Kinder Morgan Inc.: The Stock Rally Is 6 Months Old

| About: Kinder Morgan, (KMI)

Summary

Richard Kinder, who owns a significant amount of stock makes approximately $30 million from dividends and really nothing from salary.

The stock is up significantly from its January bottoms despite all the bearish news.

Earnings should grow faster in the future from earnings compounding from cash flow reinvestment and far less unit sales in the future.

The market could well award the stock a higher price-to-earnings ratio when earnings per share grow faster than in the past.

Joint ventures could repair the balance sheet faster than the market expects and provide assurances of profitable future business.

Here is stock that has been in an uptrend for about six months. The earnings report that came out was more than reasonable given industry conditions. Yet there is clearly a lot of pessimism surrounding Kinder Morgan Inc. (NYSE:KMI). Unnoticed by parts of the market was that the stock did not drop sharply and stay lower on the earnings announcement. So there can be a case made that a lot of the negative momentum that has accompanied this stock has finally worn itself out. Many commentators still remember that the stock was in the mid-thirties a year ago. So even though the stock has rallied from below $15 per share in January to its current level of approximately $20 presently (July 26, 2016 market close), the initial losses have still left a bad taste in the mouth of the market.

Plus the market has a very long memory when it comes to dividend cuts. The fact that the credit market has changed as industry conditions became less favorable seems to have been lost on the market. Some commentators have noted that the change in the credit markets have forced the company to change its model. Partnerships such as Linn Energy (NASDAQ:LINEQ) and Brietburn Energy Partners (OTCPK:BBEPQ) that failed change their model in time failed completely. I wrote about several of these companies articles that cataloged the way down and it was not pretty.

The company has actually been forced to reinvest its earnings rather than pay those earnings to unit holders. Reinvesting of earnings leads to compounding of investment returns and that should mean faster corporate earnings and cash flow growth (especially per share) than when earnings are paid out and more units are sold. This is clearly a very different business model than the market was used to and this new model will appeal to a different set of investors. Looking at the stock price history over the last year, it is becoming clear that the process has begun and the new investors will carry with them a different set of expectations. Those new investors have also clearly bid the stock price up significantly from its lows, although the twelve month period still shows a loss.

Of course whether this rally continues will depend upon the future financial results. Cash flow from operations was shown as $2.344 billion. The only reason cash flow was down was a negative swing in the various working capital accounts and miscellaneous items in the calculation of cash flow from operations. Otherwise, cash flow was basically flat with the second quarter in the previous year. The company has managed to hold operations reasonably flat at a time when oil and gas industry activities keep decreasing. Plus the company has insulated the majority of its business from this downturn for a few years.

That gives the company plenty of time to react to this downturn if it lasts that long. In fact the company may grow its way out of the downturn, as certain areas still need its services. But commodity prices have begun to rise, leading to an increase in activity throughout the industry. The industry has become so much more efficient, that a small fraction of previous budgets will not only maintain production, but enable production to grow. So production volumes that Kinder Morgan needs to transport or store may increase on far less activity increase than was needed in the past.

In the meantime, the company is not sitting still. The company is strengthening the balance sheet through the sale of joint ventures. Joint ventures not only raise cash but they also insure a reliable partner who will contribute future business to the company. Done properly, joint ventures are a huge plus far beyond balance sheet effects and those effects will last long into the future. The company spoke of lowering the long term debt-to-EBITDA ratio significantly by December. Investors should watch the long term debt-to-cash flow from operations, because that number needs to grow on other gains may not prove permanent. The company has a satisfactory debt rating and wants to prevent a down-grade of that rating or possibly improve it a little.

But the key is that as long as management is pursuing cash raising possibilities to increase the speed of the balance sheet strengthening process, then many good things will also happen faster. A stronger balance sheet will enable the company to pursue more of the capital projects in the backlog and will hasten the day that the company can raise its dividend.

If the company sticks with the new model where the dividend is a lower ratio of the cash flow, then the dividend will be much more secure in the future. A future dividend equal to the old rate a year ago will have far more earnings and cash flow to back up that rate in the future. The compounding of earnings caused by the reinvestment of a significant portion of earnings and the lack of dilution from future unit or stock sales should eventually cause the market to value future earnings higher than currently.

It was interesting that Richard Kinder, who owns a significant amount of the common stock, makes about $30 million every time the dividend is paid. People who build companies like this are rarely satisfied with the status quo. Therefore, Richard Kinder will most likely continue to attempt to build this company larger until he retires or dies. He has an impressive track record so far up until the hiccup a year ago. Therefore a very reasonable assumption is that he will return the company to the growth track (which will be to the advantage of shareholders).

Investors may want to review this company as part of a batch of companies in a portfolio. Diversification is always advised to minimize the risk of company specific problems while maximizing the profits of industry recovery (or just plain portfolio) results. While the stock is clearly up significantly from its lows, the stock will probably increase in price as a track record for the new corporate model is established.

Plus sooner or later the market will realize that the underlying business is still doing just fine and that business is just as profitable as it was before. Now however, with the reinvestment of earnings, the business will grow faster which could eventually lead to a higher price-earnings ratio than in the past. Kinder Morgan is a large company, but there is a whole continental that offers the company many avenues to grow. The market still appears much to bearish on this stock which indicates the rally in the stock still has a ways to go.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

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.