The increase in oil and gas prices this year will prove to be a tailwind for Kinder Morgan (NYSE:KMI) since it will witness a rise in its cash flow performance. The reason why I am saying so is because after the recent production cut decision taken by the OPEC and non-OPEC countries, oil inventories will decline in 2017. The decline in oil inventories will push oil prices higher than $60 per barrel, with hedge fund managers such as Pierre Andurand forecasting that the commodity will hit $70 per barrel in June.
Now, if we assume that oil prices average even $65 per barrel in 2017, Kinder Morgan will witness strong growth in its distributable cash flow. This, in turn, will have a positive impact on the company's stock price performance. Let me explain how.
Kinder Morgan's distributable cash flow is set to increase
For fiscal year 2016, Kinder Morgan forecasts that it will be able to generate $4.7 billion in distributable cash flow. Kinder Morgan has made this distributable cash flow assumption at an oil price of $38 per barrel and natural gas price of $2.50/MMBtu. Now, this year, the price of both oil and gas are expected to go up remarkably from the levels seen in 2016.
For instance, as already discussed earlier in the article, oil prices could eventually average $65 per barrel this year as they are expected to range between $60 and $70 per barrel. This means that at the mid-point of the forecasted range, the oil price will increase around $27 per barrel from last year's levels.
Now, for a $1 per barrel increase in the price of oil, Kinder Morgan's distributable cash flow will increase by $6.5 million. Hence, if the price of oil increases by $27 per barrel as compared to last year's levels, Kinder Morgan's distributable cash flow will go up by around $175 million. On the other hand, an increase in natural gas prices will also have a positive impact on the company's distributable cash flow.
More specifically, if the price of natural gas increases by $0.10/MMBtu, Kinder Morgan's distributable cash flow will see a bump of $0.6 million. Now, this year, the price of natural gas is expected to average around $3.27 per MMBtu. This is $0.77 per MMBtu higher than Kinder Morgan's forecasted budget for 2016. Therefore, for a $0.77/MMBtu increase in the natural gas price, Kinder Morgan's distributable cash flow will go up by around $5 million.
Hence, as compared to 2016, Kinder Morgan's distributable cash flow should increase by $180 million in 2017 due to a rise in oil and gas prices. Due to a rise in the distributable cash flow, Kinder Morgan will have more money to distribute among its shareholders. Now, distributable cash flow is calculated by reducing capital expenses after adding net income and depreciation.
This means that the improvement in oil and gas prices will have a positive impact on Kinder Morgan's bottom line, which is why its cash flow performance will improve. Therefore, as Kinder Morgan's net income rises, the company will also see an improvement in its stock price performance. Let's see how.
How an increase in earnings will power the stock price higher
Due to the rise in oil and gas prices, Kinder Morgan's earnings are expected to grow to $0.71 per share as compared to projected earnings of $0.61 per share. Now, Kinder Morgan's price-to-earnings ratio for 2016 is estimated at 35. If the company is able to sustain this price-to-earnings ratio in 2017, then with earnings of $0.71 per share, its stock price will be approximately $25 per share, representing upside of close to 15% from the current levels.
What's more, Kinder Morgan will be able to sustain its bottom line growth in the long run as well, which will lead to further upside in the stock price. By the end of 2019, Kinder Morgan's stock price is anticipated to grow to $0.91 per share, a rise of almost 30% from this year's levels. Given Kinder Morgan's price-to-earnings ratio of 35 as pointed out earlier, the company's stock price by the end of 2019 should rise to almost $32 per share, indicating upside of around 47% from current levels in the next couple of years.
Kinder Morgan is trading at the higher end of its 52-week range, but I won't be surprised if the stock is able to break higher in the long run as the discussion above indicates. So, it will be a wise idea to remain invested in Kinder Morgan for more gains in the long run as the stock looks primed for more upside.
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.