Kinder Morgan, Inc. (NYSE:KMI) is offering investors exciting dividend growth potential today. In fact, the most recent dividend increase was a massive 60%. And that's just the start. But dividends are only one part of the story. You need to take a look at what backs those dividends, which is why Kinder Morgan investors need to pay close attention to the pipeline giant's balance sheet.
Kinder Morgan's 60% dividend hike in April was the start of a three-year process that will see the company's dividend go from $0.50 per share per year to $1.25 a year in 2020. The next two years, then, should each see dividend increases of 25%. It's really an understatement to say that Kinder Morgan's dividend growth will be impressive. Using today's stock price, its yield will be roughly 7% once these dividend hikes are complete.
But yield and dividend growth are only two factors you need to consider here. When examining a dividend stock like Kinder Morgan, you also need to look at the business, dividend history, and financial foundation.
A deeper dive
Kinder Morgan is one of the largest pipeline companies in North America. Its assets span across the United States and reach into Canada and Mexico. There are only a small number of competitors -- like Enterprise Products Partners L.P. (NYSE:EPD) and TransCanada Corporation (NYSE:TRP) -- that can match the company's scale. Kinder is in a truly elite group of midstream giants.
Kinder's assets are largely fee-based, meaning that it has a stable business that can support high dividends. However, that's not unique in the midstream space. Its size, meanwhile, gives it an advantage in that it can take on projects and consummate acquisitions that smaller rivals would have difficulty affording. But there's a drawback here, because Kinder Morgan needs to make big moves to keep growing, small transactions and projects won't move the needle much. However, overall, there's nothing to fear about Kinder's business and, generally speaking, it runs its assets well. That said, after 2020, dividend increases are likely to slow down.
The bigger issue that investors need to watch is leverage. Kinder has long made more aggressive use of leverage than many of its peers, and it hasn't always worked out as well as hoped. For example, the pipeline giant cut its dividend in 2016, when access to capital markets was tight, using the cash freed up from the cut to continue funding growth projects. Many pipeline companies have had to cut dividends, too, but there are enough peers that weren't forced to trim their distributions that Kinder's decision to cut its payout by 75% stands out. Especially when you take into account the company's size within the industry. For reference, neither Enterprise nor TransCanada reduced their distributions.
There are two takeaways from this. First, Enterprise has always taken a more conservative approach, preferring to keep its debt-to-EBITDA ratio toward the low end of the industry. That provides a stronger foundation on which to build its business and pay distributions and is a better balance sheet approach for conservative investors. It's also increased its distribution for 21 consecutive years. TransCanada's leverage has been similar to that of Kinder Morgan over time, but it has handled its debt load better, with its streak of dividend increases now up to 18 years. In this case, there's more balance sheet risk but TransCanada has proven more capable of managing its leverage.
Kinder Morgan has a stated goal of reducing leverage. That's a good thing and should reduce the balance sheet risk involved here. But income investors shouldn't get so caught up in the dividend growth that they overlook the leverage issue or take that deleveraging promise at face value. Leverage has caused material problems before and could easily do so again if Kinder Morgan doesn't follow through on this promise.
Think before you buy Kinder Morgan
There's a big trust issue for income investors when it comes to Kinder Morgan. Although the best move for the business, choosing to cut the dividend in the face of adversity caused by a heavy use of leverage was a bitter pill to swallow for investors. And while the company's stated goal is to reduce leverage, debt to EBITDA is still toward the high end of the industry. If you are looking at Kinder Morgan, or own it, keep a close eye on the pipeline giant's balance sheet. If it doesn't live up to the promise of reducing leverage, the dividend may be riskier than you think.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.