Kinder Morgan (NYSE:KMI) reported its Q1 results yesterday, which hardly changed the outlook of the company. Since the company decimated its dividend more than a year ago, its shareholders have been looking forward to hearing good news from the management regarding a potential dividend hike. However, in this article, I will analyze why the shareholders should not have expectations for meaningful dividend hikes anytime soon.
First of all, Kinder Morgan is the largest independent transporter of petroleum products and has the largest network of natural gas in North America. In addition, the greatest part of its revenue is fee-based and hence the company is not dramatically affected by the fluctuation of commodity prices. This predictability of its cash flows is highly attractive to its shareholders, who want to have minimum exposure to the gyrations of the highly cyclical commodity prices.
However, unfortunately for the shareholders, the management attempted to do the impossible for many years. More specifically, it invested heavily on numerous growth projects while it also paid extremely high dividends to the shareholders. Unfortunately, this profligate policy resulted in the accumulation of excessive debt, which eventually forced the management to decimate the dividend.
While the management promised to reduce the debt after the dividend cut, it has only reduced it by a minimal amount. More specifically, the net debt (as per Buffett, net debt = total liabilities - cash - receivables) has only dropped from $47.2 B in 2014 to $43.6 B in 2016. This is still about 60 times last year's earnings and hence it greatly burdens the results of the company. To be sure, the interest expense currently eats about half of the operating income of the company. This is certainly alarming, as it renders the company extremely leveraged and thus vulnerable to any headwind.
Even worse, as per its latest presentation, the management does not intend to pay off any of the debt this year. It only intends to roll over the maturing debt to the future. Unfortunately, the management has utilized this strategy to the extreme. In fact, that's why it was forced to cut the dividend. Moreover, about $2.5-$3.0 B of debt per year is maturing during the next 5 years on average. This is much more than even the highest annual free cash flow of the company during the last decade, which was $1.6 B in 2016. Therefore, the company has a very loaded program in terms of debt maturities in the next 5 years and hence it cannot meaningfully raise its dividend for the foreseeable future.
It is also worth noting that the Fed has just started to raise interest rates and seems determined to continue to do so for the next few years. The rising interest rates will adversely affect Kinder Morgan, particularly given the intention of the company to roll over its debt instead of servicing it. According to the management, every 1% rise in the interest rates increases the interest expense of the company by about $110 M per year. Therefore, the uptrend of interest rates will only render the excessive debt load of the company even more burdensome.
Some investors were markedly optimistic and were expecting a dividend hike as early as this year. However, the management has now made it clear that it will not raise the dividend until at least the end of 2018. In addition, given the above evidence and the outlook for elevated capital expenses for the next few years, the management should certainly avoid raising the dividend. Nevertheless, given the impatience of the shareholders for the next dividend hike and the historical record of the management, which has always tried to please its shareholders even though the cash flows have not been sufficient, the management may attempt to start raising the dividend once again, starting from the end of next year. However, if the management indeed proceeds this way, it will only increase the risk exposure of the company due to its huge debt pile and will set things up for another major disappointment in the future.
To conclude, while the dividend cut about a year ago was certainly a healthy step, it came too late and hence it was insufficient to put the company back to a healthy, sustainable growth trajectory. As the company keeps spending more on capital expenses and dividends than it earns, its debt remains elevated and its interest expense keeps eating a great portion of its operating income. Investors should learn their lesson from the dividend cut and thus focus only on the earnings of the company, not on its dividend. In this way, they will avoid a similar disaster in the future.
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.