Image source: Kinder Morgan Inc. 

While commodity prices were volatile during the second quarter, Kinder Morgan's (KMI 0.13%) earnings were unswayed. Overall, the natural gas pipeline giant's distributable cash flow as virtually flat at $1.050 billion, versus $1.095 billion in the year-ago quarter, while total segment earnings increased 4%. More importantly, the company made solid progress on debt and capital spending reductions through the announcement of several strategic transactions during the quarter. As a result, the company is inching closer to reaching its target leverage level, at which point it plans to begin returning more cash to shareholders.

Drilling down into the numbers

Aside from the impact low oil prices are having on its carbon dioxide segment, Kinder Morgan's underlying segment earnings continue to grow as expansion projects come online:

Data source: Kinder Morgan Inc.

Kinder Morgan's natural gas pipeline segment drove results this quarter. Not only did it produce more than half of the company's earnings, but it was also the biggest contributor to growth on an absolute basis. The expansion of the Tennessee Gas Pipeline and improved performance at the recently acquired Hiland midstream assets drove 4% segment earnings growth.

Several new additions, including two Jones Act Tankers entering service, fueled 5% earnings growth in the terminals segment, more than offsetting a $19 million impact from the bankruptcies of three coal customers. Meanwhile, higher volumes on the company's Kinder Morgan Crude and Condensate pipeline was a key factor driving the 6% growth in products pipelines earnings. Finally, robust demand for capacity on the company's Trans Mountain pipeline drove 8% earnings growth in its Canada segment, more than offsetting a 5% year-over-year decline in the Canadian dollar.

As mentioned, the only weak link was the carbon dioxide segment. This was due to lower oil-price realizations, as well as a 9% decrease in oil volumes as a result of reduced capex investments.

A look at the outlook

While Kinder Morgan's earnings remain relatively stable despite commodity-price volatility, the company still expects prices to have a negative impact on cash flow in 2016, even though oil is currently above its budget. That said, the company's outlook is unchanged from last quarter, when it guided that distributable cash flow would be about 4% below its $4.7 billion budget. 

It's worth noting that this outlook doesn't include the company's recently announced transaction with Southern Company (SO 0.23%). Under the terms of that deal, Kinder Morgan is selling a 50% stake in its Southern Natural Gas pipeline system to Southern Company for $1.47 billion, plus the assumption of half the system's debt. As a result, Kinder Morgan will hand over a 50% share in future cash flow that system generates to Southern.

While Kinder Morgan's outlook for cash flow remains unchanged, its outlook for its balance sheet has improved immensely, in part because of the Southern Company transaction. Because of that deal, and the sale of a 50% stake in its Utopia Pipeline project to a private-equity fund, the company expects its net debt-to-adjusted EBITDA ratio to end the year at 5.3, which is below its 5.5 target. That said, the company would like to get that number below 5.0 before returning additional cash to investors via dividend increases or stock buybacks.

Debt isn't the only number that continues to fall. The company also trimmed capex spending and its backlog again this quarter. Growth capex is now expected to be $2.8 billion in 2016, which is $500 million less than it anticipated last quarter. Meanwhile, the company noted that its project backlog declined from $14.1 billion as of the end of last quarter to $13.5 billion. That's partially due to removing half of the cost of the Utopia project and a reduction in the scope and cost estimates for a natural gas pipeline project. Meanwhile, the company placed a Jones Act Tanker into service during the quarter. Importantly, all of the remaining projects in the company's backlog, outside of those in its carbon dioxide segment, are expected to generate solid returns on capital.

Investor takeaway

Kinder Morgan's underlying earnings remained rock-solid during the second quarter, thanks to its robust portfolio of primarily fee-based assets. Meanwhile, the company made substantial progress to strengthen its balance sheet, causing its credit concerns to start fading away. But it still has some work to do before its leverage is below the targeted level to boost shareholder distributions.