2024-01-18 04:59:55 ET
Summary
- Kinder Morgan is back on track, and we're fans of the company's free cash flow coverage of its dividend, a far cry from the situation years ago.
- On the basis of our discounted cash flow process, we value shares of Kinder Morgan at $20 each, slightly higher than where they are trading.
- The company's solid 6.3% dividend yield is a head turner, and given that the company is trading at the low end of our fair value estimate range, we like shares.
By Valuentum Analysts
Kinder Morgan (KMI) is one of the largest midstream energy companies in North America, with thousands of miles of pipelines and over one hundred terminals. This is a huge competitive advantage as duplicating pipeline infrastructure over currently existing routes just wouldn't make sense. The way to view the pipeline plays is that they act like toll roads, collecting nice fees along the way.
The company released updated financial expectations for 2024 in its fourth-quarter report, released January 17, that showed the midstream energy giant is back on track. Years ago, Kinder Morgan was spending a considerable amount of money on total capital expenditures, pushing its traditional free cash flow--as measured by cash flow from operations less all capital expenditures--below that which it paid out as dividends.
Kinder Morgan may be among the more attractive energy plays given its financial improvements in recent years. (Kinder Morgan)
Free Cash Flow Back Then
For example, back in 2015 , Kinder Morgan's net cash from operations was $5.3 billion, while it spent $3.9 billion in capital expenditures, resulting in traditional free cash flow generation of ~1.4 billion. However, in the same fiscal year, the company paid $4.2 billion in cash dividends. Kinder Morgan's dividend at that time was unsustainable, eventually resulting in a cut to the payout, but the company has made tremendous progress since then.
Kinder Morgan's financials weren't in great shape years ago. (Kinder Morgan)
Free Cash Flow Now
During 2022, Kinder Morgan generated operating cash flow of ~$4.97 billion and spent $1.62 billion in total capital expenditures, resulting in traditional free cash flow of $3.35 billion, which handily covered the $2.5 billion and $116 million it paid out in dividends and distributions in noncontrolling interests over the same time, respectively.
Through the first nine months of 2023 , Kinder Morgan generated operating cash flow of ~$4.17 billion and spent ~$1.69 billion in capital expenditures, resulting in traditional free cash flow of ~$2.48 billion, which was comfortably greater than cash dividends and distributions to noncontrolling interests of ~$1.9 billion and $121 million over the same time, respectively (as shown below).
Kinder Morgan's financials are in much better shape today. (Kinder Morgan)
For all of 2024, Kinder Morgan generated cash flow from operations of ~$6.5 billion and spent ~$2.3 billion in capital outlays, resulting in free cash flow generation of ~$4.2 billion, which easily covered its cash dividends paid of ~$2.5 billion. Traditional free cash flow after cash dividends paid stood at ~$1.6 billion during 2024, indicating the firm has ample room to keep raising its payout. Of note, the firm is providing valuable free cash flow information in its press releases, something we're huge fans of.
Kinder Morgan plans to step up capital spending in 2024, investing $2.3 billion in discretionary capital expenditures, but free cash flow should still come out more than dividends paid during the year based on our expectations of its operating cash flow. We're huge fans of companies that generate free cash flow sustainably in excess of cash dividends paid, and it looks to us that this is the path forward at Kinder Morgan.
Trends in Its 2024 Guidance
Back in December, Kinder Morgan provided preliminary 2024 expectations. Excluding its recent purchase of NextEra Energy Partners’ ( NEP ) STX Midstream assets, Kinder Morgan had expected 5% expansion in adjusted EBITDA and distributable cash flow [DCF] in 2024 thanks to growth in its Natural Gas Pipelines and Energy Transition Ventures segments coupled with rate escalations across its operations, as shown in the image below.
Kinder Morgan is back on track (December update). (Kinder Morgan)
For 2024, management is targeting its 7th consecutive year of dividend increases with a projected annualized dividend of $1.15 in 2024. Back in December, net debt-to-Adjusted EBITDA was targeted at 3.8x at the end of 2024, a level that is materially lower than its long-term target of 4.5x. We're liking the continued improvements at Kinder Morgan in recent years. Here is what Kinder Morgan’s President Tom Martin had to say in the December press release :
We expect to continue benefiting from strong natural gas market fundamentals driving growth on our existing natural gas transportation, storage, and gathering and processing assets as well as expansion opportunities. In addition, we anticipate benefitting from increased rates in our refined products businesses, demand for renewable diesel and renewable diesel feedstocks, and demand for renewable natural gas.
