Kinder Morgan: Don't Feel Kindered
- Kinder Morgan released its first quarter results, showing a solid performance.
- The dividend was increased, although not by as much as originally planned.
- Shares continue to look attractive.
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Kinder Morgan (NYSE:KMI) has announced a dividend increase for 2020, although it was a smaller hike compared to what management had guided for in the past. The current crisis and its unprecedented impact on global energy markets were not foreseeable for management, though, which is why investors can't really blame management for the smaller-than-forecasted dividend increase too much.
Kinder Morgan is seeing a negative impact from the oil price crash, but the company is well-positioned to weather the current storm. Its balance sheet will not suffer too much, and a recovery of oil markets during the second half of the year should help bring Kinder Morgan's ability to generate strong cash flows back to pre-crisis levels in the not too distant future.
Source: Seeking Alpha's image bank
Kinder Morgan's First Quarter Results And The Impact Of Low Oil Prices
A month ago with Kinder Morgan at $13.40, we penned the article No More Kindering. The firm is now priced 9% higher, and, more importantly, it has released one of the first earnings reports and conference calls in the midstream sector. We therefore thought it would be worthy of reviewing. We are not only looking at whether Kinder Morgan is still a buy, but also for what clues it might give us regarding the rest of the midstream sector. Source: Stock Rover
Kinder Morgan primarily is a natural gas pipeline company that has fee-based contracts, thus, the majority of its business is not dependent on what oil prices and oil consumption look like. There are, however, also business units that are impacted by oil consumption and commodity prices, primarily its CO2 segment and its refined products segment.
Through the impact that lower oil consumption and lower oil prices have on these segments, Kinder Morgan did see a hit to its first quarter results that stemmed from the coronavirus crisis and the failure of OPEC+ to find an agreement. Together, these two macro factors have resulted in substantially lower oil prices, while consumption declined as well, as people stayed home more, while business and personal travel froze.
During the first quarter, Kinder Morgan generated revenues of $3.1 billion, which was down 9% year over year. A single-digit revenue decline during the worst oil price decline in recent memory is not disastrous at all, and many oil-related companies would wish to report a decline this small. Yet, Kinder Morgan still felt an impact from the oil price crash, which also resulted in lower profits and cash generation. Source: Kinder Morgan presentation
We see that Kinder Morgan's first quarter EBITDA was down from the previous quarter, which had set a record for the company, and EBITDA also was down on a year-over-year basis. The decline, however, was not overly large, and all in all the first quarter still can be described as a solid quarter compared to the EBITDA that Kinder Morgan had been generating on a quarterly basis during the last five years.
First quarter distributable cash flows (operating cash flows minus maintenance capital expenditures) totaled $1.26 billion, down 8% year over year. Again, the oil price crash did have an impact, but a decline in the single digits during an unprecedented crisis still shows that the business is, overall, rather resilient. Many other companies from both the midstream industry (AMLP) as well as from the oil industry (XLE) will see their cash flows evaporate completely during this crisis. Compared to that, a small decline like the one that Kinder Morgan has reported is not disastrous at all.
The Macro Picture Remains Favorable
During the current crisis, some industries are hit way harder than others. Oil, automobiles, travel are hit very hard, whereas other industries are not as cyclical and more resilient versus recessions. The natural gas industry, which is the most important customer for Kinder Morgan by far, luckily is a rather resilient industry: What continues to remain apparent is the overall volume of natural gas demand is not declining significantly. The following chart shows that natural gas demand didn’t decline during the Great Recession and even increased slightly during the 2015 oil price shock.
Source: Energy Information Administration
Likewise, natural gas volume demand is unlikely to decrease a lot due to coronavirus-caused shutdowns and the current oil price war. This is because the main uses of natural gas - electricity production, heating, cooking, and even some major industrial uses such as fertilizer manufacture - continue even as everyone stays at home and practices social distancing. Some uses (such as to make plastic) may decline, but the continued ramp of natural gas for electricity production and export should make up for that.
Source: Energy Information Administration
There are currently even 5 Liquified Natural Gas carriers on the water transporting LNG from the US to China. These are the first LNG ships from the US to offload in China in more than a year. These exports should help keep the demand for natural gas high during the current recession. This helps Kinder Morgan's customers, which, in turn, is positive for the pipeline company. Kinder Morgan even specified that natural gas transportation volumes have increased during the current crisis, as volumes rose by 8% through the first quarter. The macro environment for Kinder Morgan's main business is thus not bad at all, and investors can count on ongoing solid cash generation by the company. A meaningful portion of the cash that Kinder Morgan generates gets paid out to investors via dividends, which gets us to the next subject - Kinder Morgan's dividend increase.
Kinder Morgan's Dividend Increase Was Not As Large As Originally Planned
Kinder Morgan hiked its dividend by 5% when it announced its earnings, which was not as much as the 25% dividend increase that management had guided for in the past. On the other hand, the combination of the current oil price slump and the coronavirus crisis could not have been foreseen by management, thus, one could argue that management was free to adjust plans to weather this unprecedented crisis.
When we look at the comment stream here on Seeking Alpha, we see that most investors seem to agree that the current environment justifies that management's original plans are being amended. Most investors seem fine with the 5% hike, and there are not a lot of investors that feel tricked or "kindered."
When we look at what management says, the dividend increase to $1.25 has basically been pushed into the future:
Management states that for the current quarter, the dividend gets raised by only 5%, but they still plan to increase the payout to the $1.25 that was originally planned at a later point in time. This decision could be made in January 2021, i.e. nine months later than originally planned.
One could argue that management did not meet its original targets that were laid out in 2017. But due to the fact that the current crisis was impossible to foresee, coupled with the fact that the dividend hike will (most likely) happen just nine months later than planned, most investors, including us, seem to be okay with this decision.
Kinder Morgan's shares trade for $14.50 right now, which means that the current dividend yield is 7.2% based on a payout of $1.05 per share per year. Once the dividend has been raised to the original target of $1.25, the yield on cost for someone that buys right here is 8.6%.
Those are rather attractive dividend yields for a large infrastructure company that holds irreplaceable assets, that has a solid balance sheet, and that easily covers the dividend with a payout ratio of just around 50%. On top of that, there is no K-1 with Kinder Morgan, which makes it an even less complicated investment compared to some other large pipeline companies.
Even if an investor wants to be conservative and assumes that the dividend increase to $1.25 annually is not at all a sure thing, Kinder Morgan looks rather compelling at the current price. A dividend yield of more than 7% that has just increased its dividend by 5% during one of the largest economic crisis of our lifetimes is nothing to sneeze at.
Kinder Morgan is a rather defensive investment, as its main business, the transportation of natural gas, is not very cyclical. Adjacent businesses such as the CO2 segment are seeing some headwinds from low oil prices, but Kinder Morgan still managed to generate solid results during the first quarter.
There is little risk that things will be much worse in Q2, and management also seems confident, having just raised the dividend during this crisis. The dividend increase was not as large as originally planned, but due to the fact that the hike to $1.25 per year has only been pushed to the future, we don't see this as a reason to feel betrayed by management. The fact that they raised the dividend at all during a time when many other companies are cutting their payouts deserves respect.
Kinder Morgan's shares are inexpensive, trading for around 7 times annual distributable cash flows, and the dividend that yields more than 7% looks quite attractive right here.
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