When Kinder Morgan (NYSE:KMI) rolled up all of its publicly traded entities under one umbrella in late 2014, it also unified its vision behind one goal: Grow the dividend. As such, its plan was to drive 10% compound dividend growth through at least 2020 by building out its massive backlog of primarily fee-based projects. That plan, however, needed a couple of things to remain constant in order for it to work, namely fairly steady commodity prices and wide-open capital markets.
Unfortunately, it hasn't gotten either over the past year, forcing it to reverse course. That's leading the company's founder and largest shareholder, Richard Kinder, to unveil a new way forward, which he did on the most recent quarterly conference call.
Built on a solid foundation
On the call, Kinder started by reminding investors of the foundation the company has built over the last several years. He noted:
Kinder Morgan's underlying business remains strong even in this challenging environment. Our year-end results turned out very consistent with what we projected to you in our third quarter call both from a DCF standpoint and a debt-to-EBITDA standpoint. This says to me that our fundamental businesses are doing well, notwithstanding the current weakness in our industry.
Kinder hammers home the point that its underlying business experienced relatively little impact from the current weakness in the oil and gas market. Because of that the company has continued to deliver financial results that are very close to its expectations. Despite that, Kinder lamented:
The fundamentals don't seem to matter in this 'Chicken Little, the sky is falling' market, but they should to prudent to long-term investors. We are a generator of a tremendous amount of free cash flow about $5 billion per year and that's after we've paid all of our operating cost, our interest expense and our sustaining CapEx.
Even though its underlying business is experiencing relatively minor impact from the oil market downturn, its stock price has been hammered by investors fearing the worst. It frustrates Kinder because his company should be a safe haven because it generates such robust cash flow.
From one purpose to a myriad of options
However, because investors have bailed on the company, and the midstream sector in general, Kinder Morgan has been forced to take an action it never expected it would have to do: Slash the dividend. However, in doing so, the company has opened up a new set of options for its prodigious cash flow. Its new strategy going forward will be focused on taking advantage of its best options for that cash flow, with Kinder noting that:
Now, there are several ways we can utilize that cash flow. We can de-lever the balance sheet and totally fund our growth capital needs and/or return cash to our shareholders through either increasing the dividend and/or buying back shares.
In other words, instead of focusing on returning the bulk of its cash flow to shareholders via the dividend, Kinder Morgan can choose between a number of competing options. Furthermore, this optionality also enables it to take a step back from its bold growth plans and only focus on its best capital project options, instead of pursing growth to meet an ambitious dividend growth target. Because of this, Kinder pointed out that:
We have significantly reduced our anticipated capital expansion expenditures for 2016... And that's a trend you can expect to continue as we high-grade our capital investments and selectively joint venture projects where appropriate. As we reduce those expenditures, we will obviously have more cash to continue to strengthen our balance sheet and return to our shareholders. Reducing the dividend was not an easy decision, but given the strength and sustainability of our business and the cash generated thereby, I believe as the largest shareholder, you will see Kinder Morgan emerge as a stronger company with a strengthened balance sheet, higher coverage on the dividends we pay, and with no need to access to equity markets for the foreseeable future.
With the company no longer solely focused on growing the dividend anymore, it's shifting its focus toward improving its returns, which means abandoning some projects that were only being built to help it meet its dividend target. Also, by increasing its flexibility, it can focus on creating the best total return for shareholders as opposed to relying on the dividend to drive returns. It's a plan that should provide a lot more long-term stability because it eliminates some of the external risk factors, such as its need to access the capital markets at attractive terms, that have been weighing its stock down lately.
When most companies significantly reduce their dividend, it's because their underlying business is under stress. That, however, wasn't the case at Kinder Morgan because its underlying business is strong. That strength has provided the company with flexibility that it now intends to use to choose among the best options to drive long-term returns for its investors.
Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of 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.