Kinder Morgan - My Top Midstream Pick For The Next Decade

|
About: Kinder Morgan, Inc. (KMI)
by: The Value Portfolio
Summary

Kinder Morgan had a tough time in 2015, however, the company has managed to significantly improve its business since then, and will continue.

The company is going back to increasing its dividend. The company anticipates 2020 dividends of $1.25 per share, which is a 7.7% yield on cost.

The company's discretionary cash flow should only increase going forward. This will help support strong shareholder returns going forward.

Kinder Morgan (NYSE: KMI) is one of the largest midstream companies in the world, worth almost $40 billion. The company has an impressive portfolio of assets with tens of thousands of miles of pipelines. Since the company’s difficult 2015, as a result of too much debt, the company has taken steps to improve its business. These business improvements make the company my top midstream pick for the next decade.

Kinder Morgan - Tax Chronicle

Midstream Natural Gas Demand

Kinder Morgan’s businesses rely on having continued investment opportunities, and as a result, midstream natural gas demand is important.

U.S. Natural Gas Supply - Kinder Morgan Investor Presentation

U.S. natural gas and oil production is anticipated to grow significantly from key basins. The company’s production is projected to grow by >30 bcfd or >40% over the next 10 years. At the same time, as the U.S. because an increasing player in LNG exports and turns to natural gas power to avoid dirty coal power, demand for oil and natural gas in the United States is expected to grow by ~40%.

One of the enormous advantages of Kinder Morgan is that the company isn’t heavily affected by natural gas or oil prices. For example, an 30% decrease in natural gas prices won’t cause a 50+% decrease in profits, like it does for many oil companies due to a larger shrink in their margins. As a result, the company simply benefits from growing natural gas supply and demand that needs to be moved around.

The amount of demand is most evident in the Permian Basin. Glowing oil supply led to a rapid drop in prices for oil, as pipeline capacity became constrained and couldn’t be moved out. This lack of pipelines means enormous opportunity for Kinder Morgan, as a company.

Kinder Morgan Asset Portfolio and Growth

Kinder Morgan has an incredibly impressive asset portfolio that the company is focused on growing significantly.

Kinder Morgan Asset Network - Kinder Morgan Investor Presentation

Kinder Morgan’s incredibly strong portfolio of assets touches almost every single state in the United States. The company movies oil and natural gas across the country with assets in both growing supply areas and key areas of demand growth. On the Texas Gulf Coast, the energy capital of the United States, the company assets are so heavily concentrated you can’t actually pick them

The company’s impressive and diverse portfolio of assets mean consistent cash flow.

Kinder Morgan Capital Projects - Kinder Morgan Investor Presentation

At the same time, Kinder Morgan has a significant $6.5 billion in projects underway, of which $4.6 billion are natural gas projects, and $1.9 billion are other segments. These projects are expected to come in-service at various dates starting from late-2018 through 2020. These projects all have a significant amount of potential going forward, and will generate strong EBITDA.

Past the company’s backlog, which is effectively projects the company has already decided for the next two years, the company anticipates $2-3 billion of organic investment opportunities. These opportunities will lead to some respectable increase in annual EBITDA every single year. At the same time, these opportunities will be covered by the company’s earnings each year.

In the long-term, the company anticipates that opportunities will be tied primarily to LNG, and increased shale takeaway.

I want to take a moment to highlight the potential from LNG. A major LNG shortage is anticipated to become increasingly likely. Kinder Morgan currently supplies 42% of U.S. liquefaction capacity under long-term contracts, with these contracts providing secure long-term cash flow into the 2030s. The company is planning to expand this significantly through the Elba Island LNG export terminal.

The Elba Island LNG export terminal consists of 10 small-scale module units. The liquefaction of this plant is expected to be an astounding 2.5 mtpa or 350 mmcfd. The project is anticipated to start Kinder Morgan more than $1 billion in capital and come in service throughout 2019. The project has a 20 year take-or-pay agreement with Shell, which like all of Kinder Morgan’s projects is a long-term payout.

