Kinder Morgan (KMI) drew the ire of investors years ago when it cut the dividend. That was never supposed to happen. But in the years since then, the debt has been reduced to the “new” lending requirements and the dividend is now on the way back. This company is now three years into a recovery that puts this management ahead of much of the midstream industry.
Management again aggravated Mr. Market by abandoning the original plan to increase the dividend this year 25%. Instead management opted for a more pedestrian 5% increase while retaining cash to ride out the coronavirus demand destruction. The “you said it so you have to do it no matter what crowd” screamed loud and long for a while. But the wisdom of facing the unknown current situation with more cash is really hard to dispute.
In the meantime, the dividend has now been increased for three consecutive years. Management has stated that it still has that $1.25 annual dividend as a goal. All management wants to do is wait for things to return to something “normal”.
The dividend cut a few years back put this management in the position of retaining more cash going into the coronavirus demand destruction. All that was really necessary was the determination of an adequate reserve cash position. The issues from a few years back have been resolved. Therefore Kinder Morgan is now in a position to take advantage of distressed sellers. and continue to slowly increase that dividend. That is good news for long suffering shareholders.
Stock In the Doghouse
But Mr. Market really only likes momentum stories. But the last few years there really is not much momentum to talk about here. The result is the stock is now among a lot of forgotten issues.
Source: Seeking Alpha Website October 7, 2020
Ever since the dividend cut in 2016, this stock has clearly not done well for a variety of reasons. The 2016 industry downturn had its own issues. But measures were also taken to reduce debt and reduce the Canadian exposure to zero.
All of that left an impression upon Mr. Market that the growth stories and profitable acquisitions were a thing of the past. The stock is now priced to never grow again. But the new dividend policy retains cash to fund organic growth. Ironically, when the stock price was higher, that was not the case. Basically this stock is now valued for its income. For whatever reason, the market believes that income has some risk even with the enhanced cash position and lower debt.
The dividend alone provides the same amount of total return that many investors make in the stock market annually in the long term. Any stock recovery and long-term appreciation potential would mean an above-average return with less risk than the usual upstream company.
Once Mr. Market figures out that this stock is now in a position to return to the growth of the past, then this stock will be revalued by the market. In the meantime, now is the time to look at a company that has darn good finances and a conservative dividend payout ratio for the midstream industry.
Source: Kinder Morgan Second Quarter Earnings Press Release July 2020
As shown above the distribution amount is a little more than half of the distributable cash flow shown. By that measure this company retains far more cash for growth than many midstream companies. Yet Mr. Market is valuing this company as if the distribution retention was the same as the industry average around 80% (very approximately).
Clearly the market has yet to value the fact that some companies retain more money to grow organically than others. This may be due to the fact that different projects have different profit abilities and cash flow. That could mean that more profitable projects require less upfront cash and allow more lending. Yet that company would grow as fast as a company engaging in lower profitability requirements.
Therefore Mr. Market may wait to see growth while maintaining key debt ratios before revaluing this company to anticipate future growth. That waiting period could signify a relatively safe time to consider investing in Kinder Morgan as the stock would have little downside risk while retaining the potential for a re-evaluation to a higher value once it returns to its historical growth strategy that includes periodic acquisitions.
Despite the decline in business from the coronavirus, the cash flow appears to be reasonably healthy.
Source: Kinder Morgan Second Quarter 2020, 10-Q Report
As shown above, the cash flow has actually increased for the six-month period. Most of that increase came from some favorable swings in “changes in components of working capital”. Then again tight management of cash flow should be expected from superior management.
Even though business is down approximately 10% by some measures, the cash flow remains intact. The management has plenty of financial flexibility during the coming recovery as well as the means to make a small acquisition or two for cash.
From a valuation standpoint, the annualized cash flow shown above will be about $4 billion. Long-term debt is about $31 billion. Meanwhile the market value of the common is $30 billion. Therefore enterprise value is about 15 times cash flow and about 9 times projected EBITDA. These valuations are extremely reasonable given the long-term record of this management.
Kinder Morgan common stock was depressed a few years back due to the dividend cut needed to bring debt ratios in line with changing debt market expectations. That dividend cut was followed by a period of periodic sales to pay down debt. Mr. Market has yet to forgive the dividend cut (let alone appreciate the balance sheet improvements).
In the meantime, the company has begun to restore the dividend as conditions have improved while retaining a larger amount of cash flow to fund organic growth. This new cash retention strategy should allow for more per-share growth in the future at the cost of a lower distribution in relation to cash available to distribute.
This change in strategy appears to imply a time period when income investors may divest the stock while investors favoring income and growth may see this stock appealing to them. However, to attract new investors, the company needs to establish a growth record. Management has now positioned the company to do just that.
The coronavirus demand destruction period has provided a stock price that represents an exceptional bargain. This management has retained an unusually large amount of cash to fund internal growth. Now if those funds are reasonably reinvested, then this midstream company should grow faster than many competitors.
In the meantime there is a stock repurchase program to indicate that management feels the stock is one of the better uses of corporate cash. Once the current coronavirus challenges begin to fade, the stock will probably not return to the current level for a long time if ever.
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Disclosure: I am/we are long KMI. 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.
Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.