If you are sitting in North Dakota with a load of natural gas in need of getting to market, Kinder Morgan (KMI) has the pipeline to do the job. In fact, anyone involved in transporting natural gas, oil or CO2 very likely have Kinder Morgan on their contact list.
KMI has it all, the pipelines, a network that includes 180 terminals, and lots of storage. From British Columbia to the Texas Gulf Coast, KMI is in all the right locations. They own enough pipeline to circle the earth three times over.
Almost $15 billion in annual business places KMI at the top of the pipeline heap.
Like others dealing in fossil fuels, recent times have not been kind to this Houston based company. In the last year, earnings and the price of the stock fell as the dividend was cut 75% to current levels.
A year ago the stock was a perfect dividend trap. Are the tough times over and better cash flow, earnings and dividends ahead?
Berkshire Hathaway owns a $400 million position, acquired around present levels, so disciples of Warren Buffett are in the Kinder Morgan fan club. Will they be rewarded?
The current annual payout of $0.50 per share offers a 2.3% yield. This alone may not be enough for every investor. There could be more to Kinder Morgan like the value of its assets that offer long-term value. Read on and we will find out.
Kinder Morgan owns and operates the largest natural gas pipeline network in North America.
Kinder Morgan is also the largest independent transporter of petroleum products and carbon dioxide in the country and the largest independent terminal network operator.
Lastly, Kinder Morgan controls the only oil sands pipeline to Canada’s West Coast. Kinder Morgan is king. They own or operate over 84,000 miles of pipelines and 180 terminals.
Some 61% of revenues and 53% of earnings are from Natural Gas Pipelines. Oil sands and other pipeline activity accounts for 13% of revenues and 19% of earnings, while terminal operations chip in 13% of the top line and 15% to operating earnings. The remaining 12% of both measures consist of CO2 and Kinder Morgan Canada.
Kinder Morgan’s assets hold value beyond the pure numbers. Pipeline assets are costly to build, and their approval is tightly regulated. The approval process is lengthy and unpredictable. This effectively blocks new competition.
In the Natural Gas Pipeline business, the company boasts of being connected to every important natural gas resource basin to market centers. This gives Kinder Morgan superior access to the best markets where it’s customers can sell at the highest prices.
As an independent transporter, KMI’s size and scale enables them to meet customer needs than their competitors.
Finally, KMI’s Oil Sands pipeline offers the only option Canadian oil producers have to get their oil to Asian customers affording monopoly-pricing advantages.
Kinder Morgan is an energy company whose revenues are linked to demand for fossil fuels. But, unlike the price of crude oil or natural gas, Kinder Morgan revenues are more stable.
Often, the company and its stock get grouped in with a typical energy drilling and production company. This is a mistake as the Kinder Morgan business model sets them apart. Here is how their business works.
Kinder Morgan is not directly tied to the price of oil or natural gas. Instead, revenues are based on volume. Most of the company’s customers are on guaranteed minimum contracts called “take or pay.”
A glut of oil and gas is the usual cause of falling energy prices. Abundant supplies still need transporting and take up lots of storage. This is good for KMI.
The CO2 and transportation business primarily has third-party contracts with minimum volume requirements, which have a remaining average contract life of approximately nine years.
Revenue from the Terminals business segment differ depending on whether the terminal is a liquids or bulk terminal, and in the case of a bulk terminal, the type of product being handled or stored.
The liquids terminals business generally has longer-term contracts that require the customer to pay regardless of whether they use the capacity. Much like the natural gas pipeline business, Kinder Morgan’s liquids terminals business is not sensitive to short-term changes in supply and demand.
The investor appeal of this fixed cost business model is the cash flow it generates.
Kinder Morgan’s balance sheet is leveraged. Cash amounts to $309 million, and total Assets equal $84 billion, of which $41 billion represent its valuable pipeline, terminal assets and related assets.
Long-term debt is $40 billion. The company has relied heavily on capital markets to finance its growth. When energy markets slowed and some operators were at risk of breaking their “take or pay” contracts, KMI’s cost of capital increased significantly. Rather than risk its credit rating, KMI slashed its dividend.
In January, the $1.93 per share dividend was cut 75% and the quarterly payout of $0.125 has remained there since. The company’s bank account is now three times the current annual payout, so the dividend appears quite safe and the somewhat higher price of oil since February has improved conditions.
Drilling activity and rig count have steadily increased in recent months according to the weekly report from Baker Hughes. This is a key leading indicator for KMI, so the worst may be over. Earnings in the most recent quarter support this possibility.
The Warren Buffett Factor
Earlier this year Berkshire Hathaway acquired a $400 million position in KMI at an average cost of $20+ per share. This was just after the dividend was reduced. Was this the action of a Buffett surrogate or the man himself?
Kinder Morgan is one of those unique cash flow asset companies that Mr. Buffett is drawn to. Just as his habit was during the financial crisis, he tends to step up to the plate at the right time during a period of distress building positions over extended periods. At present Berkshire owns only 1.1% of Kinder Morgan in its portfolio of dividend stocks.
The current $0.50 per share annual payout offers a 2.3% yield. This is hardly an eye-popping dividend, and KMI shares few qualities with Dividend Aristocrats. For investors seeking high yield and growth, KMI won’t bring you to your goals.
KMI’s current bank account balance of $309 million covers the dividend nicely, and the business appears better positioned to continue making payments. So, KMI may be best suited for investors seeking reasonable yields and capital appreciation. In other words; a value investor like Buffett. Let’s look at this side of the equation.
Value investors will note that KMI’s total market value is roughly half of so called Enterprise Value. This is the amount an acquiring company would have to pay (plus a premium) to own KMI’s valuable pipeline assets. These days, pipeline acquisition activity is quiet and may continue to be. This strategy will require a generous dose of patience. So, what about earnings?
Assuming that guidance is correct, revenue in 2016 will reach $15-$16 billion. With $18.5 billion in order backlogs, this appears like a reasonable probability. Consensus estimates for per share earnings is $0.67. If this EPS is achieved, it leaves the common stock valuation at a big premium to the S&P 500, not to mention a dividend payout ratio that would equal 75%.
The stock underperformed the S&P 500 until earlier this year. In the past 6 months it has appreciated 21%, mirroring the trend of higher drilling activity and rig count.
By either method of value, KMI investors need loads of patience while receiving a 2.3% current dividend yield. This may turn out to be a good choice for Berkshire Hathaway, but it’s not for everyone.
Disclosure: this author has no positions in any stock mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.