Last year, natural gas pipeline giant Kinder Morgan (NYSE:KMI) generated $4.48 billion, or $2 per share, of free cash flow. That's down fractionally from the $4.51 billion, or $2.02 per share, it pulled in during 2016. However, despite that relatively steady cash flow, Kinder Morgan's stock shed 12.7% of its value last year. In fact, shares have lost 55% of their value in the past three years even though cash flow has dipped only 6.5% from the peak.
As a result, Kinder Morgan currently trades at an unbelievable value these days compared with other pipeline companies. That disconnect makes it a no-brainer for value investors, since there's no reason it sells for as deep a discount as it does.
Digging into the math
After dipping again last year, Kinder Morgan's cash flow should start growing this year. It's on pace to hit $2.05 per share, or up about 2.5% from 2017. With shares recently selling for around $19 apiece, the stock trades at about 9.3 times free cash flow. That makes it the cheapest one in its peer group, where the average rival sells for around 12.1 times cash flow. In fact, some peers trade well above that level, with ONEOK (NYSE:OKE), for example, trading at more than 14 times cash flow. While ONEOK is on pace to grow faster than Kinder Morgan this year, that still doesn't justify the rock-bottom valuation, especially considering Kinder Morgan's improving financial metrics and growth prospects beyond 2018.
One of the things that had been weighing Kinder Morgan down in recent years was its debt. However, the company has reduced it by a nearly $6 billion since the end of 2015, which pushed its leverage ratio down from a worrisome 5.6 to a more comfortable 5.1. That puts it ahead of rival Enbridge (NYSE:ENB), for example, which is working to get its leverage down from around 5.6 at the end of last year to below 5 by the end of 2018. But even with the higher leverage ratio, Enbridge sells for about 11.2 times its expected free cash flow for 2018 -- though even that metric seems low, since Enbridge is on pace to increase cash flow per share 15% this year and at a 10% rate through 2020.
The calm before storming ahead
Investors are clearly willing to pay more for faster-growing pipeline companies. But while Kinder Morgan isn't growing as fast as its rivals this year, it does have plenty of growth coming down the pipeline. In 2018, for example, it expects to place $3.2 billion of growth projects into service, $2.9 billion of which are fee-based expansions, giving it a clear line of sight to generate an incremental $400 million of annual earnings. Meanwhile, it has another $8.9 billion of projects coming in behind those. In the company's estimate, its fee-based projects alone, which total $10.2 billion, should supply it with $1.6 billion of incremental annual earnings in the coming years, or 22% more than last year's total.
However, there's some concern about the company's ability to hit that target since its biggest growth driver is the controversial Trans Mountain Pipeline expansion. That $5.7 billion project is already a year behind schedule and now won't enter service until late 2020 at the earliest. That delay is one of the things weighing down Kinder Morgan's stock. However, it isn't the only pipeline company with uncertain growth prospects. Enbridge's largest project, the Line 3 Replacement, has run into opposition in Minnesota, which could delay its in-service date past the second half of 2019. Meanwhile, ONEOK hasn't yet secured all the capital projects needed to fuel its growth forecast, which would see the company boost its dividend at a 9% to 11% rate through 2020. In other words, investors are discounting Kinder Morgan's growth prospects, even though it's not the only one with hurdles to overcome.
Furthermore, Kinder Morgan has more growth potential than what's currently in its backlog. The North American energy industry needs to invest an estimated $26 billion per year in expanding its infrastructure through 2035, according to a recent study, with 60% of that spending directed toward gas-related projects. Given Kinder Morgan's industry-leading position, it should capture a significant share of these expansions. In fact, it just recently secured a $1.7 billion natural gas pipeline project. Meanwhile, it has a history of making acquisitions to fill in the gaps and fuel further growth. These two factors suggest the company has plenty of growth left in the tank.
It just doesn't make any sense
The market seems to have valued Kinder Morgan's stock as if it were a company in decline. However, that's clearly not the case, since cash flow has already started heading higher and should continue growing in the coming years. That leaves no logical reason why shares trade as cheaply as they do against rivals that have just as many questions as does Kinder Morgan. In fact, the discount to its peer group so confounds management that it's started buying back the stock in what it sees as a no-brainer move. Value investors, likewise, would be wise to consider following management's lead, since this stock is just too cheap to ignore.