Get ready for some big numbers: The world's largest pipeline operator, Kinder Morgan (NYSE:KMI), just boosted its dividend by 60%. Yes, you read that right: sixty percent!
Sounds wonderful, until I tell you that in 2016, it cut its dividend by more than 75%, which knocked the share price down to historic lows.
Today, the company's stock is still trading near those lows, despite the dividend hike. Maybe Wall Street is just being cautious -- once bitten, twice shy, after all. But there also might be a good reason for the stock market's pessimism. Let's dig into this beaten-down energy industry giant and see if this is a value too good to pass up...or a sucker's bet.
It's party time
The last few years have been rocky for Kinder Morgan shareholders, thanks mostly to the aforementioned dividend cut. Of course, they've been rough for many pipeline operators, too: TransCanada shares, for example, are down 5.7% over the last three years, while Enbridge's have sunk 37% during the same period. But neither even comes close to Kinder Morgan's gut-wrenching 61% drop.
Kinder Morgan seems to be pulling out of the doldrums, though, aided by the U.S. petroleum production boom that's resulted in more traffic through its pipelines. More petroleum means more profits for Kinder Morgan and its peers, and Kinder Morgan's impressive Q1 2018 results seem to indicate the company is successfully executing its growth plans.
It managed to churn out 3% more distributable cash flow than in the year-ago quarter. That was driven by a 10% year-over-year increase in natural gas transportation volumes and a 7% year-over-year improvement in earnings from the company's carbon dioxide segment.
In addition, Kinder Morgan just managed to get itself untangled from the controversial Trans Mountain Expansion pipeline in Canada, which it sold to the Canadian government for 4.5 billion Canadian dollars. The on-again, off-again project had been weighing on the company's growth prospects. Kinder Morgan expects to net about $2 billion in cash from the transaction. That's on top of the $804 million in excess cash it generated in Q1, over and above its higher dividend obligations.
All in all, Kinder Morgan's recent performance paints a rosy picture for the company's near-term future.
The debt abides
With Kinder Morgan firing on all cylinders and raking in cash, it's easy for investors to overlook the company's balance sheet. And it seems like the company's management may be doing the same...at least for the time being.
When Kinder Morgan slashed its dividend back in 2016, one of the arguments was that the move would free up cash to allow the company to pay down some of its debt, which at the time was about 6.5 times EBITDA. The company did start to pay off some of its debt, but not very much of it. Back then, the company's total long-term debt was just under $44 billion, while today it's about $38 billion, or about 6.2 times EBITDA. That's much higher than the 5 times EBITDA that's generally considered the upper limit of acceptable. Sure enough, Moody's rates Kinder Morgan's credit as Baa3, just one level above junk.
The company's management, of course, would prefer you focus on the company's net debt-to-adjusted-EBITDA ratio, which is a much-more-palatable (but still high) 5.1. And when talking about possible uses for its cash, paying down debt is usually mentioned as only one of several options. Take this statement from company founder and Executive Chairman Richard Kinder on the Q1 2018 earnings call:
We can [fund] expansion CapEx or selective acquisitions, either of which helps us grow the company. We can use the funds to pay dividends to our shareholders. We can buy back shares or we can pay down our debt. In my judgment, any and all of these options create value for our shareholders.
It's completely understandable why the company would want to buy back shares as opposed to pay down debt: Kinder Morgan's shares look cheap right now. The company's enterprise value-to-EBITDA ratio is 12.1, lower than TransCanada's 12.9 or Enbridge's 23.9. Kinder hit the nail on the head later on the call when he said that there's "a weighing process between de-levering and buying back shares." And right now, the company's cheap valuation is tipping the scales toward buybacks. Since December, the company has repurchased $500 million in shares.
While the company's debt level is a long-term concern, and may indeed be weighing down the share price, there doesn't seem to be any immediate danger to shareholders from the threat of a credit downgrade or a cash crunch.
I'm a little concerned that despite all the good news coming out of Kinder Morgan -- increased dividend, improved performance, Trans Mountain sale -- the company's shares have continued to languish, sliding almost 10% so far in 2018. That's enough to make me wonder if the share price is ever going to appreciate, or if the market has effectively written off the stock. The silver lining, perhaps, is that TransCanada's and Enbridge's shares have had an even worse year, down 14% and 21%, respectively, so maybe it's not so much the company as the industry that's out of favor.
But given its cheap valuation, its new-and-improved dividend, and a continually improving North American energy production trend, Kinder Morgan still seems to have all the winning elements in place, and looks like a buy. The only question is when the market will decide to agree.