Natural gas pipeline giant Kinder Morgan (KMI +2.67%) recently reported third-quarter results. On the one hand, they weren't all that exciting since everything lined up with the company's guidance. That said, the boring stability of the company's underlying results reflect the beauty of its business model.
That predictability in the company's cash flow was the critical theme of founder Richard Kinder's opening remarks on the accompanying conference call. He noted that while the company has had three policies dictating how it used its cash flow in recent years, the one constant was that its income stream barely budged despite one of the worst downturns to hit the oil market in decades.
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While the oil market crashed, cash flow barely wavered
One of the highlights this quarter was that Kinder Morgan generated $1.055 billion in distributable cash flow (DCF). That was down slightly from the $1.081 billion it produced in the year-ago quarter, due in part to selling a 50% stake in Southern Natural Gas (SNG) to Southern Company (SO +1.42%) last year as well as some minor impacts from Hurricane Harvey. However, despite those items, DCF was right on target for the quarter, keeping the company on pace with its full-year DCF guidance.
In reflecting on those results, Kinder stated that "but once again the cash flow of KMI remains strong and demonstrates in my mind the strength and stability of the assets underpinning Kinder Morgan." He continued by reflecting back a bit further, noting that,
Now let me remind you that the segue into the fact that generating strong, sustainable and growing cash flow is our prime objective of Kinder Morgan. Until late 2015, after the collapse of oil prices occurred, our strategy was to distribute essentially all of that operating cash flow to our shareholders through dividends and to fund our expansion CapEx by issuing equity and debt in roughly equal increments. That approach worked through thick and thin for about 18 years, but it became prohibitively expensive with the events of the weakened energy markets after the oil collapse. And thus, in December 2015, we cut our dividend. That's the hardest decision we've ever had to make at our company.
To put Kinder Morgan's cash flow stability into perspective, in 2015 the company generated $2.14 per share in DCF. While the oil market downturn, the sale of a stake in SNG, and some other issues had some impact on cash flow, the company remains on pace to generate $1.99 per share in DCF this year, or just 7% less than the peak. So, while the company made the difficult decision to alter its dividend policy dramatically, that was due to the decline in capital market conditions, not cash flow.
The policy changed worked because our cash flow remained steady
Kinder then reminded investors of its capital allocation policy of the past two years and the impact that has had on its financial situation by saying that,
We changed our strategy and decided that going forward we would live within our cash flow funding our expansion CapEx and dividends entirely out that cash flow without needing to access capital markets for debt or equity except, of course, to roll over of long-term debt obligations. At the same time, we wanted to strengthen our investment-grade balance sheet and reduce our debt-to-EBITDA ratio to around 5x. How have we done in the seven quarters since we change our modus operandi? Well, we paid down approximately $5.9 billion in debt. Thereby strengthening our balance sheet and we paid for a fairly robust expansion program and all our dividends out of our cash flow.
As Kinder points out, thanks to the underlying stability of the company's cash flow, it was able to fully fund a meaningful growth program, pay a smaller dividend, and shore up its balance sheet. Further, that cash flow stability provided the company with time to patiently search out the best solutions for bolstering its financial position. A prime example of that was securing a joint venture with Southern Company in July of 2016. Not only did that transaction bring in $1.47 billion in cash and transfer half the system's debt to its partner, but Southern Company will finance 50% of the growth capital on SNG going forward.
Image source: Getty Images.
Because our plan worked and cash flow barely budged, we're ready to return more to investors
With its balance sheet back on solid ground, and its cash flow still steady, Kinder reminded investors of the most recent shift in how the company plans to use those funds. He noted that,
As a consequence, we announced on last quarter's call our future dividend policy, which calls for increasing the annual dividend from our current $0.50 to $0.80 in 2018, that's an increase of 60% and with further increases of 25% per year in 2019 and 2020, which results in $1 dividend in 2019 and $1.25 in 2020. In addition, our board authorized $2 billion in share repurchases during that three-year period, and we intend to continue to fund all expansion CapEx needs out of our cash flow.
As he points out, the company now expects to return more cash to investors each year through a rapidly rising dividend and share buyback program. At the same time, it also plans to continue fully funding expansion projects out of cash flow. This revised policy once again highlights the massive size and overall stability of Kinder Morgan's income stream.
The lone constant
Kinder Morgan has dramatically altered its capital allocation policy over the past few years as it has adjusted to changing market conditions. However, the one constant during this time has been its underlying cash flow, which has shown remarkable resilience. Because of that, the company plans to return a more generous portion of it to investors starting next year, while still fully funding growth. That will help insulate it from future market shocks, while still providing investors with a meaningful income stream.
