The natural gas pipeline and storage industry has slowed down in recent years. Many players are prioritizing improvements to existing operations instead of growth capital expenditures (capex). Like its peers, industry-leading pipeline giant Kinder Morgan (KMI +0.34%) is focused on shoring up its balance sheet so that it can outlast future downturns. Financial health adds stability to Kinder Morgan's business, but the trade-off is that it requires preserving cash and spending less money, which impedes its ability to grow.
Investors on the hunt for fast-growing energy stocks probably won't like Kinder Morgan's slow and safe strategy. But their loss could be income investors' gain. What Kinder Morgan lacks in growth it makes up for with a dividend yield above 6%. The question is, can it support it? Let's take a look at Kinder Morgan's business to determine if its dividend yield is sustainable, or if it's bleeding the company dry of too much cash.
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Finding a balance
The challenge for many oil and gas companies is finding a balance among growth, financial health, and creating shareholder value through stock buybacks and dividend payments. Debt can increase a company's leverage and accelerate growth. But leverage cuts both ways, as too much debt can compound losses and could even leave a company prone to insolvency during downturns.
Kinder Morgan experienced the pitfalls of too much debt and too high of a dividend obligation firsthand when it was pressured to slash its dividend by 75% in late 2015. Since then, strengthening its balance sheet by reducing debt has been a key way to regain shareholder trust.
Debt reduction
Since the beginning of 2015, the company has reduced its net financial debt by 25%. Today, its debt-to-capital and financial debt-to-equity ratios are both at reasonable levels, indicating its financial structure is less reliant on debt than it used to be.
KMI Net Financial Debt (Quarterly) data by YCharts
Add it all up, and it's safe to say Kinder Morgan's balance sheet is in its best shape in five years. Management has reiterated its focus on reducing debt and maintaining a healthy balance sheet. The company has a long-term goal to maintain a debt-to-EBITDA ratio of 4.5. This target keeps the company accountable because it can only increase its debt proportionally to its earnings.
Reducing debt is all good and well so long as it doesn't interfere with running the business or paying dividends. Thanks in part to lower spending, Kinder Morgan has shown it can generate enough cash to run the business, pay down debt, and grow the dividend. Its quarterly dividend payout was just increased to $0.27 per share, which is more than double what it was paying in early 2018.
KMI Cash from Operations (Annual) data by YCharts
With cash flow from operations exceeding capex and dividend obligations, Kinder Morgan continues to demonstrate it can fund a high dividend payment with cash while decreasing its debt. This rare combination is a highly sought-after attribute that top-tier high-yield dividend stocks possess.
Risks worth considering
There are plenty of stocks that pay a higher dividend yield than Kinder Morgan. But many of those companies lack the financial health, industry-leading position, or consistent earnings that it has demonstrated over the last five years.
The two main downsides of investing in Kinder Morgan are the company's low growth and the threat that natural gas demand will stagnate or even decline over time.
A lot of the industry's growth is tied to liquefied natural gas (LNG) export projects. Kinder Morgan's dense pipeline network is set up nicely to transport gas to LNG terminals along the U.S. Gulf Coast. The Gulf Coast serves as the primary export market of LNG out of the U.S. to buyers in Europe and Asia. Aside from that, Kinder Morgan can grow by acquiring companies for good prices. Its recent acquisitions of Stagecoach Gas Services and Kinetrex Energy serve the dual purpose of improving its transitional business while also investing in alternative fuels like renewable natural gas.
Kinder Morgan is, at the end of the day, a natural gas company that faces its fair share of risks. However, natural gas has proved it can work with renewable energy sources as developed countries transition to a clean energy future.
Natural gas prices have rebounded nicely from the multidecade lows set in 2020, a year in which Kinder Morgan's business suffered only minor hits to its performance. The business climate has improved dramatically this year. The U.S. Department of Energy reported that natural gas prices in June were the highest in a summer month since 2014. Renewed strength in the natural gas market and a thriving U.S. economy bode well for Kinder Morgan.
A dividend investor's dream
Kinder Morgan has the means to grow its dividend while improving its financial position. During bull markets fueled by growth stocks, there's a good chance that the company could underperform the market. Therefore, buying its stock makes sense for folks looking for a stable return no matter what the stock market is doing, as well as for retirees looking to generate income without having to sell assets.
