Key Points
- Leverage has been the ruin of many oil and gas companies, including Kinder Morgan in 2015.
- The company’s actions prove it doesn’t want to make the same mistake twice.
- Kinder Morgan has sold off assets, but its business is better because of it.
IMAGE SOURCE: GETTY IMAGES.
Some context
When oil and gas companies get in trouble, it’s usually due to too much debt. Yes, lower oil and gas prices play a role, but financially responsible companies find a way to keep cash reserves on hand so they can ride out the downturns. Kinder Morgan was hit hard by the oil and gas crash of 2015. The pain was amplified because Kinder Morgan overextended by taking on too much debt. Strained to make ends meet, it was forced to slash its dividend by 75%. Since then, Kinder Morgan has been in the process of reinventing itself, which starts by getting its balance sheet back in order.
Fast forward to today, and Kinder Morgan carries an investment-grade credit rating from Moody’s. In June, Moody’s concluded that Kinder Morgan’s free cash flow (FCF) supports its ability to “modestly deleverage” over time. Kinder Morgan has gradually increased its dividend over the last few years. Today, it pays $0.27 per share per quarter, representing a high yield of 6.2% for the year.
Balance sheet breakdown
During its second-quarter earnings call, Kinder Morgan announced that its net debt position for the quarter ended at $30.2 billion, down $1.85 billion from the end of 2020 and down $500 million from the end of the first quarter. Add it all up, and Kinder Morgan has been able to reduce its net debt by a whopping $12 billion, or roughly 30% from its peak level.
| Metric | 2020 | 2019 | 2018 | 2017 | 2016 |
|---|---|---|---|---|---|
| Net plant, property, and equipment (PPE) |
$35.84 billion |
$36.42 billion |
$37.90 billion |
$40.16 billion |
$38.71 billion |
| Total assets |
$71.97 billion |
$74.16 billion |
$78.87 billion |
$79.06 billion |
$80.31 billion |
| Current portion of debt |
$2.56 billion |
$2.48 billion |
$3.39 billion |
$2.83 billion |
$2.70 billion |
| Long-term debt |
$30.84 billion |
$30.88 billion |
$33.21 billion |
$34.09 billion |
$36.21 billion |
DATA SOURCE: KINDER MORGAN INC.
In the table above, it’s clear to see that Kinder Morgan has been gradually reducing its net PPE, total assets, and long-term debt. Strong FCF generation has supported the company’s ability to pay down debt, but Kinder Morgan has also sold off quite a few assets. For example, it sold shares in Pembina Pipeline stock to help pay down debt in 2020 and early 2021. Last year, Kinder Morgan issued $2.25 billion in new senior notes and repaid $2.2 billion in senior notes — effectively leaving its long-term debt position nearly unchanged. But aside from 2020, it’s generally been using cash to pay down debt.
At first glance, it may seem that Kinder Morgan’s business is worth less than it was a few years ago — but not all assets are created equal. Rather, Kinder Morgan has been trimming what doesn’t work and keeping the assets that can generate positive FCF.
KMI REVENUE (ANNUAL) DATA BY YCHARTS
As a result of selling assets for a loss or writing down the value of existing assets, Kinder Morgan’s net income has been all over the place. And given that its business is leaner, it isn’t all that surprising to see revenue trending down. However, these two metrics aren’t really Kinder Morgan’s focus. Rather, the company has repeatedly stressed its emphasis on increasing FCF. And to its credit, it’s done just that.
Balance sheet accountability
Kinder Morgan’s long-term goal is to maintain a debt-to-EBITDA ratio of 4.5. EBITDA — or earnings before interest, taxes, depreciation, and amortization — is a useful financial metric for determining business performance independent of some accounting factors. It’s particularly relevant to Kinder Morgan since the company measures its performance mostly on its cash flow and not its net income or revenue. Specifically, debt-to-EBITDA can be useful because it shows a company’s debt relative to how much it’s earning. Therefore, if Kinder Morgan begins earning a lot more money, it could still have a lower debt to EBITDA ratio even if its debt were to increase. On the contrary, it could lower its debt to EBITDA ratio by paying down debt even if earnings are also declining.
At year-end 2020, it finished with a 4.6 debt-to-EBITDA ratio but reduced it down to 3.8 at the end of the second quarter largely due to ongoing debt reductions and strong EBITDA generation for the first half of the year. Investors can follow Kinder Morgan’s debt-to-EBITDA to gauge the overall health of its balance sheet.
The bottom line
Strong balance sheets form the foundation of good dividend stocks, and Kinder Morgan is no exception. Just as a bad balance sheet made it a poor dividend stock in years past, a good balance sheet, modest spending, and strong FCF make it an excellent dividend stock now. Given these strong fundamentals and the importance of natural gas in North America, Kinder Morgan looks like a great income stock to buy now.
