Quantcast

Why This Time It May Be Different for Kinder Morgan Stock


Shutterstock photo

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

There's a lot to like about Kinder Morgan  (NYSE: KMI ) at the moment. The company is one of the largest pipeline owners in the U.S., at a time when the country's crude oil production is rising.

While KMI is still heavily leveraged, the balance sheet is improving. KMI stock looks reasonably cheap compared to peers, and plans for an increasing dividend suggest the yield could exceed 7% (against current prices) in just two years.

But overshadowing all that is the performance of the company - and of KMI stock - back in 2015-2016. KMI converted from an MLP (master limited partnership) structure to a C-corporation. Then, as the crude oil bust hit, Kinder Morgan was hammered. The dividend was slashed, shareholders were diluted, and KMI dropped by over 75% from 2015 peaks.

This time very well may be different, and there remains a strong bull case for KMI after some recent good news. But the potential returns here have to be balanced with the very real risk that history may repeat.

The Bull Case for KMI Stock

The bull case for KMI stock is that the company is getting back to normal, along with U.S. energy production. As the company phrased it in a presentation last month, the "corner has been turned." Over half of profit comes from natural gas pipelines, which should benefit from increasing production going forward.

Across the business as a whole, two-thirds of profit comes from "take or pay" agreements, in which Kinder Morgan gets paid whether or not capacity is used. That limits the company's exposure (at least in the short term) to any volatility in pricing and its effects on producer decisions.

Valuation is reasonable, with KMI trading at about 11x EBITDA, a discount to large midstream peers like Enbridge Inc  (NYSE: ENB ) and Williams Partners (NYSE: WPZ ). Meanwhile, KMI looks like an extremely attractive dividend play. The stock already yields 4.6%. Plans for a $1.25 distribution in 2020 suggest that yield would rise to 7.25% against today's prices.

And the balance sheet is getting better, with the company targeting a 5.1x net leverage ratio. That's a somewhat high figure but not unusual for the industry. Per a Williams Companies (NYSE: WMB ) presentation last month, the industry average is about 4.7x.

From a broad standpoint, then, there's a nice bull case here. More recently, there's been some good news as well.

The Trans Mountain Sale

Last month, Kinder Morgan subsidiary Kinder Morgan Canada (OTCMKTS: KMLGF ) sold its Trans Mountain oil pipeline to the Canadian government. Josh Enomoto argued on this site that the move doesn't change the outlook for KMI stock all that much, but I disagree.

Admittedly, a US$3.5 billion sale by a 70%-owned subsidiary isn't necessarily a game changer here. But Trans Mountain does derisk the portfolio. It also removes the steady drumbeat of bad news associated with the pipeline that perhaps distracted investors from the more stable, existing assets Kinder Morgan already owns.

More broadly, the pipeline fits with the narrative KMI management is trying to push. This isn't the same Kinder Morgan. It's a lower-risk, more mature and more grounded company. And if that's the case, a repeat of the crash a few years ago is much less likely.

Watch the Risks

I do believe management's broad point is correct. The proportion of "take or pay" agreements provides steady cash flow. Leverage should come down. Kinder Morgan Canada will have a few billion dollars with which to expand its own asset base .

And as Aaron Levitt pointed out in April, existing cash flow comfortably covers the dividend - and will do so even with sharp raises expected over the next couple of years.

For an income-focused investor, in particular, KMI looks attractive. Its yield should surpass that of Enbridge by 2020. And while growth isn't exactly spectacular, the company expects 4% growth in adjusted EBITDA and a 2% increase in distributable cash flow this year, which is enough to support that yield.

Meanwhile, current production growth suggests more opportunities in shale: Pioneer Natural Resources (NYSE: PXD ) has said Permian pipelines are about to reach their limit .

Still, there are risks, as KMI already has proven. And there are two key questions. First, are investors willing to take on the industry risk for an above-market yield? KMI's natural gas-heavy portfolio would mitigate that risk, but it's still out there.

Secondly, is KMI the best play in the space? There are higher yielders out there, including Buckeye Partners  (NYSE: BPL ) (though BPL has a risk of a dividend cut, despite management protestations to the contrary). Investors betting on U.S. energy strength are better served with higher-risk and higher-reward plays like Chesapeake Energy (NYSE: CHK ).

KMI does look attractive here, and for what it's worth, Wall Street agrees. (The average target price is over $20, almost 20% upside.) But investors need to understand what they're getting into. KMI is going to offer an attractive yield and potentially share appreciation as well. That said, it's not a play without risk, and for proof, an investor just needs to look at a three-year chart of KMI stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

More From InvestorPlace

Compare Brokers

The post Why This Time It May Be Different for Kinder Morgan Stock appeared first on InvestorPlace .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



This article appears in: Investing , Stocks
Referenced Symbols: KMI , WMB , ENB , CHK



More from InvestorPlace Media

Subscribe






InvestorPlace Media
Contributor:

InvestorPlace Media

Investing, Financial News










Research Brokers before you trade

Want to trade FX?