On January 17, Kinder Morgan reported fourth-quarter results that came in slightly lower than what the Street was expecting on both the top and bottom lines. As it brings STX Midstream into the fold, its numbers for 2024 have been modified. It has since finetuned its guidance for the year.
Kinder Morgan ended the fourth quarter with a Net debt-to-adjusted EBITDA ratio of 4.2x, and now is targeting EPS of $1.22 (up 15% versus 2023), DCF per share of $2.26, and adjusted EBITDA of $8.16 billion for 2024. It kept its dividend-per-share target unchanged for 2024, but its leverage target is now 3.9x for the end of the year.
Discounted Cash Flow Valuation
Our valuation breakdown of Kinder Morgan. (Valuentum)
Kinder Morgan is one of the most well-known midstream players in our coverage universe. The company cut its dividend by ~75% in late 2015, and since then, it has been steadily improving its balance sheet health while resuming payout increases. The firm exited Canada in 2019 as part of a broader portfolio optimization process.
As of 2023, Kinder Morgan had increased its payout over the past six consecutive years. Kinder Morgan is focused on growing its U.S. natural gas pipelines business and potential growth opportunities include Permian Basin pipelines, export pipelines to Mexico, and pipelines that support domestic LNG export facilities. Here is what Kinder Morgan had to say about its growth opportunities in its fourth-quarter press release:
Our project backlog at the end of the fourth quarter was $3 billion, down from $3.8 billion in the third quarter due to the completion of multiple large projects including Tennessee Gas Pipeline’s ((TGP)) East 300 line upgrade, the Permian Highway Pipeline (PHP) expansion project and our Texas Intrastate’s Freer to Sinton project.
We don't pay too much attention to distributable cash flow [DCF] with respect to valuation and use a discounted cash-flow method to calculate intrinsic value. We also don't like to use relative valuation techniques as the primary consideration for investing, but we do note that Kinder Morgan is trading at about 14-15x next year's earnings, which is quite reasonable.
Kinder Morgan is trading at a reasonable valuation multiple. (Seeking Alpha)
Based on our discounted cash flow process, we think Kinder Morgan is worth $20 per share with a fair value range of $15.00-$25.00. Shares are trading at ~$17-18 each at the time of this writing.
The margin of safety around our fair value estimate is driven by the company's MEDIUM ValueRisk rating, which we use in setting the bands around of our fair value estimate. For riskier companies, the bands are larger. For companies that have fewer risks, the bands might be smaller.
Our fair value estimate range for Kinder Morgan. (Valuentum)
As in the case with most of our coverage, our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates. Over the next five years, excluding STX Midstream, we forecast roughly flat sales expansion, a pace that is lower than the firm's 3-year historical compound annual growth rate.
Our valuation model reflects a 5-year projected average operating margin of 27.1%, which is above Kinder Morgan's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.6% for the next 15 years and 3% in perpetuity. For Kinder Morgan, we use a 7.8% weighted average cost of capital to discount future free cash flows.
Relative Valuation (data as of December 26) (Valuentum)
Risks
The biggest threats to Kinder Morgan’s dividend program are its large net debt load, exposure to volatile raw energy resources pricing, and re-contracting risk. Kinder Morgan’s financial performance is heavily exposed to the state of the North American energy complex, with an eye towards oil & gas production levels in the U.S. and the state of the global LNG market.
Additionally, Kinder Morgan has a sizable upstream segment that produces oil via CO2 injection extraction methods, leaving the firm directly exposed to fluctuations in raw energy resources pricing. Going forward, Kinder Morgan’s capital allocation policies need to be closely monitored, but we like management's prudence of late.
Regulatory risks come up from time to time, but Kinder Morgan continues to be a great pipeline operator, in our view. Long-term, there is always the risk of the fading out of fossil fuels as a primary energy source in North America, but this won't happen for some time. We don't think this is a reasonable risk to impede Kinder Morgan's price-to-fair value convergence.
Concluding Thoughts
Our focus when it comes to the strongest income ideas rests in part on whether the company can generate traditional free cash flow, as measured by cash flow from operations less all capital spending, in excess of cash dividends or distributions paid, and Kinder Morgan has made significant progress on this front.
Quite simply, Kinder Morgan’s dividend is much stronger these days, and the company’s ~6.3% yield isn’t too shabby, and neither is the price discount to our estimate of its intrinsic value. If Kinder Morgan can work to drive its net debt load continuously lower, we would not be surprised if it eventually makes the cut for our simulated newsletter portfolios. We're liking Kinder Morgan more and more these days.
For further details see:
Kinder Morgan's Financials Are Much Stronger These Days