Kinder Morgan Permian Growth - Kinder Morgan Investor Presentation

Another important aspect of Kinder Morgan’s growth potential is the Permian Basin which has seen oil and gas production grow by more than 50%. The company’s largest growth project is the Permian takeaway pipeline, and the company is continuing to partner with other market leaders to offer long-term solutions. At the same time, the company here can work to leverage or connect with existing assets.

Here in the Permian Basin is another way for the company build a multi-billion asset, that can provide multiple decades of steady cash flow.

Kinder Morgan Shareholder Returns

Kinder Morgan operates in a growing market. On top of this, the company operates in the market with an impressive and distributed portfolio of assets. Together, these two things will allow for impressive shareholder returns.

Kinder Morgan Earnings - Kinder Morgan Investor Presentation

Kinder Morgan has $8.3 billion in annual cash flow, the most of which is either based on take-or-pay contracts or hedged. I am happy to see the company hedging the part of its production that varies. While having some upside is exciting, I think is more important to minimize variability. The company hedging its sales, helps it to provide more reliable cash flow to investors.

Kinder Morgan is focused on returning this cash flow to shareholders. The company has been focused on delevering its balance sheet and has reduced its net debt by close to $8 billion since 3Q 2015. This ratio excludes $0.9 billion in expected cash proceeds from Kinder Morgan Canada’s sale. The company is currently at 4.6x net debt / EBITDA and planning to use that 4.5x.

The company has improved its financial portfolio and is now reducing cash to shareholders. The company increased its dividend 60% year over year in 2018, and plans 25% annual increases for both 2019 and 2020. At the same time, the company repurchased $0.5 billion shares during year-end 2018 out of a $2 billion repurchase program.

This is enough for the company to reduce its float by the mid-single digit range while continuing to provide shareholders with strong returns. The company’s dividend is almost 5%, and that’s expected to continue growing going forward.

Kinder Morgan 2030

As stated in the title of this article, Kinder Morgan is my top midstream pick for the next decade. Above, I attempted to highlight the strength of the company’s shareholder return program. Now it’s time to focus on the Kinder Morgan of 2030, the main reason why the company is my top midstream pick for the next decade.

Kinder Morgan 2019 Cash Flow - Kinder Morgan Investor Presentation

First, let’s discuss some assumptions that I’m making.

Equity Issue: $0

Dividend Increase: 25% 2019, 25% 2020 ($1.25 in 2020)

Growth Capital Spending: $2.5 billion

Total Debt: $35 billion (4.5x debt / adjusted EBITDA for 2018)

Share Repurchase: 2018-2019 $1.5 billion

Discretionary Free Cash Flow(cash flow after investments): $0.5 billion

Let’s discuss these assumptions supported by the company’s 2019 guidance. The first is $0 in equity issuances. Kinder Morgan’s 2015 crash in share price was caused by the company’s use of the equity markets. The company had previously been issuing equity in order to expand. However, in 2015, investors worried about the company’s dividend drove down its share price.

As a result, the drove down share price meant the company could no longer issue equity for growth. Since the company had already committed to growth projects, the company was forced to cut its dividend to save the cash for growth projects. The company managed to maintain its investment grade credit rating, however, it’s stock price took a strong hit.

In terms of the other numbers, those are all from the company’s guidance. It’s important to take into account the fact that the company has stated its long-term debt to EBITDA plan is 4.5x, which the company has achieved this year.

Kinder Morgan Returns - Kinder Morgan Investor Presentation

Another important graph to look at is the one above. This shows the company’s ratio between capital invested to year-2 EBITDA. The company’s ratio here is well below its estimates and somewhere from 5.5 to 6.0. At the same time, as can be seen from the company’s 2019 guidance, the company has a 64% conversion rate between EBITDA and DCF.

