Kinder Morgan (KMI +0.55%) has disappointed dividend investors in the past. The pipeline giant had hoped to maintain its lucrative dividend during the oil market downturn but capitulated as market conditions worsened, slashing its payout 75% toward the end of 2015. The company reallocated that cash to fund growth projects and improve its balance sheet, which was under pressure from the amount of debt it had taken on to finance expansion.
However, Kinder Morgan has come a long way since that time. As a result, its dividend is not only on the upswing but also safer than it has ever been. Now the company is an attractive option for income-seeking investors.
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Drilling down into the dividend
Kinder Morgan currently yields about 4.2%, which is double that of the average stock in the S&P 500. The company plans on increasing its payout by 25% this year, which is on top of the 60% increase it provided investors last year. Assuming the company goes through with that raise, Kinder Morgan's yield would improve to 5.2%. Meanwhile, the company expects a further 25% increase in 2020, implying a forward yield of 6.5%. Driving that dividend growth plan is the $5.7 billion of high-return expansion projects Kinder Morgan currently has under construction and a slight increase in its payout ratio.
The company's high-yield dividend is on a much firmer foundation than it was in 2015, before it reduced its payout. At that time, the company was paying out roughly 90% of its cash flow to support its dividend. While that was common practice in the pipeline industry, it proved to be too aggressive, as market conditions deteriorated since it didn't leave much margin of error, especially for financing expansion projects, which Kinder Morgan and its peers primarily funded by selling stock and issuing more debt.
However, with the company's leverage growing to an uncomfortable level of 5.9 times debt-to-EBITDA in late 2015, -- which had it on the verge of losing its treasured investment-grade credit rating -- and its stock price cratering, it became too costly to use those funding options to pay for growth projects. As a result, the company reduced its dividend, which gave it enough cash to finance its expansions.
Those metrics, however, have improved tremendously since that time. Kinder Morgan currently expects to produce $5 billion, or $2.20 per share, of cash flow in 2019. If we assume a 25% increase in the company's 2019 dividend to $1 per share, it implies that the pipeline giant is only paying out about 45% of its cash flow in dividends. That's a conservative level for a pipeline company, since most are comfortable with payout ratios in the 60% to 80% range these days.
As a result of its lower payout ratio, Kinder Morgan will retain roughly $2.7 billion in cash this year, which can cover all but $400 million of its $3.1 billion capital spending plan. The company can easily bridge that gap with incremental debt, since its leverage ratio had fallen all the way down to 4.6 times debt-to-EBITDA at the end of last year. In response, credit rating agencies recently rewarded Kinder Morgan by upgrading its credit rating further into investment-grade territory, which will make it easier and less expensive for the company to borrow money in the future.
Check out the latest Kinder Morgan earnings call transcript.
The verdict: Kinder Morgan's dividend is one of the safest in the sector
Kinder Morgan has gone from having a weak financial profile to one of the strongest in the pipeline industry, and now the company's dividend is on an increasingly secure foundation. That makes it an ideal choice for income-seeking investors who want a low-risk payout.
