides Income Boost (NYSE:KMI) | Seeking Alpha

Kinder Morgan: Share Price Slump Provides Income Boost
Kinder Morgan, Inc. (KMI) 17 Comments

Summary

- Kinder Morgan is a diversified energy midstream company with a high dividend yield and shares trading below recent levels, presenting a potential buying opportunity.
- The company benefits from growing natural gas consumption in the US, as well as increasing exports via LNG, and has a project backlog of $3.7 billion.
- Kinder Morgan offers a 6.8% dividend yield and an undemanding valuation, with potential for significant total returns.
- Looking for more investing ideas like this one? Get them exclusively at Cash Flow Club. Learn More »

Olivier Le Moal

Article Thesis

Kinder Morgan, Inc. (NYSE: KMI) is a large and diversified energy midstream company that offers a high dividend yield that looks pretty safe. With shares trading well below the levels seen over the last couple of months, investors could be looking at a buying opportunity right here.

Kinder Morgan And The Macro Picture

Kinder Morgan is active across different businesses, including oil production, storage, and transportation of energy commodities. Moving natural gas via its vast pipeline network is the most important business, however.

Natural gas demand experiences ups and downs, but those are mostly tied to seasonal patterns: Depending on the market, natural gas demand is either high in the summer months (in hotter climates, where a lot of electricity is used for cooling during summer) or in the winter months -- in colder climates, where the natural gas demand boost during the heating season is more impactful.

Looking at the United States in total, which is the most important market for Kinder Morgan by far, natural gas demand is stronger during the winter months, but in some states, demand is higher in the summer months:

The seasonal pattern is clearly visible. While the peaks are not equally high across all years -- some winters are colder than others -- the overall trend has been pretty consistent. Over time, natural gas consumption in the United States is growing. That can be attributed to several factors, including population growth and changes in how electricity is being produced. While burning natural gas causes CO2 emissions, natural gas is a much cleaner and more environmentally friendly fuel compared to coal. It thus makes sense, from a pollution and climate perspective, to shut down coal-fired power plants and to replace them with natural gas-fired power plants. After all, this is way cleaner, natural gas is cheap and abundant in North America, and natural gas-powered power plants can produce electricity independent of time of day, weather, and so on, which does not hold true for solar and wind power. A combination of solar/wind and natural gas makes sense, as one is pretty low in CO2 emissions, while the other is easy to regulate (and still a lot cleaner than coal).

While natural gas is not a "green" technology, it's a much better choice than the alternative, and thus demand has been growing reliably for the last two decades. It seems likely that consumption in the US will continue to expand, as oil-powered heating is replaced by gas-powered heating, and as more coal power plants are being replaced by natural gas power plants.

On top of that, there's another factor at play that should be beneficial for natural gas transportation volumes and natural gas production in the US: Exports via LNG. While exported gas is not being burned in the US, it still needs to be produced and moved across the country. Since Europe and some other markets are seeking to become less dependent on Russian natural gas supplies, which means that these countries have to buy natural gas elsewhere, the outlook for LNG exports is pretty positive.

While the overall energy midstream industry is not a growth industry per se, the natural gas transportation market should expand over the coming years. As a major player in this space -- Kinder Morgan moves around 40% of US natural gas production -- the company should benefit from this positive macro development, I believe.

Kinder Morgan Is A Reliable Performer

During the first quarter, Kinder Morgan's natural gas transportation business experienced a 3% increase in transported volumes. Due to the aforementioned factors that impact natural gas consumption and exports positively, that's not surprising. Of course, 3% business growth is far from explosive, but explosive growth is not needed when a company offers a high dividend yield and when it also trades at an undemanding valuation -- both of these statements hold true for Kinder Morgan. Kinder Morgan also experienced growth in natural gas gathering volumes, again benefitting from positive macro trends.

Kinder Morgan's CO2/oil production segment is somewhat more volatile compared to the transportation business, which is why company-wide earnings and cash flows can experience some ups and downs. Oil prices were lower during the first quarter, relative to the last couple of quarters before that, which negatively impacted Kinder Morgan's profitability.

