Midstream oil and gas giant Kinder Morgan, Inc. (NYSE:KMI) has announced plans to increase its dividend by an average of around 25% a year between 2018 and 2020. At first blush, that's a pretty incredible announcement, until you step back and take a look at what's actually going on: Kinder is working the dividend back from a massive 75% cut in 2016. With dividend growth back on the table, you might think that everything is fine, but that's not exactly true. Here's the simple reason I won't buy Kinder Morgan.
How we got here
The dividend cut was really about access to capital to help fund Kinder's growth spending. Oil prices were low, selling stock wasn't a great option, and the company already had a lot of debt on its balance sheet. That left cutting the dividend to free up capital, which was probably the right move.
To be honest, that cut left a bad taste in my mouth since management had been promising dividend hikes just a month or so before announcing it. It even professed a dedication to "continue to return cash to [its] shareholders in increasing amounts." So I have trust issues when it comes to Kinder's management team.
However, leverage was a clear problem. For example, debt-to-EBITDA levels at the midstream player had skyrocketed from around 5.5 times in late 2014 to around nine times by the end of 2016, when the cut was announced. It peaked at over 9.5 times in early 2017. In other words, I can see why management made the decision it did -- I just don't like the flip-flop on the dividend.
But here's a bigger question for you, assuming you can forgive the dividend cut: How much progress has been made on the leverage front?
Where we are now
Kinder's long-term debt stood at around $40 billion at the end of 2014, up around 30% from the prior year. It peaked at roughly $42.4 billion at the end of 2015. This was when debt to EBITDA was spiking. But it wasn't just about a rising debt level -- falling oil prices were also pushing Kinder's EBITDA lower. This was partly driven by a business that provides carbon dioxide used to enhance oil extraction from mature wells; this division of Kinder actually owns interests in oil assets, so oil's troubles directly hit its top- and bottom-lines.
Kinder's EBITDA improved notably toward the end of 2017, so things are starting to look a little better on that front as new assets come on line. And debt has come down as well, with the company selling assets and spinning off a stake in its Canadian business to help reduce leverage. At the end of the third quarter, long-term debt stood at around $34 billion, down over 17% from its peak. Progress has clearly been made.
But when you look at the debt-to-EBITDA figure, that number is still nearly 6.5 times, which compares to equally large and diversified peer Enterprise Products Partners' (NYSE:EPD) roughly 4.5 times and superconservative Magellan Midstream Partners' (NYSE:MMP) 3.5 times.
In fact, Kinder Morgan generally uses more leverage than its peers, as the chart above shows. The company's goal is to keep reducing leverage, but it's unlikely to radically change its business approach on the leverage front relative to peers. Yes, Kinder has done a great deal to reduce its debt and improve its debt-to-EBITDA metrics from what were obviously dangerous levels. However, in a very important way, it still hasn't changed its approach all that much. Note that Enterprise has increased its distribution every year for 20 years running, with Magellan's streak at 17 years. For income investors, being conservative clearly has its benefits if you want to avoid dividend cuts.
Kinder's dividend cut is a good example of what can happen when leverage gets out of hand. After that experience, I think most income investors would be better off focusing on more conservatively financed pipeline players, like Enterprise or Magellan. Kinder just hasn't changed its leverage approach enough for me to think that the dividend is safe from another reduction if times get tough again.