Kinder Morgan: Don't Be Disappointed

| About: Kinder Morgan, (KMI)
This article is now exclusive for PRO subscribers.

Summary

KMI shares have lost value since Q2 results as management decided not to hike the dividend, which left investors disappointed.

KMI was forced to keep its dividend at the same level owing to weakness in its revenue, which has also impacted its distributable cash flow.

KMI’s prime concern is to keep its distributable cash flow in good shape, so the company has also decided to reduce its capex by another $500 million.

KMI’s volumes should improve in the long run owing to higher natural gas demand in the U.S., along with a favorable inventory position that will lead to higher fee-based revenue.

KMI will also benefit from exports of natural gas into Mexico, along with the Trans Mountain pipeline in Canada where it has 80% of its volumes already contracted.

It has been almost a week since Kinder Morgan (NYSE:KMI) released its results for the second quarter, but investors haven't reacted kindly to the results. In fact, Kinder Morgan shares are down over 6% since the results were released as the company decided not to hike its dividend, even though its earnings were in line with estimates.

Why Kinder Morgan has made the right move by keeping the dividend the same

However, in my opinion, Kinder Morgan has done the right thing by not hiking the dividend since the company's results were not that great. Kinder Morgan's sales were down almost 9% year-over-year, while the distributable cash flow also took a tumble to $0.47 per share from last year's $0.50 per share. What's more, in the first quarter of 2016, Kinder Morgan's distributable cash flow was even better at $0.58 per share.

Therefore, the weakness in volumes owing to low commodity prices has had a negative impact on Kinder Morgan's business, which is why the company is being conservative about its dividend. In fact, Kinder Morgan aims to keep its 2016 distributable cash flow more than the capital expenditure, which is why it has kept the dividend at earlier levels. Moreover, the company has also decided to reduce its capital expenditure forecast for the year by $500 million.

Thus, quite evidently, Kinder Morgan's prime focus is on keeping its liquidity in good shape. This is a smart strategy in my opinion as Kinder Morgan seems to be waiting for the improvements in the natural gas markets to come into effect. The good part is that there have been certain tailwinds on this front of late, with natural gas transport volumes up 3% year-over-year in the latest quarter. Looking ahead, I believe that Kinder Morgan will continue to witness a rise in natural gas volumes. Let's see why.

Kinder Morgan's natural gas volumes will improve

The conditions in the natural gas market have started improving as demand for natural gas for powering electricity generation has risen, while natural gas production continues to decline. According to the United States Energy Information Administration, natural gas production in June averaged 79.1 Bcf/d, representing a decrease of 1.0 Bcf/d from the record-high daily average production in February this year. In fact, natural gas production has declined significantly in the first half of 2016 as compared to the same period last year.

This decline in natural gas production is due to lower shale gas production and conventional gas that has either stopped growing or have been declining in the past few years. As a result, the supply surplus that was at record high less than two years ago could move into deficit by November 2016, as per data released by the EIA.

On the other hand, the consumption of natural gas is rising consistently. According to the EIA, natural gas consumption will average approximately 76.6 Bcf/d in 2016 in the U.S. and about 77.8 Bcf per day in 2017, as against 75.3Bcf/d in 2015. This increase in the natural gas consumption is due to an increase in the use of natural gas to generate electricity.

EIA expects that the use of natural gas in the electric power sector will rise by 5.1% in 2016, while the industrial sector will witness a rise of 2.7% in 2016 and 1.7% next year. More importantly, the strength in natural gas demand is here to stay for the long run.

I am saying this because it is expected that the demand for natural gas in the United States will rise by 27% through 2020, driven by growth in both the electric power and the industrial sectors. Natural gas usage to generate electricity will increase 16% in 2020 from last year. Similarly, industrial usage of natural gas will go up by 17% over the same time period.

These improving fundamentals for natural gas suggest that the demand for the commodity will eventually rise going forward, along with improved prices. In fact, the recent decline in natural gas production, along with higher demand, has led to an average price of $2.59/MMBtu for the month of June 2016, the highest monthly average since September 2015.

Therefore, an improvement in the price of natural gas, along with higher demand, will lead to an increase in both volumes and fees for Kinder Morgan.

LNG exports and some more positives

Apart from an increase in the consumption of natural gas in the U.S., Kinder Morgan will also benefit from the connection of gas markets such as Canada and Mexico through its North American gas pipeline system.

For instance, the exports of natural gas to Mexico have grown to 3.3 Bcf/day this year. According to EIA, the natural gas pipeline exports are growing significantly due to an increase in demand from Mexico's electric power sector as well as a flat natural gas production in the country. Thus, the agency expects gross pipeline exports to Mexico will increase by 0.7 Bcf/d in 2016.

At the same time, Kinder Morgan should benefit from the expansion of the Trans Mountain Pipeline project in Canada. The expansion of this project is expected to enhance its capacity to 890 MBbl/d from the current capacity of 300 MBbl/d. According to management, the National Energy Board of Canada has recommended an approval of its Trans Mountain expansion project and the company expects the final decision from the council to come by the end of December 2016.

The good part is that Kinder Morgan sees strong commercial support from shippers for the Trans Mountain Pipeline project. I can say this because the company has entered into binding long-term 15-year and 20-year contracts for 708 MBbl/d of firm transport capacity, which means that it has already received contracts for almost 80% of the expanded pipeline.

Conclusion

Given the points discussed above, I think that investors should not be selling their position in Kinder Morgan even though the company failed to enhance the dividend last quarter. Looking ahead, there will be ample opportunities for Kinder Morgan to raise the dividend since its addressable market is getting better. Therefore, it makes sense to remain invested in Kinder Morgan going forward in light of the discussion above.

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.