2024-01-08 13:30:00 ET
Summary
- Kinder Morgan stock has outperformed my expectations since my Buy rating in 2022, outperforming KMI's 1Y total return. Hence, entry levels matter for total return investors.
- The recent revival in natural gas futures has boosted buying sentiments for KMI. I believe the worst hammering in KMI is likely over.
- Kinder Morgan's business model, sustainability, and low distributable cash flow payout ratio make it a stable investment with the potential for dividend growth.
- Income investors will likely find little to complain about, with its forward dividend yield still above 6%. However, you must carefully consider the risk/reward profile of KMI's entry levels to outperform potentially.
- With that in mind, I argue why the current levels aren't exciting enough to maintain my Buy rating.
Kinder Morgan, Inc. ( KMI ) is one of the leading natural gas infrastructure companies in the US that has recovered remarkably on a total return basis since my update in October 2022. Accordingly, I urged income investors to consider KMI's relatively attractive valuation and constructive price action and add on weakness then. KMI has posted a total return of 14.4% since then, significantly outperforming its 1Y total return of 5.6%. As a result, capital appreciation is still expected to feature prominently in KMI's total return profile, even though it's generally perceived as an income play. As a result, investors must consider KMI's risk/reward level appropriately to try and make the most out of their entry levels.
The recent revival in the underlying natural gas futures ( NG1:COM ) has also lifted buying sentiments on KMI. I remain bullish on NG1 since it bottomed out in early 2023. Buying sentiments on NG1 have continued to improve, notwithstanding the significant pullback in late 2023. Despite that, I don't expect things to get worse for natural gas futures, although the days of significant price surges in 2022 will not likely be revisited in the near term.
However, based on the business model of Kinder Morgan, I don't think that's necessary. Based on the company's most recent update, 93% of its cash flows " come from take-or-pay, hedged, and fee-based sources." For income investors, providing significant visibility into the sustainability of the company's earnings profile is a critical requirement. In addition, Kinder Morgan has also positioned well for energy transition, as it remains "committed to investing in a lower carbon future." They have a $3.8B backlog in their energy transition investments (84% allocated to lower carbon themes), with projects spanning several themes in "natural gas, renewable natural gas or RNG, liquid biofuels, and carbon capture and storage or CCS infrastructure." Coupled with a relatively low distributable cash flow payout ratio of about 53% based on its FY23 estimates, investors can continue to expect stable dividend growth rates over time. Bolstered by a solid forward dividend yield of 6.4% (above its 10Y average of 5.4%), I remain optimistic about Kinder Morgan as a robust investment opportunity for income investors at the right levels.
Kinder Morgan attracts a relatively healthy balance sheet profile, with a "low-cost capital structure, mid-BBB credit ratings, ample liquidity, and conservative financial assumptions." It has remained below its long-term targeted adjusted EBITDA leverage ratio of 4.5x, even with the recent completion of the acquired STX Midstream assets from NextEra Energy Partners ( NEP ). It isn't expected to significantly alter its balance sheet risk profile despite tapping into cash and short-term borrowings. Furthermore, Kinder Morgan sees "strategic value in adding these assets to its natural gas portfolio" while also improving the "connectivity" of its existing energy infrastructure, "particularly in areas with lower nitrogen natural gas supply."
With that in mind, I believe the company's recently improved guidance is achievable, further bolstered by the recovery in underlying energy prices. As a result, I'm not surprised that the market has already lifted its buying sentiments on KMI, as it recently re-tested highs last observed in July 2023.
KMI price chart (monthly, long-term) (TradingView)
KMI has remained in a consolidation zone since 2021, with its 2022 highs likely unattainable in the near- and medium-term unless we expect another price spike in Henry Hub's natural gas futures. However, with NG1 more than 70% below its 2022 highs, investors must remain realistic and not expect significant capital appreciation potential from the current levels in KMI.
Despite that, KMI remains a solid income play for investors, and it doesn't seem overvalued at the current levels. Seeking Alpha Quant's "C-" valuation grade corroborates my assessment, suggesting a Hold rating seems apt.
As a total return investor, I assessed that we could do better with an improved entry level for KMI for me to continue rating it as a Buy to improve the potential outperformance against its long-term average return.
Rating: Downgraded to Hold.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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For further details see:
Kinder Morgan: Solid Income Play But Not Exciting Enough For Me (Downgrade)