Kinder Morgan's Canadian And CO2 Cash Flow Drivers

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About: Kinder Morgan, Inc. (KMI)
by: Kirk Spano
Summary

Kinder Morgan's earning are tomorrow April 17th.

We will want to keep an eye on the usual items, including balance sheet progress, growth outlook and returns of cash to shareholders via buybacks and dividends.

Kinder Morgan Canada needs a strategic plan to unlock value or accelerate growth. Look for a sale of the subsidiary or a take private to fold it back in.

The unloved business of carbon dioxide transportation continues to grow and has a very positive long-term outlook as carbon capture, EOR and use for plastics expand.

Richard Kinder continues to make significant insider buys of KMI shares.

In August 2017, I suggested that Kinder Morgan (NYSE:KMI) could double from the middle teens within about five years. I was roundly criticized. Now, more analysts are coming on board. About one-third of the journey has already been completed.

I still expect the stock to reach around $30 per share the next several years, as well as continue to provide income via dividends and potentially special dividends.

What Is The Plan With Kinder Morgan Canada?

The next phase for Kinder Morgan Canada (OTCPK:KMLGF) now that they've dumped their Trans Mountain pipeline expansion on the Canadian government is to continue to find a way forward, or over, or away.

The subsidiary, which Kinder Morgan owns 70% of, still regains a significant portion of the cash from the Trans Mountain sale - the rest paid to Kinder Morgan as a special dividend in January.

The company's assets lie in Western Canada and include terminals in Edmonton, the Cochin Pipeline and terminal in Vancouver. None of the assets are significant growth drivers.

Kinder Morgan is expected to announce a plan for their shares of KML. They could merge the company with another, sell it outright (optimal), take it private or leave it public.

Selling the company outright would allow Kinder to further improve its balance sheet and return more cash to shareholders. A merger might enable it to grow; however, that is a risky proposition that I don't believe the market would like.

I suspect a sale to Chevron (CVX) which uses parts of their capacity or a Canadian pipeline company is in the offing. Enbridge (ENB) makes some sense as they have substantial Canadian operations and would value the Cochin natural gas liquids capacity.

Kinder Morgan's second best choice if it can't fetch a price would appear to be to take the company private, keep Cochin and sell off the terminals. We'll see, there are no real bad options, just better.

Carbon Dioxide Is Ignored, But High On Potential

One of the biggest problems facing mankind is climate change. In order to prevent catastrophic impacts on the global climate, methods of reducing man's carbon footprint is required. Environmentalist demonstrators aren't the only ones who know this.

Billionaires, corporations, foundations and financial institutions are all on board with reducing man's carbon dioxide and methane output. And, there's the Paris Climate Accord for what that's currently worth, an agreement of over 190 nations that reducing man's carbon footprint is imperative.

Kinder Morgan is the largest transporter of carbon dioxide in America. It moves over 1.2 billion cubic feet of CO2 per day. Most of that is in the Permian Basin.

Because the Permian Basin is the source of most U.S. oil production growth and very significant natural gas output, Kinder Morgan has a golden opportunity to take part in reducing the impact of greenhouse gases in America's most important oil field.

Occidental Petroleum (OXY) is also taking the hint as they ramp up their EOR (enhanced oil recovery) activities and sequestration of carbon dioxide in underground reservoirs.

Kinder Morgan is using CO2 in their own EOR activities, as well as selling to other customers. A rumor persists that Kinder Morgan is trying to sell its CO2 unit for upwards of $5 billion. This is a misunderstood idea.

Kinder Morgan could very well be looking to sell its last oil fields where it engages in EOR. However, it is unlikely looking to sell its CO2 pipes. And, with their experience in EOR, it makes them a strong partner for companies engaged in EOR or looking to expand.

Expansion of EOR activities and sequestration of CO2 could become compelling from a regulatory standpoint in the 2020s. The Department of Energy is actively looking to expand EOR to more oil fields where it believes up to 60 billion barrels of oil could be produced. According to the IEA, over two-thirds of carbon capture and storage projects are associated with EOR.

In its most recent Investor Day presentation, the company identified the value of CO2 transport for mitigating climate change. The CO2 segment will generate over $400 million of free cash flow in 2019 with an internal rate of return of about 28%. EOR CO2 growth from 2018 to 2019 will be approximately 15%.

Kinder Morgan is identified as a leader in EOR and CO2 solutions along with Occidental, Chevron (CVX), ConocoPhillips (COP), Exxon Mobil (XOM) and Hess (HES) in a recent analysis by Global Info Research. The CO2 EOR growth rate is likely to exceed 19% through 2024, according to the EIA.

It Matters That Richard Kinder Is Buying Heavily

There are investors who blame Richard Kinder for the slump that Kinder Morgan shares have had the past several years. Nevermind the oil and gas crash. Nevermind a once-in-a-generation event. Reduce their dividend and you are the devil. Whatever.

Richard Kinder gets one dollar per year of pay from Kinder Morgan. No stock options, no grants and no bonus (I presume he gets health insurance, maybe a car and company paid transportation). That's a pretty thin payment for a chairman and co-founder.

How does he get paid then? Well, he buys Kinder Morgan shares. He's completely invested in the outcome of this company. Recently, he has bought over 3 million shares of Kinder Morgan with his own cash this year.

Kinder now owns directly or indirectly over a quarter billion shares of Kinder Morgan stock for about a 12% stake. That's about as aligned with shareholders as it gets.

Investor Thesis

Markets are relatively efficient most of the time. When there is an inefficiency, whether bullish or bearish, is where investors can make hay.

Consider the articles you have read on Kinder Morgan, how many have discussed Kinder Morgan Canada and the CO2 business? Very few, if any. If there is value to be had in Kinder Morgan, that's where it is, the underfollowed, unloved portion of the company. The rest is priced in.

The analysts that have started cheerleading recently are know-nothings who are regurgitating. Real analysis is understanding that parts of a company are not valued by the market right now or are dramatically overvalued.

In Kinder Morgan's case, the Canadian assets and CO2 business are getting almost no attention. I would submit that the Canadian subsidiary offers a one-time drop-down to the bottom line. The CO2 business is a legitimate growth driver that climate change deniers and superficial analysis ignore.

Richard Kinder who gets a buck a year of compensation obviously sees value somewhere. I'd bet it's the CO2, but the money to come from a Canada decision is good too.

I rate Kinder Morgan a buy and am buying more shares of Kinder Morgan after having taken some profits last autumn.

I am also selling cash-secured puts near the money a few months out, as well as buying a handful of short-term calls in case the stock really rallies on a bigger cash drop-down from Canada than folks expect or higher than forecast growth. I am also buying a few puts below the strike prices I am selling at.

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.

Additional disclosure: I am also engaged in options trades to generate income, enhance returns and hedge downside. --- I own a Registered Investment Advisor, Bluemound Asset Management, LLC, but publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.