How risky is Kinder Morgan?

Intermediate Energy Giant Kinder Morgan (KMI 3.21%) offers investors a whopping 7.5% dividend yield. That’s pretty tempting, but high yields sometimes suggest that investors are worried about the future. So, before jumping in here, it’s worth considering how risky Kinder Morgan is today.

The core business

Kinder Morgan is one of North America’s largest and most diversified midstream energy companies. It would be virtually impossible for a competitor to replace the assets it owns.

The middle niche of the broader energy sector helps transport and process oil and natural gas. Kinder Morgan’s operations are largely fee-based, meaning it is paid for the use of its assets. The company has some exposure to commodity prices, but generally costs are more important to its revenue and bottom line.

Image source: Getty Images.

Many peers in society are incorporated as Master Limited Partnerships (MLPs), which are a bit more complicated tax-wise. Kinder Morgan chose to move away from this structure several years ago to simplify its business. This is a net benefit to conservative investors, as there is no need to worry about changes in MLP format tax law affecting Kinder Morgan’s business or resulting in a decision to move from a MLP to a company – this work has already been done.

The real problem today is that the demand for oil, natural gas and the products that transform them has declined thanks to the coronavirus pandemic. This is why investors are generally pessimistic about the middle space. But Kinder Morgan’s distributable cash flow payout ratio was a very strong 47% for the first nine months of 2020, so the payout doesn’t appear to be at risk. And, as a big player, Kinder Morgan is likely to be a consolidator in the industry if the current environment persists and opportunities for building from scratch dry up. In other words, he seems to be doing quite well and is solidly positioned given the circumstances.

Some issues to consider

That said, no company is perfect, and Kinder Morgan has warts. The first to look at is leverage. It has historically made greater use of leverage than its peers. Today, its financial debt to EBITDA ratio is approximately 5.7 times. That’s less than a few years ago, but still towards the high end of its median peer group.

KMI Financial Debt to EBITDA (TTM) graph

KMI Financial Debt to EBITDA (TTM) data by YCharts. TTM = last 12 months.

This is relevant as the additional leverage could make it more difficult for Kinder Morgan to shift to acquisition-driven growth. That’s not to say he won’t make such a shift if that’s where the industry is heading, only that debt-fueled buying would further increase his leverage and thus increase financial risk here. This takes the story back to 2016, when Kinder Morgan’s leverage was much higher than it is today.

At that time, the midstream industry was going through a period when it was difficult to raise capital. Kinder Morgan’s relatively high leverage, meanwhile, made access to capital markets even more troublesome. The management had to make a choice between financing its investment plans or continuing to pay its dividend. He chose capital spending, cutting the dividend by a whopping 75%. That’s not good news per se, but the real big deal is that just months before the drop, he was telling investors to expect up to 10% upside.

It has since returned to dividend growth mode, struggling to regain investor confidence. He presented a multi-year plan which called for a 25% dividend increase in 2020. Due to market conditions this year, he chose to only increase the dividend by 5%. It’s clearly better than a dividend cut and, like the 2016 decision, it was a good call for the company given the headwinds of the pandemic.

Still, conservative investors would be forgiven if they had trust issues here. And that’s on top of the company’s relatively aggressive use of leverage – which was a key part of the 2016 decision to cut the dividend.

food for thought

To be fair, Kinder Morgan is generally considered a well-run company, and the dividend decision it made in 2020 was to ensure it didn’t have to cut the payout down the line. So it’s not a terrible business filled with all sorts of investment risks.

But conservative dividend investors should consider the company’s leverage and the two instances in which management made dividend-related statements it couldn’t meet. Kinder Morgan is not high risk, but it is not risk free either.

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