Kinder Morgan (KMI -0.64%) has one of the highest dividend yields in the S&P 500 at 7%. While payouts that high might seem suspect, the natural gas pipeline giant has worked hard to ensure it's sustainable. It has taken steps to enhance its financial profile while expanding into more sustainable energy markets.
These factors make Kinder Morgan look like a great stock for income-focused investors to buy and hold long term.
Fortifying the foundation
Kinder Morgan has always generated very stable cash flow. This year, roughly 67% of its earnings will come from take-or-pay contracts or hedging agreements, which lock in that revenue. Meanwhile, another 26% of its earnings come from fee-based contracts. While they have exposure to volume risk, it's paid a fixed fee regardless of energy prices. The final 7% are more volatile commodity-based earnings.
The pipeline giant pays slightly more than half of its stable cash flow to shareholders in dividends. That allows it to retain substantial cash flows to fund expansion projects, strengthen its balance sheet, and repurchase shares. The company anticipates producing about $400 million in excess free cash flow after paying dividends and funding its growth capital projects this year.
Kinder Morgan has used retained cash flows and asset sales to repay debt. It has cut its net debt by 19% since 2016. That has driven down its leverage ratio to 4.0 times, putting it below its 4.5 times target. The pipeline company's low leverage ratio gives it tremendous financial flexibility. Kinder Morgan estimates it has about $3.6 billion of balance sheet capacity.
The company's stable cash flows, conservative dividend payout ratio, and low leverage level put its dividend on a very sustainable foundation.
Growing into a more sustainable business
Kinder Morgan currently makes most of its money on hydrocarbons. The majority is from natural gas (62% of its earnings), while the rest comes from refined products (15%), terminal operations (15%), and carbon dioxide (11%, including enhanced oil recovery).
Its focus on cleaner-burning natural gas gives it an advantage. That lower-carbon fuel is replacing dirty coal in the power system. It also enhances renewable energy because gas can fill the gap during intermittency periods.
The energy infrastructure giant currently has a $3.7 billion backlog of secured expansion projects. About 80% of that spending is on lower-carbon projects, like natural gas, carbon capture and storage, renewable natural gas (RNG), and renewable fuels projects.
The company sees tremendous investment prospects in the transition to lower-carbon energy. That led it to form an energy transition ventures group to evaluate commercial opportunities. It has already built a growing RNG platform and started investing in carbon capture. It also sees the potential to invest in hydrogen in the future.
Kinder Morgan believes it's in an ideal position to capture future lower-carbon investment opportunities. It has a vast network of existing infrastructure that it could repurpose for lower-carbon energy. For example, it has connected its 10 RNG sites to its existing pipeline network. Meanwhile, it will transport captured carbon dioxide through existing pipelines.
Kinder Morgan believes it could eventually repurpose more assets to support lower-carbon fuels. Future projects will help sustain and grow its cash flow.
That would give the company more fuel to increase its dividend. It raised its payout by 2% earlier this year, its sixth straight year of dividend growth.
A rock-solid income stock
Kinder Morgan has taken the necessary steps to make its dividend more sustainable. It has cut debt to increase its financial flexibility while increasingly investing in lower-carbon projects. That makes it look like an excellent dividend stock to buy for what could be a lifetime of income.
