Over the past several weeks, Kinder Morgan Inc.'s (NYSE:KMI) stock has been hammered as it's down 32% from its recent peak. This drop is having an inverse impact on the company's dividend yield, which as the following chart shows has increased to more than 6% for investors buying today.
That's a pretty compelling yield to say the least. The question is if it's too good to pass up or if it's simply too good to be true.
It's all about the cash flow
The oil market downturn has had a big impact on energy-related dividends over the past year with several being cut or suspended. The reason for this is quite simple: Lower oil and gas prices mean lower cash flow for companies directly exposed to commodity prices. That being said, not all energy-related cash flows are being affected by the weakness in commodity prices as companies with long-term fee-based contracts or a strong hedge position aren't seeing their cash flows affected all that much. Kinder Morgan is among that second group as 96% of its cash flow is either fee-based or hedged.
Even better is the type of fee-based cash flow the company generates. As the following slide notes, 65% of its cash flow is based on take-or-pay contracts.
What this means is that Kinder Morgan gets paid whether its customers use its pipelines or terminals. In a sense, it's as if the company's customers signed a long-term lease and will pay rent each month even if they had to move back in with their parents because they can't pay for utilities and food. Meanwhile, the rest of the company's fee-based cash flows are pretty solid even if there is some commodity price exposure.
In fact, Kinder Morgan's overall exposure to commodity prices is just a couple hundred million dollars. While that might sound like a lot, it's not much more than a rounding error on the company's $8.2 billion in projected segment earnings. We can see the full extent of its commodity price exposure on the following slide:
As that slide notes, the company's budget projections this year were based on $70 oil and $3.80 gas, which turned out to be quite optimistic. That said, even at the current price point closer to $40 oil and $2.50 gas, the company will generate more than $300 million in excess cash flow after paying out its dividend.
Verdict: Too good to pass up
In other words, its current dividend isn't in any risk. Instead, it will most definitely keep going higher as the company still expects to be able to grow its dividend by 10% per year through 2020 while still generating substantial excess cash flow. This growth projection is based on its current backlog of projects, which are 90% fee-based and already secured by commercial contracts. There's plenty of upside beyond these projects from acquisitions as well as additional projects the company develops.
One thing that is important to note here is the fact that a growing portion of Kinder Morgan's backlog isn't based on supply growth, which is tougher in a lower commodity price environment. Instead, more growth will be coming from demand-driven projects as lower prices fuel incremental demand. For example, low natural gas prices are fueling investments in petrochemical plants and natural gas-fired power-generation facilities while lower oil prices have the potential to fuel increased demand for refined petroleum products in the U.S. Because of these trends, demand-pull projects are expected to drive a growing portion of the company's growth in the years ahead.
The bottom line is that Kinder Morgan looks like a real bargain right here. While there could be more downside as the market could remain irrational for quite some time, Kinder Morgan's cash flow is only expected to grow. That'll fuel double-digit dividend growth for years to come, which will really add up over the long term.
Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2016 $32.5 puts and long January 2016 $32.5 calls. The Motley Fool owns and recommends Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.