What Does Kinder Morgan's Expanding Terminals Segment Imply About Commodities?

| About: Kinder Morgan, (KMI)

Summary

KMI resigned with Nucor, a key customer in the Terminals segment.

KMI has made Terminals a strategic priority, and this has important implications on the outlook for commodities going forward.

Commodity prices are unlikely to recover anytime soon, but KMI is better insulated than it used to be.

Compared to its pipeline businesses, Kinder Morgan's (NYSE:KMI) Terminal segment doesn't get much attention. But it has gradually become more integral to the company's plans as low oil prices have weakened demand for transportation services. KMI has invested heavily in its Terminals business over the past three years, and just resigned key customer Nucor (NYSE:NUE), a steelmaker, to a 10-year $900 million agreement. KMI will provide in-plant services for five of Nucor's facilities that produce a total of 13.4 million tons of steel per year. The deal offers some insight on how the company plans to navigate the challenging environment, and, according to Terminals president John Schlosser, "reconfirms KMI's commitment to growing [its] terminal business". This has important implications on the outlook for commodity prices going forward.

KMI will rely on its Terminal segment for growth over the next few years. The segment operates terminals that transload and store refined petroleum products, crude oil and condensate, and bulk commodities such as coal, petroleum coke, cement, alumina, and steel. Excess capacity in commodity markets has driven demand for terminals, as producers have needed a place to store their unused output. Storage provides the luxury of flexibility, and allows producers to keep their stock on-hand until conditions moderate and commodity prices rise, at which point they can transport their product to wherever demand is strongest. By virtue of being the largest independent terminal operator in the US, KMI has benefited handsomely from the rising demand for storage capacity. The firm's vast terminal network throughout North America offers unmatched flexibility, and allows KMI to attract new and existing customers. While its other segments have stayed flat over the past two years, Terminals revenues grew 33% between 2013 and 2015. Of course, not all of this is organic growth, but the move to expand into terminals implies that management expects commodity prices to remain weak for the foreseeable future.

The Nucor deal reaffirms that conditions in the steel sector will continue to be a challenge. The domestic steel industry has been battered lately as a result of the construction slowdown in China and weakness in the energy sector, which has led to overcapacity and low prices. Construction activity and auto demand in the US are keeping firms alive, but declining global investment and manufacturing levels appear to be long-term headwinds. The US government recently raised tariffs to protect domestic producers from cheap imports from China, propping up domestic steel prices, but US operators are having trouble selling their products abroad due to dollar strength. This leaves the industry more reliant on domestic demand, and this is a big problem given that US industrial activity is in secular decline. Many analysts predict the US steel sector to grow in 2016, thanks to Chinese curtailments, modest growth in the US and EU, and additional strength in India, but growth projections are optimistic and KMI will benefit from a prolonged period of low steel prices.

Protracted weakness in commodity prices will drive demand for KMI's terminals segment. The fee-based structure of the terminal business is an important feature, and a key reason why management is expanding in this area. Fees generate recurring revenues, and help insulate KMI during periods of wild commodity price swings. This keeps cash flows relatively stable and allows the company to fund growth internally, a huge advantage given how costly it is to borrow or issue new shares in the current economic climate. Rather than having to borrow, KMI has been able to protect its balance sheet and better position itself for when condition improve. Management's focus on the terminal segment for growth implies that it might be a while before things get better, but the company's continued shift to fee-based businesses will ultimately make KMI a healthier, more self-sufficient company.

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