I assume that this ratio is expected to remain fairly constant. The company has stated its debt / EBITDA ratio is at 4.6x, fairly close to 4.5x. As a result, I anticipate the company’s interest expenses will remain fairly constant going forward.

Using all of these numbers, I anticipate the company’s $2.5 billion in long-term annual capital spending will provide year-2 DCF of $270 million. As a result, in my numbers I’ll assume annual DCF growth of $270 million per annum.

One last note. Kinder Morgan currently has 2.2 billion shares outstanding, with share prices at $16.2 per share The company also has $1.5 billion left on its share buyback program. When the company chooses to do this is up for debate, but I personally believe with recent oil and stock price drops, the company will pick sooner than later. As a result, I will assume the company buyback shares and has 2.1 billion shares through this math.

The company has announced 2019 dividend per share at $1 per share increasing to $1.25 per share by 2020. As of now that’s a 7.69% yield on cost. For now I will assume no future dividend increases.

Year

DCF

Dividend Expenses

Discretionary Cash Flow

2019

$5.00 billion

$2.10 billion

$0.50 billion

2020

$5.27 billion

$2.63 billion

$0.14 billion

2021

$5.54 billion

$2.63 billion

$0.41 billion

2022

$5.81 billion

$2.63 billion

$0.68 billion

2023

$6.08 billion

$2.63 billion

$0.95 billion

2024

$6.35 billion

$2.63 billion

$1.22 billion

2025

$6.62 billion

$2.63 billion

$1.49 billion

2026

$6.89 billion

$2.63 billion

$1.76 billion

2027

$7.16 billion

$2.63 billion

$2.03 billion

2028

$7.43 billion

$2.63 billion

$2.30 billion

2029

$7.70 billion

$2.63 billion

$2.57 billion

2030

$7.97 billion

$2.63 billion

$2.84 billion

*Discretionary Cash Flow = DCF - Dividend - Capital Expenditures ($2.5 billion)

Kinder Morgan has a market cap of $36 billion. For investors who invest today, they can get a 7.7% yield on cost starting in 2020 and continuing onwards. At the same time, the company’s discretionary cash flow is continuing significantly. That is cash flow the company can use for anything, whether that’s further growth or dividend increases for companies.

The company’s discretionary cash flow increases by $0.27 billion annually, and the company could put that into further dividend increases after 2020. One potentially impressive thing to see if the company were to use it’s incredible discretionary cash flow in 2030, for dividends, investors would receive a strong 15+% yield on cost. That’s a strong long-term return for an investor.

Kinder Morgan could become a dividend aristocrat, should they chose.

Alternatively, Kinder Morgan can undergo the Apple strategy and use its additional discretionary cash flow to buyback shares. Given the company’s market cap is a mere $36 billion, it could undergo several percent dividend increases, while buying back shares. To me, Kinder Morgan’s incredible cash generating power is why the company is my top midstream pick for the next decade.

Kinder Morgan Risks

One last thing I want to touch on quickly is potential risks that Kinder Morgan face. In my opinion, they’re quite minimal. The company’s real risk is a sizeable turn down in oil and natural gas markets. That would both prevent the company from carrying out its several billion in anticipated annual growth, while potentially hurting capacity on the company’s current assets.

I recommend investors paying attention for a sizeable turndown in U.S. oil and gas production, but personally I see it as a minimal risk.

Conclusion

Kinder Morgan has strong long-term potential and that makes the company my top midstream pick for the next decade. The company has incredibly strong cash flow generation which will only increase going forward. This is supported by the company’s commitment to increasing dividends, those who invest today should have a 7.7% yield on cost for next year, which is exciting to see.

Long-term, Kinder Morgan’s discretionary cash flow should go up by $0.27 billion per year. The company can choose to utilize this for dividend increases or share buybacks, however, both will be rewarding to shareholders. The company will continue to invest in its business. Overall, this makes the company my top midstream investment pick for the next decade.

Disclosure: I am/we are long KMI. 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.