Kinder Morgan Inc.’s (KMI) dividend cut after market close Tuesday lifted shares in Wednesday’s trading. Some analysts and investors were relieved that KMI would retain its investment-grade credit rating and not be accessing unattractive equity markets to fund growth.
The company slashed its quarterly dividend by 75% to 12.5 cents from 51 cents/share. The cut begins this quarter with the dividend payable in February.
"We evaluated numerous options, including significant asset sales, but ultimately concluded that these other options were uneconomic to our investors in the long run," said Chairman Rich Kinder. "This decision was not made lightly, but we believe it is in the best interests of the company, its shareholders and employees.
"It will allow us to continue to maintain and grow our outstanding set of midstream energy assets without being required to issue equity at valuations prevalent in today's market while maintaining a solid investment-grade rating on our debt obligations. We are directly addressing concerns about our investment-grade rating and concerns about the need to issue additional equity."
The company said it has reviewed planned spending for 2017 and 2018 and management believes cash flow will allow it to continue to fund the equity portion of its capital budget. It said it expects to keep its investment-grade rating at all three ratings agencies. The net debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio is expected to be 5.5 for 2016 and lower in subsequent years.
Moody’s Investors Service, which had recently cut its outlook on KMI to “negative” returned the outlook to “stable” following the dividend cut.
U.S. Capital Advisors said in a note that KMI had been paying out too much of its cash flow. While painful, cutting the dividend is “finally the right way to run this company,” analyst Becca Followill and associates wrote. “Instead of playing the ‘hope it gets better strategy,’ Kinder is positioning the company to capitalize on future opportunities that would be untenable in the status quo.”
In a note following the dividend cut, Jefferies analysts, led by Christopher Sighinolfi, referred to the "concerns" around KMI as the "elephant" and said they had been addressed for now. "We applaud the strategy of cutting to the point that prevents the need for capital funding through 2018...but believe the initial market reaction will be negative given the magnitude of the cut is greater than many had contemplated."
KMI closed Tuesday at $15.72 after charting a new 52-week low intraday of $15.06, a far cry from its 52-week high of $44.71. On Wednesday KMI shares closed up nearly 7%, at $16.81.
The dividend cut by North America's largest pipeline operator had been expected, as the company had hinted last week (see Daily GPI, Dec. 4).
In the summer of 2014, what was to become KMI was then a handful of master limited partnerships (MLP) that were later rolled up to create KMI, an entity said at the time to have a lower cost of capital and be better suited for acquisitions and infrastructure development (see Shale Daily, Aug. 11, 2014).
A dividend cut is a disappointment for yield investors, but it's the right long-term move for KMI, said analysts at Tudor, Pickering & Holt (TPH), which upgraded KMI to a "buy" while bemoaning "constant negative headlines" about the company. "In any world where the U.S. independent producers survive, infrastructure will be needed to service that production and continue generating cash flow," TPH said of the midstream sector.
During a conference call Wednesday morning, Rich Kinder reminded listeners that a significant portion of management compensation comes in the form of dividends.
"Our strategy always has been, and will continue to be, to focus on fee-based midstream energy assets that are core to North American energy markets," said CEO Steve Kean. "Our execution of that strategy has enabled us to grow distributable cash flow (DCF) per share and we believe we will continue to do so."
KMI said it has completed its budget for 2016 and expects DCF available to equity holders of slightly more than $5 billion, an increase of 8% over 2015. "We grew our DCF per share in 2015 and we expect to grow again in 2016, despite a very difficult environment in the energy sector, Kean said. "We believe we have the best set of assets in the midstream energy business and the cash generated by those assets is fee-based and growing."
KMI’s recent acquisition of a larger stake in debt-laden Natural Gas Pipeline Co. of America (NGPL) (see Daily GPI, Dec. 1) is what caused Moody’s to briefly lower its outlook on the company. On Wednesday, Rich Kinder talked with analysts about why NGPL is strategic to KMI.
"People think of [NGPL] as only a pipeline into Chicago, and it certainly is the most important pipeline coming into Chicago and actually benefits some from the REX [Rockies Express Pipeline] reversal, which is moving Marcellus/Utica gas into Chicago [see Daily GPI, July 28], so we're a beneficiary of that.
“But also, given the tentacles of NGPL that extend into the southwestern United States...we're able to use the southern part of that system to be reversed, like we have done to Tennessee [Gas Pipeline] and to get extensive amounts of natural gas down into the petrochemical and LNG [liquefied natural gas] facilities along the Gulf Coast. We see it long term as a very strategic opportunity and it's one that has a nice return based on our investment."
As he’s said before, KMI is highly levered to a future in which natural gas markets grow on the back of power generation, petrochemical and LNG export demand. “We love our position in the natural gas area, and we think there's going to tremendous growth,” Rich Kinder said. “We're seeing it now in demand for natural gas around North America. We hope to be able use our system to exploit the need for more natural gas transportation access.”
TPH analysts said midstream investors in other companies should be looking for moves similar to that made by KMI.
"KMI's aggressive dividend cuts will open the door to an entire sector to do the same," TPH said. "Management teams with meaningful backlogs of growth projects will be considering a similar 'cut near-term distribution and self-fund' strategy. But this does not mean the midstream model of distributing all cash flow and relying on new capital to fund growth permanently. The market sending share prices down and yields to the moon ultimately forced this behavior. As the sector recovers and yields moderate, expect a return to the previous status quo."