Kinder Morgan Trading at Attractive Levels

Company is oversold in near term, and dividend cut decision is more positive than negative

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Dec 10, 2015
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Several factors have contributed to a steep decline in stock price for Kinder Morgan (KMI, Financial) recently. Even for YTD15, the stock has declined by 60% with the decline primarily accelerating after June. The most recent factor in the decline in Kinder Morgan is its dividend cut to 12.5 cents per share (quarterly) from an earlier 51 cents per share. The markets have overreacted to this news, and Kinder Morgan is likely to bounce back from current levels. The stock is attractive in the near term.

Kinder Morgan announced financial expectations for 2016 on Dec. 4, and the DCF per share expectation for 2016 is in line with an earlier guidance of 6% to 10% growth as compared to 2015. Therefore, there were no negative revisions related to the financial outlook.

On Dec. 8, Kinder Morgan reiterated that distributable cash flow for 2016 is likely to be over $5 billion. However, the dividend cut has been enforced because of the following factors:

  • First, the excess liquidity will be deployed for expansion capital requirement, and this would imply higher distributable cash flow in the coming years.
  • Second, the dividend cut ensures Kinder Morgan is fully funded for 2016, and there is no equity dilution requirement even for 2017 and 2018.
  • Third, Kinder Morgan expects to deleverage beyond 2016 through cash preservation. While the net debt to EBITDA is likely to remain at 5.5 for 2016, it is likely to decline in the subsequent years.

These factors will ensure that the company’s credit profile remains healthy in challenging times for the broad industry. Kinder Morgan expects to maintain investment grade rating with all rating agencies, and that outcome is likely with the current fee-based income and cash flow preservation strategy. Overall, the dividend cut decision might have impacted sentiments in the near term, but there are significant positives that are likely to emerge from dividend cut.

An important point from a revenue and cash flow perspective is that a large portion of the company’s backlog is fee based, and this makes Kinder Morgan relatively insulated from lower oil prices. For 2015, nearly 86% of the company’s income is derived from fee-based cash flows with 74% of the fee-based cash flow secured by take-or-pay contracts.

In terms of concerns, the existing customer contracts will ensure firm cash flow in 2016; however, the new backlog addition is likely to be sluggish. Investors should be concerned if the current weakness in the energy sector continues beyond 2016.

Kinder Morgan mentioned in its latest press release that the company evaluated selling assets to generate cash, but the idea was “uneconomic.” If weakness continues in the energy sector into 2017, Kinder Morgan will be forced to re-evaluate the option of selling assets. The stock is due to bounce back from a steep correction, but the worries are far from over, and investors are advised to avoid long-term positions in the stock. From a trading perspective, the current levels are attractive.

Kinder Morgan bounced back by 6.9% in last trade, and more upside for the stock can be expected in the foreseeable future. However, even traders should not take a big plunge in the stock as the energy sector has been volatile.

From a long-term investment perspective, only consider exposure to Kinder Morgan once oil prices trend higher and stabilize. With the Iran oil supply factor looming large, I don’t see that coming any time soon.

Disclosure: No positions in the stock