In recent years energy transportation and storage stocks and Master Limited Partnerships (MLPs) have become some of the most popular high dividend stocks for income investors to find attractive yields in this record-low interest rate environment.
Kinder Morgan (KMI) is one of the oldest names in this space, having helped to popularize the sector with its previous MLPs, Kinder Morgan Energy Partners and El Paso Energy Partners, which were acquired in 2015 by Kinder Morgan Inc (the general partner, sponsor, and manager of their assets).
But thanks to the worst oil crash in over 50 years, Kinder Morgan quickly became a cautionary tale about what can go wrong, especially when management takes on too much debt in a highly cyclical industry.
Let’s take a closer look at Kinder Morgan’s business to see just what went wrong for Kinder and more importantly, if management’s turnaround efforts make this a high dividend stock worth owning in our Conservative Retirees dividend portfolio.
With 84,000 miles of natural gas, oil, CO2, and natural gas liquids (NGL) pipelines, processing facilities, and 180 distribution and storage terminals, Kinder Morgan is North America’s second largest energy infrastructure operator.
Source: Kinder Morgan
The company has five operating segments:
Natural Gas Pipelines (55% of earnings before depreciation & amortization): 69,000 miles of pipelines that transport 38% of America’s natural gas each day.
Products Pipelines (16%): America’s largest transporter of oil products, shipping 2.1 million barrels per day through its 9,000 miles of pipelines and 60 distribution terminals.
Terminals (16%): America’s largest oil and petroleum product storage network, with 152 million barrels of capacity.
Carbon Dioxide (11%): America’s largest producer (1.2 billion cubic feet per day) and transporter of CO2, for enhanced oil recovery, via its 1,300 miles of CO2 pipelines.
Canada (2%): One of Canada’s largest oil pipeline operators with six major pipeline, storage, and export terminal systems.
Since it’s a midstream operator, 91% of Kinder’s cash flow is derived from long-term, fixed-fee contracts, which helps to generate far more stable results than other sectors of the energy industry.
However, as you can see from the table below, despite these contracts, many of which minimize volume risk by requiring energy producers to ship a minimum amount of product, the collapse in energy prices has resulted in a continued earnings decline in natural gas pipelines and CO2, which account for more than 65% of total profits.
Source: Motley Fool
Kinder experienced many years of strong growth during the boom times, when oil prices were around $100. This was due to the torrid pace of new projects put into service, as well as the rollup the company underwent in 2015 when it acquired all of its MLPs.
Unfortunately, despite its tollbooth business model, the company’s sales and profitability haven’t fared well during the oil crash.
Source: Simply Safe Dividends
That’s largely due to the business model, which involves Kinder paying out the vast majority of its distributable cash flow, or DCF (EBITDA – maintenance capex), as dividends and using debt and equity markets for its growth capex needs.
In the past few years the company has had to raise a lot of debt and equity at unfavorable rates, resulting in very poor profitability and returns on investor capital.
|Company||Operating Margin||Net Margin||Return On Assets||Return On Equity||Return On Invested Capital|
Unfortunately, due to one of the largest debt loads in the industry (more on this in a moment), management had to make deleveraging a priority, which has involved the sale of numerous assets, including 50% of its Southern Natural Gas pipeline system to Southern Company (SO), for $4.15 billion.
In addition, Kinder has also recently sold off 50% of its Utopia Ethane pipeline as well as the last 50% of its Parkway Refined Products pipeline.
The company is also considering selling off a 50% stake (turning it into a joint venture) of its largest growth project, the $6.8 billion Trans Mountain Pipeline expansion, which would greatly lower the company’s capital spending needs and help pay down debt with the proceeds.
In addition, Forbes recently reported that Kinder is considering selling off its oil & CO2 assets (which are the most profitable segment when oil prices are high) for as much as $10 billion.
The problem of course is that selling assets is a one-off, short-term solution, but one that will permanently impair Kinder Morgan’s future DCF (what pays the dividend) growth.
What’s worse, because of the oil crash, Kinder Morgan’s backlog of growth projects has been shrinking at an alarming rate, from a peak of $22 billion in mid-2015, to just $12 billion today.
The vast majority of this shrinkage in future potential growth is courtesy of deferred and cancelled CO2 projects, whose economics no longer make sense unless oil prices recover significantly.
While management’s aggressive asset sales might make sense in the short-term, in terms of strengthening the balance sheet, Kinder Morgan has very little growth potential remaining, especially as a percentage of its already vast assets.
Or put another way, what remaining cash flow growth the company can look forward to is likely to be too small to move the needle in terms of DCF growth, making long-term dividend growth potential marginal at best.
Kinder Morgan faces numerous risks to its already limited growth. The first is the potential for oil prices to remain at today’s low levels for several more years.
In fact, current long-term futures contracts for West Texas Intermediate, the U.S. oil standard, have stabilized in the $50s…all the way through 2020.
While that doesn’t necessarily ensure that oil prices remain half of what they were before the oil crash started, it means that the market is not expecting an oil recovery anytime soon.
This is due to three main factors. First, slowing global economic growth, as well as improving global fuel efficiency, is creating slower demand growth for oil.
Second, the oil crash has forced U.S. shale producers to become incredibly efficient, which has lowered the breakeven price for most U.S. shale formations to levels where reasonable returns can be achieved at far lower prices.
In fact, since oil prices bottomed at $26 in February of 2016, the number of oil rigs drilling in U.S. shale formations has started rising quickly.
Specifically, since bottoming in early May 2016, the number of U.S. oil rigs has soared over 70%, which means that U.S. production may soon start to climb, offsetting the recent OPEC production cuts.
The world could remain oversupplied with oil for several more years. In addition, global storage capacity is at all-time highs, and that inventory will likely take years to work off, even if oil production were to decrease significantly.
All of which means that investors hoping that Kinder Morgan’s fortunes might be turned around quickly by a fast crude recovery (which would return many of its CO2 projects to its backlog and increase CO2 business margins) are likely to be disappointed.
Next there is Kinder Morgan’s mammoth debt burden, which despite its asset sales, continues to weigh on the