The broader energy sector can be volatile, but midstream companies like Kinder Morgan (KMI 2.53%) are supposed to be fairly consistent. That's because, in many cases, they get paid fees for transporting oil and natural gas -- so commodity price volatility isn't a big issue. But after a cut in 2016, investors should keep a close eye on Kinder Morgan's dividend-paying ability. Here are some key facts.
The background of the cut
Times were tough in the energy sector in 2016, and accessing capital markets for cash was difficult. With a heavy debt load, Kinder Morgan was forced to make a call between supporting its dividend or using that cash to make the long-term capital investments that would grow its business. The midstream giant made the right call for the company, but investors who had trusted it to be a reliable dividend payer were let down.
Image source: Getty Images.
That's where the big problem really comes in, because just a couple of months before the cut, management had told investors to expect a dividend increase of up to 10%. It would be completely understandable if more conservative investors chose to pass Kinder Morgan by because of this trust-destroying choice. For more aggressive types, however, Kinder Morgan has been working hard to regain investor trust. That's included dividend increases every year since 2018.
To be fair, the company had laid out an aggressive plan for its dividend after the cut, and it didn't actually live up to it. That's because the pandemic-led energy downturn in 2020 resulted in Kinder Morgan increasing its dividend by 5% instead of the 20% hike it had originally planned. But the reason for that change is notable: Management basically didn't want to find itself in the position of cutting the distribution again. Indeed, it was focused on the company's ongoing financial strength and dividend-paying ability.
Similar company but different
So where does Kinder Morgan sit today? In the third quarter of 2021, Kinder Morgan's distributable cash flow covered the dividend payment by 1.6 times. That's pretty strong coverage, and it provides ample room for adversity before the dividend would be at risk. To be fair, the dividend increase in 2021 was a very modest 3% or so. So dividend growth remains slow -- but given the clean-energy zeitgeist, that probably makes sense, and it clearly preserves the strength of the payment backing the company's generous 6.5% dividend yield.
EPD Financial Debt to EBITDA (TTM) data by YCharts
But what about the balance sheet, which was a big piece of the problem when the dividend got cut in 2016? The midstream giant's debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio isn't out of line with its closest peers. It's not the lowest in the grouping, but it's definitely not the highest, either. Perhaps more important is that the current level of around 5.1 is down materially from the peak of more than 9 it hit in 2016. To the company's credit, it recognized an important dividend safety issue and has taken material steps to address it.
KMI Financial Debt to EBITDA (TTM) data by YCharts
Kinder Morgan still has plans to invest in growth, with a $1.3 billion backlog of work that will take it through 2023. However, it is working on this with a much different financial foundation and a different perspective on the dividend. Essentially, dividend safety has increased in importance, and that shows through in the company's healthy dividend coverage ratio, recent prudence with dividend increases, and its more conservative balance sheet.
(Dividend) safety first
Kinder Morgan appears to have turned over a new leaf on the dividend front since the cut in 2016. That's very good news for income investors looking to find a high-yield option in the energy patch. Really conservative types with trust issues because of the 2016 cut (after the company had promised an increase) will probably never give Kinder Morgan a second chance. But those that can look to the future with an open mind may want to give it a closer look. The dividend does, indeed, look pretty safe today.
