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3 Reasons to Love Kinder Morgan

By Jay Yao – Mar 23, 2016 at 9:00AM

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Kinder Morgan shares have been beaten up. Here are three reasons to believe its shares will do better going forward.

Kinder Morgan (KMI 0.27%) shares have been beaten up pretty badly. Shares dropped 65% alone in 2015 because of the investor concern that low energy prices will cause U.S. oil and gas production to decline substantially. Because the capital markets have been skittish toward leveraged energy companies, Kinder Morgan's management, in the hopes of alleviating investor fears, made the fateful decision to cut the company's quarterly dividend by 75% in December. It was either that, or drastically cut the company's future growth plans. The dividend decrease was a big reversal from management's previous promises of steady dividend raises of around 10% a year through 2020 and severely damaged management's credibility.

Needless to say, Kinder Morgan has disappointed many investors over the past year. However, there are several reasons to believe Kinder Morgan will outperform going forward.

1. Berkshire Hathaway is a buyer
According to SEC filings, Berkshire Hathaway established a 26.5 million-share position in Kinder Morgan in the fourth quarter of 2015. Although Warren Buffett has stated that he wasn't the buyer, the Berkshire purchase nevertheless gives management more credibility. The purchase shows that a savvy investor that Buffett believes in -- either Ted Weschler or Todd Combs -- trusts Kinder Morgan management enough to invest hundreds of millions of dollars into the company. The increased management credibility from the Berkshire purchase is important because it will improve Kinder Morgan's access to capital markets, which could lower its cost of capital. The Berkshire endorsement is a strong one. The increased credibility could also lower Kinder Morgan's future interest rate payments on the company's $41 billion of net debt.   

2. Ample liquidity for funding projects 
Given that the company cut its dividend by 75% in December, Kinder Morgan expects to have ample liquidity for 2016. Kinder management said the following in a January press release: 

We expect the reduced dividend has completely eliminated our need to access the capital markets to fund growth projects in 2016. This insulates us from challenging capital markets and significantly enhances our credit profile. Moreover, by reducing the dividend and high-grading our backlog, we do not expect to need to access the capital markets to fund our growth projects for the foreseeable future beyond 2016.

 Kinder Morgan expects to generate $3.6 billion of cash flow in excess of its dividend for 2016, or $300 million more than the company's planned $3.3 billion in growth capital expenditures for the year. Because Kinder Morgan doesn't have much direct commodity exposure (with the company's distributable cash flow expected to change by only $6.5 million for every $1 change in the average WTI crude oil price), the company's actual results and guidance probably won't deviate by much even if energy prices remain weak. Kinder Morgan's ample liquidity to fund both its dividend and its growth expenditures is good, because it means that there won't be any dilutive stock issuances or dividend cuts for 2016. The extra $300 million in cash will help the company lower its net debt-to-EBITDA ratio to 5.5 by the end of 2016.

3. The energy capital markets will come back if energy prices normalize
Although Kinder Morgan only has modest direct commodity exposure, it does have indirect exposure. Because capital markets have been skittish as  of late, Kinder Morgan couldn't raise money at reasonable rates, and the company had to cut its dividend to support its growth plans. The lower dividend led to the major stock drop. 

Fortunately for investors, the reverse is also true. If natural gas and WTI prices rise, U.S. production will increase, and more volume will flow through Kinder Morgan's pipes. The capital markets will again lend at reasonable rates, and Kinder Morgan will have substantial distributable cash flow to raise its dividend quickly.  

Kinder Morgan looks like a good bet
Although its stock has fallen substantially, Kinder Morgan's problems are solvable. The Berkshire Hathaway purchase improves the company's credibility, and the dividend cut last December provides Kinder Morgan with enough cash flow to sustain its present dividend and debt rating until energy prices recover. If/when energy prices rebound, the capital markets will be back and Kinder Morgan will have substantial distributable cash flow to raise its dividend quickly.

TMFJay22 has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway and Kinder Morgan. The Motley Fool has the following options: short June 2016 $12 puts on Kinder Morgan. 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.

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