Last month, Kinder Morgan (KMI -0.88%) finally put an end to the uncertainty surrounding the future of the Trans Mountain Pipeline expansion project by selling the entire system to the government of Canada for $3.5 billion. Not only does that sale remove a huge overhang, but it will significantly bolster the company's balance sheet in the near term, thus lifting another weight that has been holding shares down to a bottom-of-the-barrel valuation versus its peer group.
That proverbial killing of two birds with one stone is just what analysts have wanted to see from the company. As a result, several have already upgraded the stock, with Wells Fargo now rating it an outperform and setting a $20 price target while Bernstein recently joined it with that rating while upping the ante with a $22 price target. However, in both cases, the analysts thought the Trans Mountain sale was only the beginning of the transformative moves that the pipeline giant will make in the coming months.
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A sign of things to come?
In the Bernstein upgrade, the analyst stated that Kinder Morgan's decision to sell the Trans Mountain Pipeline might "finally be the start of something good" for the company. Driving that view is that the sale of the controversial system "could give them a path to outperformance." That's because it shows a willingness to make the necessary changes to transform into a stronger company for the long term.
The Bernstein analyst believes the sale sets the stage for the company to make other moves, including selling its enhanced oil recovery (EOR) business, jettisoning other noncore assets, and bringing Kinder Morgan Canada Limited (KML) back into the fold. Those moves would enable the company to reduce leverage from an elevated 5.1 times debt to EBITDA at the moment to a much more comfortable 4.5 times. Furthermore, it would eliminate the volatility of its oil production business, which has been hard hit by the oil market downturn. If the company made those moves, it could declare itself a safe, defensive, predictable, and financially strong midstream company, which is what it's supposed to be in the view of Bernstein.
This view matches that of Wells Fargo, which also thinks Kinder Morgan could have more catalysts on the horizon, including announcing a second gas pipeline in the Permian (which it did this week) and the sale of its EOR business to reduce debt and further stabilize cash flow.
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How likely are these moves?
Both analysts believe that one of Kinder Morgan's next moves will be to sell its carbon dioxide business. This segment consists of two parts: carbon dioxide source fields as well as associated pipelines and oil field in Texas' Permian Basin. The supply and transportation business is the largest of its kind in North America and contributes about 4% of the company's earnings. Meanwhile, the oil production business is the 13th largest in Texas, accounting for 2% of the state's output and contributes about 7% of the company's earnings.
There have been rumblings in the past that Kinder Morgan has considered selling its oil business. In late 2016, Forbes reported that the company was looking for a buyer so that it could reduce debt and was reportedly seeking more than $10 billion for the business. CEO Steve Kean commented on those rumors during the company's fourth-quarter conference call in early 2017, saying that while it would consider a sale of any business as long as it bolstered shareholder value, it was in no rush to sell a business that generates lots of cash.
The company continues to get questions about the future of this business. In responding to the strategic fit of the oil business, it said in a recent investor presentation that while it generates the highest returns and significant free cash flow, "as a shareholder-driven firm, we continuously evaluate all options to enhance shareholder value." In other words, for the right price, it could sell, though that doesn't seem to be a priority.
Another move many analysts would like to see the company make is buying back Kinder Morgan Canada Limited, which it just took public last year to finance the Trans Mountain Expansion. While that would simplify its corporate structure, CEO Steve Kean stated on last quarter's conference call that it's interested in acquiring midstream assets in Canada. It would have more flexibility to make deals if it used Kinder Morgan Canada's stock as an acquisition currency, which is why it might keep that entity public.
The future is bright even without further action
Analysts following Kinder Morgan are growing increasingly optimistic about the company's future following the sale of the Trans Mountain pipeline because they believe it's the first of several big moves. While Kinder Morgan could make additional changes, it doesn't have to since its current strategy built on organic growth and returning capital to investors has the potential to grow shareholder value in the coming years.
