Since the beginning of 2021, Kinder Morgan’s (NYSE:KMI) shares have been stuck trading sideways between $15 and $20. Shares have still not gotten back to their pre-pandemic levels, and we’re approaching a decade of relatively flat returns. Long-term investors who have held shares for more than a decade are probably displeased with KMI as it went from a company with strong appreciation and dividend payments to a company whose dividend is paying 59.07% of what the dividend paid prior to the cut in 2016. It’s not about where a company came from, it’s about where the company is today and its future outlook. KMI continues to deliver on its strategic objective of financial discipline while showcasing the ability to generate sustained profitability and rebuild its capital allocation program. While the long-term and short-term charts don’t look enticing, I am bullish on KMI as the energy transition looks more like a hybrid approach as I have speculated, rather than eradicating fossil fuels. If you’re looking for income with the potential for capital appreciation, I think KMI is a strong candidate, as we could see shares break out above $20 in 2024.
Following up on my previous article about Kinder Morgan
KMI is one of the energy infrastructure companies that I am the most bullish on. Since my last article which was published on December 5, 2023 (can be read here), shares have appreciated by 3.42% compared to the S&P 500, gaining 14.2%. When the dividend is factored in, KMI’s total return since December 5 has been 5.13%. Over the past year, shares of KMI have increased 4.23% while the S&P 500 has gained 27.23%. Unlike other energy infrastructure companies, KMI hasn’t participated in the rally. In my previous article, I discussed KMI’s latest dividend increase and the strong 2024 guidance it had issued. Now that the 2023 fiscal year results are in, I wanted to provide an update on my investment thesis and discuss why I am still bullish despite shares of KMI remaining within a multi-year range.
Risks to my investment thesis
There are a number of risks to my investment thesis regarding KMI. The first risk that needs to be factored in is opportunity cost, as an investment in KMI over the past decade hasn’t provided much upside at any point. Over the past five years, if you had invested in the SPDR S&P 500 Trust (SPY) in April of 2019, shares would have rebounded from the pandemic crash and still been up 79.65% compared to KMI still being -7.93% lower than where they were five years ago. KMI’s growing dividend can’t even come close to bridging the gap between investing in an S&P 500 index fund and KMI, as the difference is just too wide. Even if you’re an investor focused on income, there is an opportunity cost to consider, as well as the ramifications of KMI’s stock trailing the market by such a large gap. A narrative about KMI being dead money could be formed, and negative investor sentiment is hard to dispose of. KMI also faces risks from environmental groups and agendas from elected officials. Going into the 2020 election cycle, there was a large push to eliminate fossil fuels over the next several decades, and KMI faces a tremendous threat from future policy change. While it looks like the attacks on the oil and gas industry have subsided, future pushes to green energy could gain traction and disrupt KMI’s business model.
Mr. Market isn’t respecting KMI for the business it has become
Shares of KMI took a one-way trip south from its April 15, 2015 price of $44.34. In less than a year, shares of KMI had fallen to $13 by January 11, 2016. Since then, shares have had a hard time staying above $20, and every time shares looked like they would break out, they just retraced to somewhere within the $15-$20 range, excluding the pandemic crash. The KMI that finished its 2015 fiscal year and the KMI of today are two completely different companies. KMI finished the 2015 fiscal year with $42.47 billion in long-term debt and a net-debt to EBITDA ratio of 6.14x ($42.96 billion/$6.22 billion). KMI has eliminated $14.24 billion in long-term debt from its balance sheet, which is a reduction of 33.54% over the past eight years. KMI’s net-debt to EBITDA ratio has also declined by 28.67% from 6.14x to 4.38x. KMI’s management team is still committed to financial discipline, and after eight years, it has been reducing debt and its leverage ratio. Despite cleaning up the balance sheet and building back its capital allocation program, shares of KMI have remained stagnant.
Since the 2016 fiscal year, KMI has produced $41 billion in cash flow and returned 64% to its equity and debt holders. Over the past eight years, KMI has returned $16.4 billion through its dividend program while repurchasing $1.4 billion worth of shares. KMI has double the amount of capital it’s allocating toward dividends on an annualized basis and provided six dividend increases since 2018. The quarterly dividend is still 55.88% of where it was in Q4 of 2015, but I am looking at where the company is today rather than where it was. KMI has established a 6-year track record of dividend growth while eliminating 33.54% of its long-term debt, and the current annualized dividend of $1.13 has a 6.12% yield.
