On January 20, after the market closes, Kinder Morgan Inc (NYSE:KMI) will announce its 2015 fourth quarter results, to start the earnings season for the infrastructure energy subsector. Since Kinder has already announced it will reduce its dividend rate by 75% in 2016 to re-purpose that cash flow, I wanted to review which metrics will provide some visibility on how the company, and stock, will perform going forward.
Still a Free Cash Flow Focus
In 2014, Kinder rolled up the two MLPs it controlled into the Kinder Morgan corporate structure. This move pulled a large amount of depreciable assets into KMI and was supposed to improve the company's ability to raise growth capital due to the lower expected dividend yield on the corporate shares. Kinder's plan was to continue with an MLP style growth model, developing or acquiring energy midstream assets with the growth funded by a combination of new debt and equity issuance. Also in the MLP vein, the company planned to pay out the majority of free cash flow as a high, and growing dividend stream.
The MLP style growth model works as long as the blended cost of debt and equity capital -bond and share yields- is below the cash flow on invested capital yields from new projects. With its investment grade credit rating resulting a 5.5% cost of debt capital, when the KMI shares were yielding 4.5% the cost of capital was justified for growth projects that would produce annual cash flow returns in the low to mid teens. However, as the KMI share price declined over 2015, that equity cost of capital moved steadily higher. By late summer the shares were yielding over 6% and October saw the yield climb to almost 8%. A rising equity yield reduces the accretive cash flow from growth projects. The falling share price/higher yield trend can set up a "death spiral" with more shares issued to cover equity capital needs, reducing net cash flow to cover future dividend increases which causes the market to drive down shares, further increasing the equity yield and further lower accretive cash flow from growth opportunities. The steep energy sector sell-off in December pushed the KMI yield into the mid-teens and the game was over.
Kinder Morgan also carries a high level of debt on a debt/EBITDA measurement. That tactic was justifiable when the MLP yields of 8% to 9% were rolled into the corporate structure with a less than 5% dividend yield. Then in 2015 when the KMI equity yield climbed into double digits, Kinder could not carry its growth plans funded with additional debt alone. Piling on more debt put the investment grade credit rating at risk, which would have increased the debt cost of capital also. Kinder Morgan really had no option except to reduce the dividend rate and use the freed up cash flow to fund growth capital expenditures in 2016 and possibly beyond.
Looking For Year Over Year Cash Flow Growth
With over $600 million per quarter (and growing) in non-cash Depreciation/Amortization expense the earnings per share metric does not tell you much about Kinder's cash flow results. For example, in Q3 2015 reported EPS was $0.19 per share, while distributable cash flow was $0.51 per share. Now that the new dividend rate of $0.125 per quarter is not sucking up almost all of the free cash flow, I want to see how the Q4 EBITDA and free/distributable cash flow come in relative to the same period last year. A year ago reported EBITDA was $1.95 billion (my math) and the company reported DCF of $1.278 billion. Kinder's cash flow declined over the first three quarters of 2015. One cause is seasonal, with revenues and cash flow historically lower in Q2 and Q3 compared to Q1 and Q4. The second reason was falling energy commodity prices. If Kinder reports 2015 Q4 results close to what the company did a year ago, it will be a strong positive for growth going forward in 2016, even with low gas and crude oil prices.
Another point of interest will be Kinder management's comments on the fate of its Trans Mountain pipeline expansion project in Western Canada. On January 11, British Columbia announced that Kinder had not the conditions the government had set to approve the project. I think the investing public would see an announcement that Kinder was suspending the project as a positive and such an announcement would boost the share price.
After slashing the dividend rate, Kinder Morgan became a lost cause in the eyes of many investors who had formerly believed in the company and were counting on the dividend payments. Now, management has to show that it can grow cash flow by reinvesting free cash flow so that the dividend can again be increased sooner than later. The Q4 earnings report and call will give some early clues as to whether it is time to again own KMI shares.
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.