Kinder Morgan (KMI -0.06%) offers investors a big-time dividend. The natural gas pipeline giant's current yield is around 6%, which is multiples above the 1.5% average dividend yield of stocks in the S&P 500. More often than not, a high dividend yield is a sign that the payout is at high risk of a reduction.
Here's a look at whether Kinder Morgan can support its big-time dividend.
Drilling down into Kinder Morgan's current dividend-paying capabilities
Kinder Morgan generates a lot of relatively predictable and stable cash flow. The natural gas pipeline company gets about 62% of its revenue from long-term take-or-pay contracts and hedging agreements, giving it a rock-solid foundation. Meanwhile, another 25% of its revenue comes from fee-based contracts that pay a fixed rate on the volumes flowing through its system. Only about 6% of its revenue has exposure to commodity price and volume fluctuations.
These contract structures provide Kinder Morgan with high visibility into its cash flow. For 2022, the company expects to generate about $4.7 billion in distributable cash flow (i.e., funds it could use to pay dividends).
After a 3% increase in the dividend payment, Kinder Morgan expects to distribute about $2.5 billion in dividends to investors in 2022. That implies a dividend payout ratio of 53%, which is very conservative for a company that generates lots of stable and predictable cash flow.
Kinder Morgan expects to invest about $1.3 billion of its excess distributable cash flow on expansion projects. That will leave it with around $900 million in spare cash. It can use those funds on other attractive investment opportunities as they emerge, or for share repurchases or debt repayment. So the company's dividend is clearly on a sustainable foundation right now.
Can Kinder Morgan's dividend stay on a sustainable footing?
Given the long-term nature of Kinder Morgan's contracts, the company maintains a solid cash flow foundation that can more than cover its current dividend outlay well into the future. Furthermore, the company noted on its first-quarter conference call that it's seeing continued improvement in renewal rates because of the strength in commodity prices over the past few months. And those higher prices are incentivizing producers to drill more wells to boost their volumes, benefiting Kinder Morgan's volume-sensitive fee-based cash flows. Because of all that, its underlying cash flows should continue rising in the near term.
Meanwhile, the company's investments in expansion projects should help grow its cash flow even more. Roughly 43% of its $1.4 billion in committed capital-project backlog will enter service next year, providing a boost to its 2023 cash flow.
The company is also starting to see new expansion opportunities emerge. Kinder Morgan noted on its conference call that Russia's invasion of Ukraine is providing its gas infrastructure business with more growth opportunities, including capacity expansions of its large Permian Basin pipelines. Meanwhile, its business in new energy ventures is working on new opportunities to support the transition to lower-carbon fuels.
The company has ample financial capacity to fund additional expansion projects. It's generating more than $2 billion in annual excess cash after paying the dividend. On top of that, it has a strong balance sheet with leverage currently below its target level. That's providing it with billions of dollars of additional investment capacity if the right opportunities emerge. These investments should help grow the company's cash flow in the future, giving it greater ability to support and grow the dividend.
One rock-solid dividend
Kinder Morgan is one example where high yield doesn't automatically mean high risk. Its dividend is on a very sustainable foundation. If anything, the recent spike in energy prices has enhanced the long-term sustainability because it's providing a boost to the company's ability to secure attractive renewal rates and expansion projects. These factors make Kinder Morgan an excellent dividend stock for those seeking a sustainable passive income stream.