KMI ended 2023 with $3 billion of capital committed to its growth projects. These are self-funded through their cash flow as KMI looks to expand its network through adding capacity in their natural gas, refined products, and gathering & processing segments. On an adjusted basis, KMI is projecting that its adjusted EPS will increase 14% YoY to $1.22, while its Adjusted EBITDA will grow 8% to $8.2 billion YoY. This will allow its distributable cash flow (DCF) to come in at $2.26 per share, which is double the current dividend. On an adjusted basis, KMI’s net-debt to Adjusted EBITDA is expected to fall to 3.9x at the end of the current fiscal year. I think Mr. Market is making a mistake in valuing KMI as the same company it was in 2016, and as we progress throughout 2024 and into 2025, I think there is a large opportunity for shares of KMI to breakout above the $20 level.
Why I am still bullish on KMI going forward
KMI operates one of the largest energy infrastructure companies in the U.S. with an asset base that is arguably impossible to replicate. New competitors can’t just enter the energy infrastructure sector as everything is regulated by the Federal Energy Regulatory Commission (FERC). The amount of resources needed to create new pipelines and storage infrastructure is immense, and this is why we are seeing more consolidation rather than new competitors throughout the sector. KMI owns an interest in and operates 82,000 miles of pipeline and transports 40% of the natural gas produced throughout the U.S. KMI’s cash flow is protected by the type of contracts it enters, as 68% is pegged to take or pay contracts. This allows KMI to enter into an agreement where the volume and price are contractually fixed, and regardless of the volume moved through KMI’s pipes, they are getting paid the full amount. If an upstream producer only transports 90% of their contracted volume, KMI is paid 100% as they are reserving the space on KMI’s system. KMI has 27% of its capacity through fee-based contracts where the price is fixed, but the volume that is transported fluctuates. The remaining 5% is based on commodity prices, and when we are in an environment with a high oil price, as we are today, KMI benefits. This is a structure that is beneficial toward KMI and has allowed them to build their infrastructure while reducing debt and increasing the dividend since 2016.
The question really is whether the demand for traditional energy sources will expand or deteriorate. I am pro-renewable energy, and I am invested in several companies that are focused on green energy. However, I make my investment decisions based on data rather than emotions. In the Energy Information Agency (EIA) Annual Energy Outlook it clearly indicates that production levels in their reference cases for petroleum and other liquids, and natural gas will increase through 2050. The U.S. is also expected to increase its position as a net exporter of both petroleum and liquefied natural gas (LNG) over the next two decades. With these projections in mind, KMI’s infrastructure is increasingly important to the global demand for energy and to meeting future domestic energy requirements. If the demand for energy does increase, then it should correlate to an increased amount of fuel moving through KMI’s system, which should lead to more contracted volumes and larger amounts of cash flow generated.
The U.S. population is 341.39 million and is expected to increase to 352.16 million by 2030 and 366.62 million by 2040. The global population is 8.1 billion and is expected to increase to 8.55 billion in 2030 and 9.12 billion in 2040. The combination of projections for population growth and where the EIA sees domestic production for traditional fuel sources makes me extremely bullish on KMI. KMI’s infrastructure strategically connects all of the major basins in the U.S. with takeaway capacity to major hubs and refineries. If the domestic and global demand for energy continues to increase, the U.S. will likely remain the larger producing nation of oil and gas to help meet the global demand for energy. All of the traditional energy sources need to be transported, and KMI’s network will be at the top of the list due to its connectivity options and takeaway capacity. This could drive KMI’s DCF and EBITDA higher for years to come, and that is why I am very bullish on KMI.
Conclusion
I am looking at KMI for the company it is today rather than the company it was. Today, KMI is in a much better financial position with a net debt to EBITDA ratio of 4.38x. While shares have traded sideways for far too long, I think 2024 is the year shares can break through $20. It’s likely that KMI can deliver on its 2024 projections as more projects come online and elevated levels of traditional energy sources move through its system. Based on its dividend history, we are probably also looking at another dividend increase heading into the Q2 dividend announcement. As the Fed starts cutting rates, I think we will see expansion throughout the economy as the cost of capital declines, which should drive the utilization rate of energy higher. I think many components are lining up well for KMI, and eventually, the negative sentiment about where the company used to be will vanish, and the market will realize that there is an opportunity for the true value of this company to be unlocked.