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People Are Scared Of Kinder Morgan - They Should Not Be

|Includes: Kinder Morgan, Inc. (KMI)

Original article here: http://bit.ly/1Q5AdT3

Crap hit the fan for Kinder Morgan (NYSE:KMI) during this year. The following charts show how badly the company's stock did over the last 52 weeks:

(Source: Bloomberg)

...And now let us look at its relative performance:

(Source: Bloomberg)

What is interesting about this stock is that it lost about 20% of its value just in the past TWO weeks! I think, most of us know what business the company is in. Just for refreshing of your memory, I will give you a short description:

Kinder Morgan, Inc. is the largest energy infrastructure company in North America. It owns an interest in or operates approximately 84,000 miles of pipelines and approximately 165 terminals. The company's pipelines transport natural gas, gasoline, crude oil, CO2 and other products, and its terminals store petroleum products and chemicals, and handle bulk materials like coal and petroleum coke. Kinder Morgan is the largest midstream and third largest energy company in North America.

(Source: corporate website)

It looks like people see the words "natural gas", "oil", "gasoline", think about "energy stocks" and panic every time Brent or WTI hit new lows and automatically transfer their perception on companies like Kinder Morgan:

(Source: NASDAQ)

While it is true that crude oil lost more than 55% this year only (currently trades at about $43 per barrel of Brent) and natural gas declined by over 50% in the last 18 months, we have to understand how these price developments actually impact the company's business. First, let us see how the company's revenue structure looks like:

(Source: KMI's November Presentation)

From the above picture we can see that almost two-thirds of cash flows are classified as "take-or-pay". This means that clients have to pay bills no matter if they use Kinder Morgan's services or not. Roughly one-quarter of cash flows is hedged. Only about 14% of total money streams is under pressure.

Now let us see how these assumptions have worked out in reality. We shall look at the company's latest quarterly statement:

(Source: Q3 Report)

The above data show that Kinder Morgan's sales declined by about 14% quarter-on-quarter and about 12% for the nine months ended. As we can see, digging into the income statement a bit deeper, the major weakness arises from natural gas sales, which are down by about 30% year-over-year. Service revenues are flat on a quarter-on-quarter basis and are up on a year-over-year basis (a 5% increase). Product sales also slided: ~(21%) q-o-q and ~(25%) y-o-y. Hence, what we can see is that the company's cash flows are not that immune from fluctuations in the energy markets.

When we look into the company's cash flow statement, we see that things are not as bad as they have been on the income statement:

(Source: Q3 Report)

Despite the fact that Kinder Morgan's net income is down by about 50% on a year-over-year basis, its cash flows from operations are actually up by about half a percent. If we go line-by-line through this section of the cash flow statement, we can find the reasons why OCF are up:

(1) There is a $500M+ add-back arising from losses on impairments and disposals of assets. This is neither good or bad. While losses on disposals are not cash outflows, they still give a dent to shareholders' money.

(2) A higher D&A expense (also added back because it is non-cash). The $200M+ positive impact on cash flows can be explained by the continual expansion of the company's asset based. Kinder Morgan is buying assets no matter if the "weather" is good or bad.

(3) Marginally better changes in net working capital (NWC): a $121M increase in NWC in 2015 vs. a $217M increase in NWC in 2014, respectively. The company saved about $100M this year on net working capital compared to the previous year mainly due to a decrease in accounts payable (+$304M) and a tax refund (+$195M).

Overall, I conclude that, despite the headwinds in sales, the company's cash flows from operations have been robust on a year-over-year basis.

Looking at the investing section of the statement, we see that the company is aggressively increasing capital expenditures:

(Source: Q3 Report)

In total, Kinder Morgan spent about $1.2B more this year on acquisitions and CapEx compared to the same period a year ago. In order to fund these activities (keep in mind that the company generated "only" $3.5B in operating cash flows this year - this does not cover the ~$3.9B investing bill), Kinder Morgan issued extra equity, totaling ~$3.8B. It also paid substantially more dividends this year, which drained the company's bank account. The aggressive increases in dividends (~14% annually - five-year average) are concerning to me, especially since the company's liquidity situation leaves much to be desired.

On the other hand, Kinder Morgan seems to maintain stable leverage ratios, despite the volatility in revenues and earnings:

(Source: KMI's November Presentation)

I also like the following statement from the recent press release:

KMI will construct its 2016 plan to maintain an investment grade rating with all three agencies. Further KMI does not plan to issue equity at current prices.

(Source: corporate website)

It looks like the company will not dilute shareholders' interests in its assets and will strive to manage debt more conservatively in 2016.

(Source: KMI's November Presentation)

The bottom line: undoubtedly, Kinder Morgan is a risky investment and the numbers have shown that the company's revenues and cash flows are not as immune to energy markets' fluctuations as previously thought. On the other hand, the company has a very diversified revenue base and has debt balance in check. Its leading position in its market niche gives is a competitive advantage. I believe that the negative factors are already reflected in the company's market price (maybe even "over-reflected"), and the stock is not attractive from the risk-reward standpoint. I also think that the market does not fully understand how Kinder Morgan differs from other energy companies and does not appreciate its strong dividend growth and the very high current yield (~11.5%!).

Hence, I rate the company's stock as a BUY and recommend investors to hold it forever.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.