Kinder Morgan (NYSE:KMI) typically has greater visibility into the future than most companies. That's because it generates the bulk of its earnings from fee-based contracts and usually has a large backlog of fee-based expansion projects in development, which gives it a good idea of what it will earn in five years.
However, the company's current five-year outlook is cloudier than normal because the largest project in its backlog faces intense opposition. Because of that, the company could go in two entirely different directions over the next five years, though both should take it to the same destination.
Route one: Kinder Morgan builds Trans Mountain
Kinder Morgan's portfolio of pipelines, storage terminals, and legacy oil assets generate very predictable cash flow thanks to long-term fee-based contracts and hedging agreements. For 2018, these assets should produce $7.5 billion in EBITDA and $4.57 billion, or $2.05 per share, in distributable cash flow (DCF), which would be about 4.5% higher for EBITDA and a 3% improvement for DCF over 2017.
Kinder Morgan believes its EBITDA could top $9 billion in five years -- a more than 20% increase -- if everything goes according to plan. Fueling that outlook is the more than $10 billion of fee-based expansion projects the company has in its backlog. That growing revenue stream leads the company to believe it can increase its dividend by 25% in both 2019 and 2020, with further growth likely beyond that timeframe, though probably at a more moderate pace.
This forecast assumes that the company's Canadian subsidiary, Kinder Morgan Canada Limited (TSX:KML), does indeed start construction on its Trans Mountain Pipeline expansion later this year. Doing so would put that line in service by late 2020 and add about $860 million of annual earnings starting in 2021. This outlook doesn't assume any acquisitions or additional expansion projects.
By taking this route, Kinder Morgan can grow its earnings by at least 20% over the next five years, which is a conservative estimate since the company should have no problem securing other opportunities to expand its energy infrastructure empire.
Route two: Kinder Morgan uses the same vehicle to grow another way
The main problem with that path is that Trans Mountain faces a significant obstacle in the form of intense opposition. Because of that, Kinder Morgan recently warned that it could abandon that project if it can't resolve two key issues by the end of May. If that deadline passes without an agreement, roughly half of the company's future growth could go out the window.
While that would be a tough blow, it wouldn't be the end of the world because the company can pursue an alternative route that could offset much of the impact. A centerpiece of that plan would be using Kinder Morgan Canada as an acquisition vehicle to expand in the country. CEO Steve Kean made it clear on the company's first quarter conference call that Kinder Morgan wants to continue investing in Canada even if it abandons the Trans Mountain Pipeline expansion. He stated that the company is interested in acquiring midstream assets in Western Canada, noting that, "it's not a large group of players there, but there are some very capable players with good midstream assets."
Given that view, we can expect Kinder Morgan Canada to use its debt-free balance sheet to gobble up assets in the region so it can offset some of the lost income from Trans Mountain. While the company wouldn't get as much bang for its buck since expansion projects tend to generate higher returns than acquisitions, it could come close. To put numbers behind it, Trans Mountain should earn an EBITDA multiple of 6.6 times, while most M&A multiples are in the eight to 12 times range. Splitting the difference, a similar investment could produce roughly $600 million in annual earnings.
The company has several ways to make up the shortfall, including more aggressively pursuing expansion opportunities in the U.S. In fact, Kinder Morgan has already added $900 million of expansion projects to its backlog this year at even higher EBITDA multiples than Trans Mountain, at around six times. On top of continuing to develop expansions internally, the company could partner with other pipeline companies on projects they initiated.
There's also a growing need within the industry to consolidate. While it would be hard for Kinder Morgan to use its stock to make acquisitions given how cheap it is these days, the company could focus on smaller assets it can buy with cash.
While this alternative route probably won't yield the same $860 million of annual earnings on a $5.7 billion investment as the company can earn from completing Trans Mountain, it could come close.
Two ways to the same destination
No matter the path it takes, Kinder Morgan will likely produce significantly more cash flow in five years than it does today. That money is vitally important to investors because it allows the company to increase the dividend, buy back stock, pay down debt, invest in growth projects, and make acquisitions. "Any and all of these options create value for our shareholders," according to founder Richard Kinder, suggesting that the company should be even more valuable in five years than it is today.