Kinder Morgan ($KMI) – Sky-high dividends worth the risk?
Favorable Exposure to Key Growth Markets Underpins Cash Flow Stability
Kinder Morgan’s built a robust, integrated natural gas network that spans the most prominent regions of the US, putting the company in a prime position to capitalize on the higher-level macro trends taking hold in the U.S. gas markets.
Following years of equity issuance and debt raises for organic projects and acquisitions, Kinder now leads the industry in Permian gas takeaway infrastructure, with substantial exposure to the inevitable mushrooming of the LNG export market and the tough-to-build Appalachia region.
This trifecta of natural gas dominance places Kinder Morgan at the forefront of the midstream infrastructure industry.
Today we discuss Kinder Morgan, a $37 billion midstream infrastructure company with the largest gas transmission network in the country with substantial storage assets. The stock has been a great vehicle, for the most part, for investors looking for steady income through the high dividend payout ratios the company pays its shareholders.
The company's robust infrastructure in the two key growth regions of the US positions itself for continued dividend increases and eventual incremental upside to the stock itself.
We went over Targa Resources ($TRGP) in a prior post – and suggest you check it out if you’re on the hunt for potential capital appreciation rather than stable income. Our predictions for the name are already taking hold, albeit much sooner than expected.
We discussed the three primary drivers for the case of investing in natural gas infrastructure assets in the U.S. Those drivers being:
Midstream infrastructure companies have the same exposure or similar capital allocation. We’re here to help you navigate the key players that will undoubtedly benefit from these industry-level drivers, and dive into their asset base and capital allocation strategies to decide which name should be a part of your longer-term portfolio.
Walking the Line: CapEx vs. Dividends
Capital allocation is the fundamental component we look at when it comes to investing in gas infrastructure companies, after first identifying the top-down reason for investing in the space, of course.
It gives us insight into management’s strategy, how the market is pricing in that strategy, and whether there are any dislocations between stock price vs. operational, industry, and financial trends.
So, how does Kinder stack up in terms of capital allocation for the next few years?
The first thing we notice: steadily rising Cash from Operations (CFO), dividend payouts, and cash balances.
About 50% of the company’s CFO is allocated to dividends - high, but on-par with most its large-cap midstream peers:
Let’s talk about their impressive projected rising cash balances.
Starting off 2023 with $745 million in cash, ending 2025 with $1.9 billion, this solid cash buffer is likely to be further distributed to investors as dividends or share repurchases. We believe the dividend yield is substantial enough to warrant an allocation towards debt reduction, and perhaps some smaller, synergistic acquisition as well – why not?
Of course, we should be cautious when using consensus numbers.
CapEx and Dividends will likely be in-line with the actuals – but the most volatile (and important) is Cash from Operations.
Any unforeseen hiccup could lead the company to tapping capital markets to fund its capex program, especially in 2023 when capex is elevated, which will drive a reduction in cash in the year.
Certainly a fine line to be walking.
We remain optimistic. The inherent earnings floor, along with its cash balances, provides a cushion to any potential setback that could occur in the year (which we don’t necessarily anticipate, but lots of volatility around Permian gas markets coupled with increasing macro uncertainty could certainly play out).
Kinder’s elevated dividend payout, as seen on the previous chart, results in the high dividend yield vs. its corporate peers (MLPs ET 0.00%↑ and EPD 0.00%↑ tend to have higher yields due to some barriers – which we’ll discuss in those deep dives).
With a 6.6% yield, it’s among the top 10 companies in the S&P 500 that yield more than 6%, and it certainly trumps the total yield of 1.7% offered by $SPY.
As we'll discuss soon, there are things we like and things we don't like about the stock. But, by synthesizing all these moving parts, we can equip our readers with the insights necessary to make a good investment decision by giving our holistic outlook and recommendation.