Still, thanks to the majority of profits and cash flows being reliable in different commodity price environments, company-wide cash flow declined only slightly during the first quarter, relative to the year-ago period. Distributable cash flow -- a non-GAAP metric that is equal to operating cash flow minus maintenance capital expenditures -- totaled $1.37 billion.

Despite oil prices being lower today compared to what Kinder Morgan had originally assumed for the current year, the company maintained its full-year earnings, EBITDA, and distributable cash flow guidance. Management believes that a positive volume performance and tight cost controls will offset headwinds from lower oil prices.

Kinder Morgan is forecasting distributable cash flows of $4.8 billion, or $2.13 per common share. Other metrics the company has guided for look positive as well, as EBITDA is forecasted at $7.7 billion, while the year-end leverage ratio (net debt to EBITDA) is forecasted to come in at 4.0 -- which is significantly below the 4.5x target. During times of rising interest rates, lower leverage could be positive, as it will limit Kinder Morgan's interest expenses. Still, with the company being underleveraged in the eyes of its management team, the company could become more aggressive when it comes to capital allocation going forward. An increased share buyback pace would be possible, as Kinder Morgan is buying back shares now, but only at a low pace. The company could also go for inorganic growth, or it could accelerate its organic growth spending. When it comes to growth spending and the current project backlog, management notes the following [emphasis by author]:

Our project backlog at the end of the first quarter was $3.7 billion, up $400 million versus the fourth quarter of 2022. The most significant additions were $324 million in interstate natural gas pipeline expansion projects, including a project on the TGP system to assist a customer in retiring a coal-fired power generation facility. Excluding the CO2 business segment, where we have higher return thresholds than our other projects, we expect the remaining $3.3 billion in projects in the backlog to generate an average Project EBITDA multiple of approximately 3.5 times.

As indicated above, coal-to-gas switching when it comes to electricity generation plays a major role in the long-term natural gas demand picture, and this is also visible in Kinder Morgan's backlog. With $3.7 billion of planned spending in total, the company will generate around $1 billion in additional EBITDA once these projects are in service. That makes for growth of around 13% from the current level, which is quite meaningful.

With Kinder Morgan's net debt being around $4 billion below the target (based on a 4.5x net leverage ratio target), the company could easily finance its entire backlog with debt without running into trouble. It's unlikely that this will happen, as Kinder Morgan retains substantial cash due to its dividend payout ratio being just 53%. But the fact that the company could easily spend billions of dollars on highly profitable growth projects in a short period of time without endangering its balance sheet is still a major positive.

KMI: A Nice Yield And An Undemanding Valuation

Some (former) Kinder Morgan shareholders still are unhappy with the company due to the dividend cut several years ago when the MLP model that was based on ongoing share issuance failed.

That being said, the company has been a reliable dividend grower in recent years, and Kinder Morgan upped its dividend again a couple of weeks ago. While the 2% dividend increase was far from drastic, it's still pretty nice considering that shares yield 6.8% for now. If Kinder Morgan were to increase its dividend by 2% per year in the future, too, the combination of the high current yield and some dividend growth could allow for total returns in the 9% range, assuming the valuation stays the same.

Speaking of KMI's valuation, the stock has become rather cheap again over the last couple of months. As shares pulled back from more than $19 to less than $17, Kinder Morgan's distributable cash flow multiple has declined to just 7.8 -- which pencils out to a 12.8% distributable cash flow yield. While I do not see any immediate catalyst for a multiple re-rating, multiple expansion in the long run seems more likely than multiple compression in the long run, I believe.

Between a nice starting yield, some expected growth, and some potential tailwinds from multiple expansion, Kinder Morgan has a good chance of delivering compelling total returns from the current level.

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This article was written by
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Disclosure:

I work together with Darren McCammon on his Marketplace Service Cash Flow Club.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of KMI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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