Source: Kinder Morgan
As a high-yield dividend stock, Kinder Morgan (KMI 0.72%) has not only failed investors over the past year, but it's also woefully underperformed most MLPs, its large midstream- asset operating peers, and the market in general.
The reason for Kinder's fall from grace was its late 2015, 80% dividend cut, necessitated by credit rating agencies threatening to slash its rating to junk. This would have made the cost of rolling over its massive debt more expensive and probably threatened its ability to profitably grow long-term.
Now that management has undertaken the painful but necessary thing to right-size the dividend, was Kinder's latest earnings report good enough to warrant a buy by dividend investors? Not by a long shot, because there are three reasons Kinder remains inferior to its peers, such as Enterprise Products Partners, (EPD 1.19%), Magellan Midstream Partners, (MMP), Spectra Energy Partners, (SEP), and its general partner, Spectra Energy Inc, (SE).
What Kinder got right this quarter
"Despite continued headwinds in our industry, we are pleased with KMI's performance for the quarter, and we are pleased to have generated $954 million of cash in excess of dividends during the quarter," said Richard Kinder, chairman and founder.
Kinder reduced its dividend mainly so it could divert its large stream of distributable cash flow (DCF) toward investing in new projects and paying down its debt. However, while nearly $1 billion in excess DCF may seem impressive, it's hardly a surprise. That's because the entire midstream MLP industry is based in long-term contracted fixed-fee and volume guarantees that allows generous yields.
And while Kinder's $0.55 per share in DCF this quarter represents a very secure 4.4 distribution coverage ratio keep in mind that all of that spare cash flow is spoken for, meaning that dividend growth isn't likely for quiet some time.
In addition, CEO Steve Kean made 2016's revised capital-spending budget of $2.9 billion, a 31% reduction over last quarter's $4.2 billion, sound like a great coup because it means paying off more debt. However, it also reveals a major problem.
Long-term growth runway continues shrinking
"We reduced our growth capital backlog from $18.2 billion at the end of the fourth quarter 2015 to $14.1 billion at the end of the first quarter 2016," Kean said.
As America's largest pipeline operator Kinder Morgan needs a massive backlog to move the needle in terms of growing its DCF and dividend.
Which is why dividend investors should be concerned that Kinder's growth backlog, once $22 billion in size, continues falling as the companies aggressively focuses on maximizing profitability. While good news in the short term, it also means that long-term DCF growth may prove anemic. This could forestall dividend growth for years after energy prices eventually recover.
In contrast, Spectra Energy has $6 billion in projects proceeding as planned, out of a potential near-term backlog of $8 billion. That means Spectra is likely to make good on management's growth guidance of a 46% per-share distribution increase over the next two years.
Similarly, Enterprise Products Partners has $6.4 billion in new projects coming online through the end of 2018. That plus its high coverage ratio indicate that the MLP is likely to continue its impressive 10-plus-year track record of growing distributions even through the most challenging of economic times. Note that the gray in the chart represents recessions:
EPD Dividend data by YCharts
Deleveraging will take years
| Pipeline Operator | Total Debt | Debt/EBITDA (Leverage) Ratio | Operating Income/Interest Costs (Interest Coverage) Ratio |
|---|---|---|---|
| Kinder Morgan | $43.807 billion | 9.72 | 1.10 |
| Spectra Energy | $14.993 billion | 7.46 | 2.21 |
| Enterprise Products Partners | $22.756 billion | 4.49 | 3.70 |
| Spectra Energy Partners | $6.591 billion | 3.79 | 5.40 |
| Magellan Midstream Partners | $3.802 billion | 3.28 | 6.51 |
Sources: Morningstar, GuruFocus.
Kinder Morgan's emphasis on reducing its leverage ratio is needed to ensure its long-term viability. However, this quarter the company didn't do a good job reducing its debt.
In fact, while its long-term debt fell by $301 million, that was more than offset by an $881 million increase in short-term debt. Since Kinder's debt is actually continuing to increase, it's no surprise that management is hailing its capital investment reduction plans for 2016 as good news.
However, keep in mind that that Kinder's overleveraged balance sheet will take years to correct. In the meantime, not only does Kinder's ability to cover its interest payments remain highly perilous relative to its peers, but that giant debt also means Kinder could potentially be destroying shareholder value.
Profitability remains elusive
| Pipeline Operator | Returns on Invested Capital (ROIC) | Weighted Average Cost of Capital (WACC) | Net ROIC (ROIC-WACC) |
|---|---|---|---|
| Kinder Morgan | 1.66% | 2.89% | (1.23%) |
| Spectra Energy | 5.69% | 5.39% | 0.30% |
| Spectra Energy Partners | 7.28% | 5.25% | 2.03% |
| Enterprise Products Partners | 8.38% | 6.94% | 1.44% |
| Magellan Midstream Partners | 17.93% | 7.11% | 10.82% |
Source: GuruFocus.
While net ROIC isn't a perfect metric for ensuring management is using investors' capital wisely (it's partially based on the volatility of an MLP's stock), nevertheless it's plain that Kinder Morgan's high debt is harming its ability to grow profitably. That explains why the company has been slashing its capital spending and project backlog so ferociously given its weak share price, which makes profitable equity capital raises impossible.
Given that the midstream MLP model involves frequent debt and equity capital infusions, thus allowing the distribution of a majority of DCF as payouts to investors, I recommend avoiding any MLP with a negative net ROIC, thus maximizing the probability that management isn't destroying shareholder value as it grows.
Bottom line
For new capital, if you're a long-term dividend investor looking to generate high, growing, and relatively secure income from America's fracking boom, then look at Enterprise Product Partners, Magellan Midstream Partners, and Spectra Energy instead of Kinder Morgan.
