I can see why investors looking to maximize the income they generate from their portfolios would like Kinder Morgan (KMI 3.46%). But I can also see some negatives associated with this stock, and that has kept me away from investing in this North American midstream giant.
Here's a quick look at some important positive and negative attributes of this investment so you can make a better decision about whether or not to buy Kinder Morgan for your portfolio.
Four good points about Kinder Morgan
First, investors looking for a high yield will likely find Kinder Morgan's roughly-6.6% dividend yield of notable interest. That's well above what you'd get from an ETF tied to the S&P 500 index. It's even a percentage point or two more than you'd get from a bank CD, which would be a largely risk-free income alternative. Moreover, the dividend doesn't come with the complication of a K-1 form, which you'd have to deal with if you bought a midstream company structured as a master limited partnership (MLP). MLPs are common in the pipeline niche of the energy sector, and they aren't a great fit for tax-advantaged retirement accounts because of their business structure.
Investors shouldn't look at dividend yield alone when making an investment decision, but Kinder Morgan's yield does stack up well against alternatives.
Image source: Getty Images.
The second point relates to one of the biggest concerns investors should have about dividends -- how well-supported they are. In Kinder Morgan's case, the answer is very well. In the fourth quarter of 2022, the company covered its distribution with distributable cash flow by a huge 1.9 times. For the full year, coverage was just shy of 2 times. That leaves ample leeway for future increases, and a lot of room for adversity before the dividend would need to be cut. In other words, Kinder Morgan's high yield looks very safe.
Third, the safety here is augmented by the company's largely fee-based business. While energy prices tend to be highly volatile over time, Kinder Morgan's top line is driven by fees that are paid for the use of its vital infrastructure assets. The value of what is flowing through its pipelines, storage, and transportation assets is much less important than the demand for those products. Even during oil price declines, demand tends to remain fairly strong given the importance of this energy source to the world economy. This is a fairly common attribute for midstream stocks, but the benefit shouldn't be ignored.
The final good point is the fact that the dividend has also been on an upward trajectory since 2018. That isn't nearly as long as some of the other options in the midstream space. However, given the strength of the distribution today, the annual increases are a sign that management is placing a high priority on prudently returning cash to investors.
Taken together, those are some very compelling reasons to invest in Kinder Morgan if you are a dividend investor looking to maximize the income your portfolio generates. But every investment comes with some warts, and Kinder Morgan's might be troubling enough to get you to consider other high-yield options.
The bad points about Kinder Morgan
Kinder Morgan cut its dividend in 2016. The haircut was a material 75%. The real problem with this cut is that, just a couple of months before, Kinder Morgan management was telling investors to expect a dividend increase of as much as 10%. In the end, the board had to make a choice between funding the dividend or using that cash to help invest in growth initiatives, including sizable capital investment projects.
Midstream companies own massive infrastructure assets that are expensive to build and buy, so they often tap the capital markets by issuing stock and debt. In 2016 the energy sector was facing headwinds, so equity sales weren't desirable. Meanwhile, Kinder Morgan has long made use of more leverage than many of its peers, so more debt wasn't desirable either. And thus dividend investors took it on the chin.
As noted above, the dividend is growing again. However, in mid-2017 Kinder Morgan laid out an aggressive plan for its dividend, including a huge 25% dividend hike in 2020. But when 2020 rolled around the energy sector was again dealing with material headwinds, thanks to a demand decline associated with global attempts to slow the spread of the coronavirus. The dividend was increased, but only 5%. While that was a prudent move, it was another example of Kinder Morgan overpromising and underdelivering for dividend investors. Notably, even after all of the dividend increases, the quarterly payment even now is still well below its pre-cut level.
As already highlighted, Kinder Morgan has historically made greater use of leverage than many of its peers. That was a key reason for the 2016 dividend cut. Although the dividend is very well covered today, the leverage picture relative to peers hasn't really changed. That means there's more financial risk here than at similarly sized peers, like Enterprise Products Partners (EPD 1.41%), with less leveraged balance sheets.
KMI Financial Debt to EBITDA (TTM) data by YCharts
While not specific to Kinder Morgan, the domestic midstream sector is mature. Most of the really good investment opportunities are in the past after years of aggressive industry growth. So Kinder Morgan doesn't really have huge growth prospects as a company, and dividend increases from here are likely to be modest. Basically, the high yield is probably going to represent the lion's share of your returns. That means the more secure the dividend you collect from a midstream company is, the better off you'll be -- which further highlights the leverage issue referenced above.
As most investors know, past returns aren't an indication of future performance. And notably, Kinder Morgan is in a much better place today than it was in 2016. However, if you look at total return, which assumes the reinvestment of dividends, this stock badly lags its closest peers, including Enterprise Products Partners (an MLP) and Enbridge (ENB 2.83%), which is based out of Canada.
The dividend cut was a big reason behind this lag since it meant that dividend reinvestment was less beneficial right when Kinder Morgan's stock price was low. Neither Enterprise nor Enbridge had to cut their disbursements.
From a big-picture perspective, however, the story here could be viewed as Kinder Morgan making bad capital allocation choices, which lead to weaker overall performance for shareholders. And while it looks like management is being more prudent today, the relatively aggressive use of leverage suggests that investors are best off remaining cautious. Sure, the past is in the past, but the backstory at Kinder Morgan doesn't paint a particularly compelling picture for the future if management hasn't materially changed its business approach.
KMI Total Return Price data by YCharts
If you consider all of the bad points here, Kinder Morgan doesn't look all that compelling anymore. The problem, as with most investments, is weighing the good against the bad.
Kinder Morgan stock is not for me
The 2016 dividend cut was enough to put me off of Kinder Morgan forever. When it comes to investing, trust is just too important to me. However, I can see how investors looking for dividend income might be interested in the stock and its generous yield today.
Before you buy, you need to consider both the good and bad. When you do that, I think the risk/reward profile is still tilted in the wrong direction for most investors. All in, I wouldn't tell you buying Kinder Morgan is an egregious mistake, but truly risk-averse dividend investors should probably still pass it by.
