The shares of midstream giant Kinder Morgan (NYSE:KMI) are up nearly 30% so far in 2019. Smaller peer Plains All American (NASDAQ:PAA), a master limited partnership, has seen its units rise by around 20%. These are heady gains when you consider that the first quarter isn't even over yet. Should investors jump aboard one or both of these rocketing midstream players, or is there something else afoot that you need to know?
Past performance is no guarantee
The past few months have been very good to Kinder Morgan and Plains All American. In fact, they've easily outdistanced peers like industry bellwether Enterprise Products Partners (NYSE:EPD), up around 15%, and super conservative Magellan Midstream Partners (NYSE:MMP), which advanced just 5% over the same span. But pull the camera back a little bit and the picture changes substantially.
Over the trailing-five-year period, all of these midstream players are down, but Enterprise and Magellan are down notably less. Go back 10 years and the divergence gets even wider, with Enterprise and Magellan up 30% and 110%, respectively, and Kinder Morgan and Plains All American down 36% and 23%, respectively. To some extent, the swift pickup at Kinder and Plains is just a case of two down-and-out midstream players making up lost ground.
But what happened that led to such disparity in performance? The quick answer is that both Kinder and Plains cut their disbursements. That, however, needs a little more examination.
The making of a cut
Kinder Morgan has long made more aggressive use of leverage than conservative peers like Enterprise. In late 2015, capital markets were tight and raising growth capital was difficult, especially for a heavily leveraged company. Management made the choice to cut the dividend a massive 75% at the start of 2016 so it could use that cash to help fund growth projects it had lined up. It was probably the right move for the company, but dividend investors relying on that dividend were shell-shocked.
Shell-shocked may sound like hyperbole, but in this case it really isn't. That's because just a month or so before the cut, Kinder Morgan's management team was telling investors to expect a dividend increase of as much as 10% in 2016. The cut blindsided investors.
Kinder Morgan is back to growing its dividend, but its debt-to-EBITDA ratio remains toward the high end of the industry. (Kinder, for reference, prefers to report adjusted debt to EBITDA, which paints a nicer picture.) Kinder is one of the largest and most diversified midstream companies. It has a runway for growth with $5.7 billion in capital projects lined up through 2022. And while it has been reducing leverage, there's still a very real trust issue here that is hard to swallow. That's doubly true with debt to EBITDA still notably higher than that of similarly sized peers like Enterprise, which didn't have to resort to a distribution cut.
Although Plains All American has notably reduced its leverage, debt played a similar role in the demise of the partnership's distribution. In 2016, Plains issued 245.5 million new units to its general partner to eliminate that entity's incentive distribution rights. Leverage at the time was relatively high, though not outlandish, but the extra units would require more cash to go out the door as distributions. With capital markets tight, management chose to trim the unitholder payment by roughly 21% so it could focus on debt reduction and continue to support its capital projects.
Unfortunately, industry conditions didn't improve and Plains cut its distribution again, about one year later, so it could continue to focus on debt reduction. The cut this time was more severe, at 45%. Between the two cuts, the total decrease was roughly 57%.
To be fair, Plains All American has notably reduced its leverage, bringing it down toward the low end of the industry. And it has roughly $1.1 billion in capital spending planned in 2019 to keep the partnership growing. It's likely that the distribution will start to head higher again at some point soon. However, the double cut is tough to swallow. Any investor who accepted the logic for the initial trim would have every right to be furious at the second cut, since it basically meant that management had badly misjudged its financial position and industry outlook. Meanwhile, similarly sized Magellan, with one of the most conservative balance sheets in the industry, managed through the same period increasing its distribution every quarter.
Getting better, but...
Both Kinder Morgan and Plains All American look set to have solid years in 2019. And while you can't live in the past, especially on Wall Street, you shouldn't forget it either. For most investors, there's no need to invest in a midstream name where there are trust issues. The midstream sector is large and there are plenty of options in the midstream space, including Enterprise and Magellan, that don't require taking that type of risk. In the end, neither Kinder nor Plains is worth buying if you have to worry about them backing their words with actions.