Please ensure Javascript is enabled for purposes of website accessibility

Kinder Morgan Inc's Stock Could Have 40% to 50% Upside From Here

By Matthew DiLallo - Aug 29, 2018 at 9:18AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The natural gas pipeline giant remains extremely undervalued relative to its peers.

Kinder Morgan's (KMI 1.63%) stock is down nearly 60% from its peak in 2015, yet the company's cash flow per share has only declined about 4% from its all-time high. This means shares of the natural gas pipeline giant are significantly undervalued right now, especially compared to its peers, suggesting that the stock has substantial upside potential.

Ahead of the game, yet falling well behind the pack

Kinder Morgan has been an early adopter of many of the trends currently dominating the energy midstream sector. The company was one of the first to roll up all its master limited partnerships into one simplified corporate structure when it made a headline-grabbing announcement in 2014 that it's folding all its public entities under one umbrella in a $70 billion deal. In the years since, rivals Targa ResourcesONEOK, Williams Companies, and Enbridge have announced deals to consolidate into simplified single corporate entities.

In late 2015, Kinder Morgan was one of the early leaders in the shift away from the operating model of distributing all its cash flow to investors to a more sustainable one that balances cash returns to shareholders while internally financing a significant portion of growth-focused investments.

However, despite these pioneering moves, Kinder Morgan's stock has significantly underperformed its rivals:

KMI Chart

KMI data by YCharts.

Shares currently trade at less than nine times free cash flow. That's at the bottom of Kinder Morgan's peer group, where the average pipeline stock trades at 12.5 times free cash flow. That valuation discount implies that shares of Kinder Morgan are 40% to 50% undervalued compared to its peer group's.

The weights have all lifted

Two factors had weighed on Kinder Morgan's stock in recent years: its balance sheet and uncertain growth prospects. However, the company has unveiled a series of moves to address both issues.

A calculator and pen on top of $100 bills.

Image source: Getty Images.

One of the tipping points for Kinder Morgan came in late 2015 when its leverage ratio rose to a concerning level. Debt climbed to more than 5.8 times EBITDA, which put it on the brink of losing its crucial investment-grade credit rating. That forced the company to slash its dividend and redirect that cash toward capital expenses and debt reduction. The company also completed several joint ventures and asset sales to bring in money and funding for expansion projects. As a result, the leverage ratio stood at a much more comfortable 4.9 at the end of the second quarter.

That ratio appears poised to improve further after Kinder Morgan announced the sale of its controversial Trans Mountain Pipeline and the associated expansion project to the Government of Canada. The company expects to receive about $2 billion in proceeds from the sale, which it plans to use to repay debt. The company believes that this move could win it a credit rating upgrade, pushing it further into investment-grade territory. 

In addition to improving its balance sheet, that transaction also clarifies the company's growth prospects. With the controversial Trans Mountain pipeline expansion no longer in the fold, Kinder Morgan now has $6.3 billion of capital projects under construction, which should drive double-digit earnings growth over the next couple of years as they enter service. Meanwhile, the company is making quick progress on another major project that it could add to the backlog later this year.

With its balance sheet back on solid ground and visibility into future growth increasing, there's nothing left to hold Kinder Morgan's stock down. There don't appear to be any hindrances that could prevent the company from achieving its goal to increase its already attractive 4.45%-yielding dividend by another 25% in 2019 and 2020. That growth would boost the company's yield up to around 7% for investors who buy today.

Something must give

Despite all the turmoil in the oil market, Kinder Morgan's cash flow has barely budged off its peak. And even though the company has addressed investors' concerns, its shares remain significantly undervalued. At some point, the market is bound to realize that shares are just too cheap. But in the meantime, value-seekers have a chance to pick up this top-tier pipeline stock at a fantastic price, which would set them up to potentially earn a windfall profit in the future. 

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Kinder Morgan, Inc. Stock Quote
Kinder Morgan, Inc.
$19.94 (1.63%) $0.32

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.