Kinder Morgan Expected To Outperform With A Positive Outlook And A Strong Focus On Balance Sheet Strength

| About: Kinder Morgan, (KMI)

Summary

KMI’s base natural gas business (55% of EBITDA) performed well despite challenging commodity prices and warm weather which is a testament to the stability of its contracts and increasing “demand-pull”.

Dividend reduction allows KMI to self-Fund Capital Investments and in the current challenging environment investors appear to be placing a premium on leverage and financial flexibility.

KMI’s take-or-pay contract mix expected to increase to 70% of cash flow in 2019-20 following the completion of the Trans Mountain expansion project.

Kinder Morgan (NYSE:KMI)

Fundamentals

Kinder Morgan is the largest midstream energy firm in North America with more than 80,000 miles of pipeline and 180 terminals. The company is active in the transportation, storage and processing of natural gas, crude oil, refined products, carbon dioxide and is the largest handler of ethanol in the country. The vast majority of Kinder Morgan's cash flows stem from fee-based contracts that provide insulation from commodity prices.

Kinder Morgan upsized its revolving credit facility to $5bn from $4bn and entered into a new three-year $1bn term loan. KMI is expected to refinance all of its $1.7bn of debt maturities in 2016 on its short-term facilities with this increased liquidity and hence company's leverage is expected to decrease to 5.5x by the end of 2016.

Financials

Financial year

FY11

FY12

FY13

FY14

FY15

In $ mn

Revenue

7,943

9,973

14,070

16,226

14,403

Revenue growth (%)

1.2%

25.6%

41.1%

15.3%

(11.2%)

Gross Profit

3,174

5,214

6,705

7,795

7,951

Gross Profit Margin (%)

40%

52%

48%

48%

55%

Operating Profit

1,423

2,593

3,990

4,448

2,417

Operating Profit Margin (%)

18%

26%

28%

27%

17%

Net Profit

383

1,092

1,197

1,026

227

Net Profit Margin (%)

5%

11%

9%

6%

2%

EPS (GAAP)

0.54

0.81

1.16

0.90

0.10

Dividends per Share

1.05

1.40

1.60

1.74

1.61

Capital Expenditures

2,379

2,105

3,661

5,005

5,975

Cash & ST Investments

411

714

598

850

736

Total Assets

30,717

68,245

75,185

83,049

84,104

Total Debt

17,278

34,401

36,193

42,814

43,227

Total Equity

3,321

13,866

13,093

34,076

35,119

ROA

1.51

2.43

3.76

3.09

0.25

ROE

11.33

12.71

8.88

4.35

0.66

No. of Employees

8,120

10,685

11,075

11,535

11,290

Click to enlarge

Competitive Advantage

Kinder Morgan is starting a new chapter as the largest midstream firm in North America and will not be required to tap equity markets in 2016 as their reduced dividend gives them the flexibility to self-fund their growth projects. The company is focused on protecting its balance sheet which a rationale move given the turmoil in energy markets.

KMI's largest customer represents just over 4.5% of revenue and has an AA- credit rating. The average customer makes up less than 0.1% of KMI's revenue and of the KMI's top 212 customers only about 3% of revenue comes from customers with credit ratings of B- or lower.

KMI'sTrans Mountain expansion could be delayed beyond the expected Q3'19 in-service date depending on the new Canadian federal government's process for large-scale oil projects. In Jan16, the federal government in Canada announced transitional measures which would delay a decision on Trans Mountain by four months to Dec 2016 rather than Aug 2016. KMI has some flexibility to offset delays by optimizing its construction schedule and hence with investors' increased focused on near-term leverage/liquidity, any potential delay in construction spending. Trans Mountain expansion could be viewed as a positive as it would accelerate KMI's debt pay down given the magnitude of capital spending associated with the project which is around $5.4bn.

Key Risks

  • With lower oil prices, there's a new headwind facing project development and it may become harder to keep project backlogs full threatening longer-term organic growth
  • The TransMountain expansion is meeting with increasing opposition. Pipeline politics are playing out, moving the project and pushing out likely in-service dates and driving up project costs
  • KMI's near term focus is on protecting the balance sheet and maintaining an investment grade rating and hence it is unlikely equity investors will see an increase to their dividends over the next few years

Outlook

KMI has guided to slight growth in EBITDA for 2016($7.5bn vs. $7.4bn in 2015, or +1.4%) and flat DCF at $4.7bn. Overall growth assumptions are: +3% Gas (TGP and other expansions offset by contract expirations), -20% CO2 (oil prices), +14% Terminals (Jones Act tankers and Edmonton tanks ramping), +12% Products (KMC and higher utilization), and -4% Canada (NYSE:FX).

KMI's management has guided to $8bn in segment EBDA (Earnings before Depreciation and Amortization) for 2016, with 91% of cash flows fee-based and an additional 6% hedged leaving only 3% directly commodity based and of that 91%,74% is take-or-pay around $5.4bn in total.

Intrastate has relatively few contract rolls coming up amounting to only 0.7% of EBDA in 2017 and 1.3% in 2018. G&P has87% (or $793mn out of $912mn in 2016 estimated EBDA) with 30% of that being take-or-pay. Products do not generally have volume commitments but have shown tremendous stability (within ~1% of budget) over the past five years.

Investment Rationale & Conclusion

The main focus for KMI remains on protecting the balance sheet with the organic growth backlog and returns to shareholders as the next priorities. The key to de-levering which the company plans to execute primarily by growing EBITDA is self-funding the backlog. Overall, this is expected to set KMI up to move from 5.6x leverage for CY15 to 5.5x at the end of this year.

Dividend reduction allows KMI to self-Fund Capital Investments and in the current challenging environment investors appear to be placing a premium on leverage and financial flexibility. KMI is likely to prioritize leverage reduction in the near term and the company is expected to reduce leverage to 5.0x by Q1'19. KMI is expected to return value more directly to shareholders by resetting the dividend higher, buying back stock and continued leverage reduction and elimination of equity financing needs.

KMI currently trades at$17.75 (price as on 24th March) with its 52 week range of $11.2 - $44.71 and provides strong upside potential over medium to long-term for reasons outlined below -

  • Strong annual growth expected from Natural gas pipelines, products pipelines, & terminals segments given the recent start-up of large-ticket projects
  • Maintains a strong balance sheet with 74% of fee-based cash flow secured by take-or-pay contracts with limited counterparty exposure
  • Focus on stable fee-based assets that are core to North American energy infrastructure

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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: Reference / Sources : Company Annual Report, SEC Filings – 10-K, 10-Q, Investor Presentation, Company Press Releases, Morningstar, CBC, Reuters, Yahoo Finance