Kinder Morgan: 2 Reasons To Stay Long

| About: Kinder Morgan, (KMI)

Summary

Kinder Morgan is taking aggressive asset sale moves in order to lower its debt, while it is entering into JVs to share development costs, which is a smart move.

Driven by asset sales and other debt-reduction moves, Kinder Morgan’s net debt-to-adjusted EBITDA is expected at 5.3 times this year, down considerably from its earlier guidance of 5.5 times.

Kinder Morgan is increasingly focusing on projects with higher margins, such as the South Mainline expansion that will lower capital costs by $250 million and increase production simultaneously.

Driven by its capital and debt reductions, Kinder Morgan expects its distributable cash flow to exceed its capital expenditure for 2016, after the payment of dividends.

Pipeline infrastructure company Kinder Morgan (NYSE:KMI) has done really well on the market this year, rising over 50% on the back of an improvement in natural gas prices and its balance sheet optimization moves. In fact, a debt of $43.6 billion and a debt-equity ratio of 1.23 have made it necessary for Kinder Morgan to make an improvement in its balance sheet, and the company has been doing just that.

Reducing the debt

Kinder Morgan has reduced its net debt by over $1 billion in the last one year. In fact, more progress is being observed on the debt front at present as the company lowered its net debt by more than $234 million by the end of the second quarter of 2016.

Moreover, Kinder Morgan plans to reduce its net debt by another$3 billion on the back of synergies from its joint ventures and asset sales. As a part of this strategy, Kinder Morgan reached an agreement to divest over $175 million of its asset last quarter in the products pipeline and terminals segments. These divestments include Kinder Morgan's interests in the "Parkway Pipeline, a transmix facility, and a biodiesel processing plant." What's more, this divestment was on top of the $220 million worth of asset sales recorded in the first quarter of 2016.

Likewise, Kinder Morgan recently announced the sale of 50% of its SNG natural gas pipeline system to Southern Company (NYSE:SO). As per this deal worth $4.15 billion, Kinder Morgan will receive nearly $1.47 billion in cash and the rest being assumption of SNG debt. Kinder Morgan can then use the cash to repay more of its debt.

As a result of these improvements in the balance sheet, Kinder Morgan expects its net debt-to-adjusted EBITDA to come in at 5.3 times this year, which is down considerably from its earlier guidance of 5.5 times net debt-to-adjusted EBITDA for the year. Thus, driven by improvements in the balance sheet, Kinder Morgan will be able to improve its liquidity position going forward. Additionally, Kinder Morgan will also benefit from an improvement in its cost profile, which will lead to further improvement in its bottom line.

Infrastructure development will lower capital costs

Last quarter, Kinder Morgan's El Paso Natural Gas Pipeline was awarded with an incremental capacity expansion of 271,000 Dth/d by the Comisión Federal de Electricidad (CFE) in order to support the South Mainline expansion. As a result of this additional capacity from CFE, Kinder Morgan can now "replace the previously approved and fully-subscribed second phase of the Upstream of Sierrita Havasu Expansion, which anticipated a 350,000 Dth/d expansion."

This is a smart move by Kinder Morgan as the new project carries higher margins. For instance, the move of expanding the South Mainline project can reduce Kinder Morgan's capital costs by $250 million. Additionally, this project will also lead to an increase in near-term revenue and a higher return on capital invested from the expansion once initial incremental volumes come online in April next year.

In addition, Kinder Morgan is trimming its project backlog to improve its leverage of capital-to-EBITDA. For instance, its current project backlog is at $13.5 billion, down by over $600 million as compared to the project backlog of $14.1 billion at the end of the first quarter of 2016. This decrease in the backlog is due to the removal of half of its Utopia Pipeline project capital that now be funded by Riverstone.

In the current situation, this is a good move because it will lower Kinder Morgan's capital costs, therefore reducing its leverage. At present, the company expects the projects in its backlog to generate an average capital-to-EBITDA multiple of around 6.5 times, which is on the higher side.

Thus, moves such as reducing capital costs across its business will enable Kinder Morgan to improve its free cash flow, which can be either used to invest in growth or increase its dividend payments. According to Barron's, Kinder Morgan may hike its dividend by over 18%, starting from 2018, driven by its efforts of optimizing its backlog over the next two to three years.

The most important thing to note here is that due to such improvements across its businesses, Kinder Morgan's operating cash flow is increasing. For instance, its operating cash flow in the second quarter came in at $1.3 billion, up nearly 30% from operating cash flow of $1 billion at the end of the first quarter of 2016.

Looking ahead, Kinder Morgan expects its distributable cash flow to exceed its capital expenditure for 2016, after the payment of dividends. This is a positive sign for its investors as the company is now able to live within its means, which implies that it doesn't need to borrow additional money to fund its capital expenditure and dividend.

Conclusion

Thus, it is evident that Kinder Morgan is making smart moves in order to optimize its balance sheet. The company is reducing its debt by selling-off less profitable assets or by entering into joint ventures to share costs. Also, the company is selecting those projects that have higher margins.

As a result, the company is able to limit its capital expenditure below its cash flow from operations. This allowed Kinder Morgan to generate $2.28 billion in distributable cash flow in the first half of the year, during which time it spent about $1.88 billion on capital expenditure. Therefore, driven by these operational improvements, Kinder Morgan will be able to do well in the long run as demand for natural gas picks up pace.

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.