Image Source: Loren Kerns
By Brian Nelson, CFA
After a rough go at it, pipeline operator Kinder Morgan (KMI) continues to get its financial house in order, and we applaud management for its continued strong efforts in this regard. The corporate released fourth-quarter results January 18, and while they came in a little light, we see no reason to change our fair value estimate for shares at this time. In many ways, management’s ongoing reiteration of its goal to work toward reaching its targeted level of ~5 times net-to-adjusted EBITDA is admirable, and we’re hoping ongoing deleveraging initiatives coupled with prudent investment in growth projects (Trans Mountain expansion project and Elba Island Liquefaction project) will pave the way for future dividend increases at the North American pipeline giant. Net debt stood at ~$38.2 billion at the end of 2016 down from ~$41.2 at the end of 2015.
Kinder Morgan remains a holding in the Best Ideas Newsletter portfolio, added in February 2016, and represents a prime example of how important fair value estimation, balance sheet assessments, and free cash flow health evaluations are to selecting entry and exit points. Kinder Morgan was removed from the Dividend Growth Newsletter portfolio at ~$40 per share in June 2015, and we’re expecting the pipeline giant to continue to recover, perhaps aided by a more favorable regulatory environment under the new Trump administration and resilient energy resource prices in 2017. We liked that the company talked about “green shoots” in the sector (XLE). Here’s what Kinder Morgan had to say about its outlook for 2017:
On Dec. 5, 2016, KMI issued its preliminary 2017 financial projections and said it expects to declare dividends of $0.50 per share and to achieve distributable cash flow of approximately $4.46 billion and Adjusted EBITDA of approximately $7.2 billion for the year. KMI also expects to invest $3.2 billion in growth projects during 2017, to be funded with internally generated cash flow without needing to access equity markets, and to end the year with a net debt-to-Adjusted EBITDA ratio of approximately 5.4 times.
We continue to encourage Kinder Morgan management and the midstream arena (AMLP) to release traditional measures of free cash flow, as measured by cash flow from operations less all capital spending, to the investment community alongside disclosures of distributable cash flow, which excludes growth capital spending but includes the growth in net income associated with such growth capital spending. Distributable cash flow has a severe imbalance in the calculation, and we believe the measure remains inadequate in explaining to investors the true cash flow dynamics of the business (i.e. what’s actually moving in and out of the business from an operating and investing standpoint). While traditional free cash flow can be calculated from the regulatory filings (sometimes days after the press release), we think it would be a step forward in improving corporate governance and the transparency of midstream entities to include free cash flow (CFO less all capex) in press releases where distributable cash flow is mentioned.
Kinder Morgan would be the one to set a fantastic example for this, and we hope that the company eventually will. We continue to include the pipeline giant as our only direct midstream exposure in either newsletter portfolio for now.