Kinder Morgan (KMI -0.11%) currently offers investors a 6.2% dividend yield. In simple terms, that means the natural gas pipeline giant can turn a $1,000 investment into a $62 annual passive income stream. For comparison, that same $1,000 investment would only generate about $17 of annual passive income from an S&P 500 index fund, given its current 1.7% dividend yield.
The big driver of Kinder Morgan's much higher dividend yield is its dirt-cheap valuation. Add that to its other attractive qualities, and it's an excellent option for those seeking to generate passive income.
A bottom-of-the-barrel valuation
Kinder Morgan expects to produce about $2.17 per share of distributable cash flow (a proxy for free cash flow) in 2022. That's about 5% above its initial budget, thanks to stronger conditions in the oil and gas market because of higher prices.
With the pipeline company's share price recently around $18, Kinder Morgan trades at 8.3 times its cash flow, or a 12% free cash flow yield. That's a ridiculously cheap price. For perspective, the S&P 500's free cash flow yield is about 5%. In other words, if Kinder Morgan paid out all its free cash flow in dividends, the yield would be in the double digits. Meanwhile, if all the companies in the S&P 500 paid out their entire free cash flow through dividends, the payout wouldn't even be as high as Kinder Morgan's current yield.
Kinder Morgan doesn't pay out anywhere near its entire cash flow via dividends. The current dividend payout ratio is closer to 50%. That enables it to retain the other half to strengthen its already solid balance sheet, repurchase some of its dirt-cheap stock, and invest in growing its future cash flows. Kinder Morgan has already repurchased 16 million of its shares through mid-July at an average price of slightly more than $17 per share. Meanwhile, it's investing money to grow its natural gas pipeline business and expand into supporting the fuels of the future. Those investments will help it sustain and grow its cash flow in the future, giving it the fuel to maintain its dividend.
A sustainable (and growing) income stream
Kinder Morgan generates most of its income from long-term contracts, which supplies it with steady cash flow. Contract renewal rates have improved this year thanks to the current strength in the energy markets. That's positioning the company's legacy pipelines to grow their income in the coming years.
In addition to the upcoming income growth of its legacy assets, Kinder Morgan continues to invest a meaningful portion of its excess cash flow on expansion projects to help grow its future cash flows. Demand for natural gas should grow for years to come, driven by its cleaner emissions profile compared to coal and the growing global need to improve energy security. The company made a final investment decision to expand its Permian Highway Pipeline in June. That expanded capacity should be available next November and boost its income. It's one of several pipeline growth projects Kinder Morgan has under way.
Kinder Morgan is also expanding its operations to support other low-carbon fuels. For example, it's investing over $1 billion to build a renewable natural gas platform. It's constructing several plants to capture methane produced at landfills that it will sell to buyers under long-term contracts. These plants will also supply incremental cash flow when they come online over the next year.
The growing cash flow from higher contract rates and new projects should enable Kinder Morgan to continue growing its dividend. The company delivered its fifth straight annual dividend increase earlier this year.
Great income for a cheap price
Kinder Morgan trades for an absurdly cheap valuation these days, meaning investors can score a high-yielding dividend. That passive income stream should steadily rise in the coming years, fueled by higher contract rates and expansion projects. Those features make it an excellent option for those seeking to make some passive income.
