After its equity value cratered last year, Kinder Morgan (KMI 2.20%) could no longer sell stock to raise the cash it needs to fund its project backlog. That left it with few options other than using internally generated cash flow to pay for these investments, which was only possible if it significantly reduced its dividend. That's the option it chose, setting its 2016 dividend 75% lower than what it paid last year. While that makes it highly unlikely that the dividend will head higher in 2016, there are a couple of scenarios that could enable the company to boost its payout above the current expectation.
Where things stand right now
When Kinder Morgan reduced its dividend from $0.51 a share each quarter to just $0.50 a share to be paid out over 2016, it did so because that was the rate it was comfortable paying given its projected capital requirements over the next few years. The company noted this in its press release announcing the dividend reduction:
Anticipates enough retained internally generated cash flow to fund all of the required equity contribution projected for 2016 and a significant portion of its debt requirements. The company has reviewed its expected investments in 2017 and 2018 and believes that its stable and growing internally generated cash flow will allow it to continue to fund the equity portion of its capital budget without the need to access the equity market.
What this switch means is that it went from one that was nearly completely reliant on the fickle capital markets to fund its growth to being almost entirely self-funding this year. Furthermore, it won't need to access the equity market until 2019 at the earliest, when it hopes that its stock price will have recovered to the point where issuing equity is accretive, not dilutive, to shareholders.
What needs to happen for the dividend to go higher
Having said all that, Kinder Morgan's outlook assumes that things stay status quo in 2016. There are, however, a few things that could happen that would enable Kinder Morgan to increase its dividend above its expectations. Topping that list is a rebound in the commodity market, which would deliver higher-than-expected cash flow from assets that are exposed to commodity prices. Last year this exposure resulted in Kinder Morgan's cash flow falling roughly $350 million under its initial budget, which was a small variance for a company that had expected to deliver roughly $5 billion in cash flow. If prices swing the other way, it would give the company a bit more cash that could be returned to investors.
Also, if commodity prices meaningfully rebound it would likely take its stock price higher. That could put issuing equity back on the table. If Kinder Morgan is able to issue equity in 2016, then it's possible that the company could then redirect more of its cash flow back to shareholders.
Image source: Kinder Morgan.
Finally, since its inception, more than half of Kinder Morgan's investment capital has been spent on acquisitions, including $6.5 billion last year. More often than not, these acquisitions are immediately accretive to the company's cash to pay dividends on a per share basis. What this suggests is that if Kinder Morgan can make meaningfully accretive acquisitions in 2016, it could then use that excess cash flow to fund a higher than expected dividend.
That said, Kinder Morgan no longer has unfettered access to capital so it likely needs to find a seller that would be willing to accept Kinder Morgan stock as currency. That's easier said than done for two reasons. First, Kinder Morgan believes its stock is significantly undervalued so it would need to buy a similarly undervalued asset and, second, while a number of midstream assets could be up for sale, many of these buyers, especially oil and gas producers, are seeking cash. That leaves troubled master limited partnerships or more complex cases as Kinder Morgan's most viable acquisition options.
A company like Summit Midstream Partners (SMLP +0.00%) could fit even if its private equity sponsor recently said that it wants to hold on to the upside it helped create. Summit Midstream Partners' sponsor said that the decision not to pursue a sale was based on its belief that Summit Midstream Partners' current unit price, which is down more than 50% over the past year, undervalues the future distribution potential of the partnership. That puts Summit on the same boat as a growing number of midstream companies that now have depressed equity values. These depressed values, however, could open the door for Kinder Morgan to seek an all-equity transaction with a seller that's looking for upside. A deal done at the right price should be immediately accretive to cash flow, enabling Kinder Morgan to boost its dividend.
Investor takeaway
Given where things stand right now, it doesn't appear that Kinder Morgan's dividend will be going higher in 2016. However, that's not to say it won't, because there are a couple of scenarios where the company could pay a modestly higher dividend than is currently expected. That said, investors shouldn't expect a return to the old days of a robust dividend that was projected to grow 10% annually.
