As expected, Kinder Morgan (KMI -0.06%) announced this week that it plans to use the bulk of the proceeds it received from the sale of its controversial Trans Mountain Pipeline to repay debt. The decision will strengthen the company's balance sheet to such a degree that it should earn a credit rating upgrade further into investment-grade territory. That's a dramatic turnaround from the end of 2015 when the company was sliding down the slippery slope toward junk-rated credit.
Putting the proceeds to work
Kinder Morgan's Canadian subsidiary Kinder Morgan Canada Limited (KML) announced this week that it would return the bulk of the cash it received from the sale of the Trans Mountain Pipeline to investors. The Canadian government forked over 4.5 billion Canadian dollars ($3.4 billion as of Sept. 5, 2018) for the legacy pipeline and associated expansion project. After paying taxes on that amount, and retiring all its existing debt, Kinder Morgan Canada will return CA$1.2 billion ($910 million), or CA$11.40 per share ($8.65), in cash to investors in early 2019. Kinder Morgan will receive 70% of that money, or about $640 million.
Kinder Morgan will use that cash to repay debt. When added to the debt reduction at the Kinder Morgan Canada level, it will reduce the company's consolidated debt level by $2 billion. That will push the company's net debt-to-adjusted EBITDA ratio to around 4.6 times by year-end. That's well below the company's initial 5 times target, which is why Kinder Morgan will revise its long-term leverage target to around 4.5 times. Company President Kim Dang noted in the press release unveiling this new aim that "we expect that [lower leverage ratio] to be recognized by the ratings agencies," implying that they believe a credit rating upgrade is in order.
From a liability to an asset
Kinder Morgan's balance sheet has come a long way in the last few years. The company's financial situation had deteriorated along with the oil market in 2015, which caused credit rating agency Moody's to change its outlook on the company from stable to negative in early December of that year. The rating agency's concern stemmed from the company's decision to team up with Brookfield Infrastructure Partners to buy out their partners and take full control of the Natural Gas Pipeline Company of America. That deeply indebted pipeline company added more weight to Kinder Morgan's balance sheet at an inopportune time, putting the company on pace to end the year with a 5.9 times leverage ratio, which was high for an investment grade company.
The warning ultimately led Kinder Morgan to slash its dividend 75% and use those cash flows to fund capital spending and reduce debt. This decision helped ease Moody's concern, which changed its outlook back to stable. From there, Kinder Morgan would go on to sell several assets and secure funding from joint venture partners to give it some more breathing room. Overall, Kinder has now reduced its net debt by roughly $7.8 billion, which dropped its leverage ratio close to 4.5 times, potentially lining it up for an upgrade, especially since Moody's recently boosted its outlook to positive.
A higher credit rating would likely lower Kinder Morgan's borrowing costs, enabling the company to get cheaper rates when it refinances maturing debt as well as when issuing new bonds to finance expansion projects or acquisitions. Further, it will provide the company with greater financial flexibility, since the company no longer needs to fund 100% of capital spending with cash flow but could shift to a more balanced mix of 50% debt/equity for new capital projects. That could enable the company to invest in more expansion projects or return a greater percentage of its cash flow to shareholders through an expanded stock buyback program.
It's time for investors to wake up and take notice
Kinder Morgan has dramatically improved its financial situation over the past few years so that it now has a much stronger balance sheet. However, despite all this progress, shares of the pipeline giant are down more than 40% in the last three years even though cash flow per share is only 4% off the peak. Because of that, the stock is absurdly undervalued and could have 40% to 50% upside from here, making it one of the top stocks to buy right now.