Kinder Morgan’s (KMI) decision to cut its dividend to 50 cents a share certainly wasn’t popular with the market and especially not with the income investors who had stuck with the company when it rolled its MLP (master limited partnership) Kinder Morgan Energy Partners into the Kinder Morgan general partner at the end of 2014. At the time of the consolidation Kinder Morgan had said it would pay a dividend of $2 a share in 2015 and projected a 10% annual increase in dividends through 2020. The December 8 announcement of a 75% cut to the dividend devastated the stock. Kinder Morgan shares are down roughly 50% from $32.68 back in October to a close at $17.42 on Tuesday, February 23.
But as painful as that drop has been, the dividend cut has positioned Kinder Morgan to be one not just one of the survivors but actually one of the few winners from the bust in the U.S. oil and gas sector. By cutting the dividend Kinder Morgan has moved into a position where it doesn’t need to tap equity or debt markets–at the current high cost that the financial markets are charging energy companies to raise capital–in order to fund its planned capital spending budget for 2016. After paying the new lower dividend, the company projects cash flow of $3.6 billion in 2016, up from $1.2 billion in 2015. That’s enough to fund the company’s $3 billion plus in projected capital spending for 2016. And at this point it looks like the company will be able to fund its 2017 capital plan internally as well. (Kinder Morgan has a backlog of some $18 billion in capital spending projects it could invest in. In the current environment the company is high grading those projects, looking for those that provide the biggest return on investment. It’s that dynamic plus the company’s sizable cash flow that has led an investment manager–probably Ted Wechsler–at Warren Buffett’s Berkshire Hathaway (BRK.B) to buy about $460 million in shares of Kinder Morgan recently.)
The advantages of being able to invest using internal cash at a time when the cost of external capital is so high for energy companies and when market turmoil is resulting in delays in competing projects are obvious. The company projects that these investments plus returns on current assets will generate about 88 cents a unit in growth to 2020. That’s a compound annual growth rate of about 7%, Credit Suisse calculates. That kind of growth would enable Kinder Morgan to restore some of the dividend it slashed in December, especially if sometime during that period financial markets cut the price that energy companies have to pay for external capital. At Tuesday’s closing price of $17.42 Kinder Morgan showed a dividend yield of 2.88%. Not stunningly high but not a bad place to start if the company is able to increase dividend payouts after 2016 or 2017.
The big question, of course, for any investor is how accurate those cash flow projections are likely to be.
These projections look as solid as projections can be. About 90% of the 2016 earnings before depreciation and amortization projection is fee-based rather than price-based so Kinder Morgan’s pipeline and storage system is relatively well buffered from the price of oil and natural gas. Of that 91% about 75% is take or pay–meaning Kinder Morgan gets paid whether the customer uses its pipelines or not–the rest is volume based. Of that volume-based 25%, about 80% is attributable to natural gas and refined product pipelines where, Credit Suisse believes, risk of volumes falling is relatively low. Kinder Morgan also looks relatively well protected from further deterioration in energy company balance sheets with 82% of its top 25 customers rated investment grade or better.
Kinder Morgan projects that a drop to $20 a barrel for West Texas Intermediate and to $1.75 per million BTUs for natural gas would result in only a $120 million hit to its budgeted dividend coverage.
Credit Suisse has a $20 one-year target price on Kinder Morgan. I think any gains in the price will depend on a turn in sentiment on energy stocks–and I’m not willing to call that yet. But cash flow does look very positive for dividend income investors.
