Natural gas pipeline giant Kinder Morgan (NYSE:KMI) continues to take positive steps toward broadening its funding base and decreasing its debt. Its latest move was announced early this week when the company entered a strategic venture with leading utility Southern Company (NYSE:SO). That transaction positions Kinder Morgan to push its leverage ratio below its year-end target of 5.5 times debt to EBITDA. With the company making substantial progress to ease its credit concerns, investors can turn their attention to the possibility that it will start sending an increasing amount of cash in their direction.
Details on the deal
In its latest strategic transaction, Kinder Morgan is selling a 50% equity interest in the Southern Natural Gas pipeline system to Southern Company for $1.47 billion. In doing so, it will be sharing the earnings generated by the system's 7,600 miles of natural gas pipelines that connect supply basins in the South with end users in the region. However, the partners will also share the systems expansion costs, which is a major factor for Kinder Morgan. The pipeline giant has run into some trouble accessing funding during the energy market downturn, so this transaction will push half of the burden of funding this system's expansion over to Southern Company.
Aside from tapping another new funding source, the other critical component of this transaction is Kinder Morgan's plans for the proceeds. According to CEO Steve Kean, the company "plans to use all of the proceeds from this transaction to reduce debt at KMI." He added that, "This is another step toward achieving our stated goals of strengthening our balance sheet and positioning the company for long-term value creation." By using the cash proceeds to reduce debt, Kinder Morgan will be able to reduce net debt to such a degree that it will hit its year-end leverage target nearly six months early.
What this means for Kinder Morgan investors
Hitting this goal is critical for the company because it will have eased a major concern that had been weighing down its stock price. Also, with its leverage concerns abating, it will have more flexibility to use any additional excess cash for the benefit of shareholders. According to Kean, "the transaction significantly advances our effort to strengthen our balance sheet and move us closer to returning value to shareholders in the form of an increased dividend or stock repurchases."
That statement is music to the ears of income investors who saw their income stream cut by 75% late last year. It is a testament to the remarkable progress the company has made to pivot its funding strategy over the past few months. Through several strategic decisions, including project cancellations and a joint venture transaction, it has significantly reduced the amount of cash flow it needs to fund growth capex. Furthermore, with oil prices starting to improve, it is poised to generate more cash flow than initially expected. These factors, when combined with the debt reduction benefits of the Southern Company venture, position the company to start ramping up its cash distributions to investors much quicker than anticipated. As Kean hinted, it is increasingly possible that the pipeline giant will announce a plan to return more cash to shareholders in the very near future.
Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.