A new month is upon us, and with that comes the necessity to purchase some new equity in order to keep my dividend snowball rolling and growing. As usual, it’s difficult to choose where to deploy my limited capital since there are so many great options out there, especially in the current bear market where a lot of wonderful companies are trading at discounted prices.
It’s no secret that the energy sector has been particularly beaten down, and as such it is rife with opportunity for long-term investors. One company in particular whose stock price has been brutally torn down, and unjustly so, is Kinder Morgan, the undisputed king of natural gas (sounds like I’m talking about a person with massive flatulence issues, lulz).
Kinder Morgan is perhaps one of the safest, most profitable dividend stocks you could ever own in your portfolio, as we shall see very soon. I had been eyeing the stock for a while now, and, given the current valuations, it was simply too good of a deal to pass up. On 10/2/2015 I purchased 15 shares of Kinder Morgan at $29.49/share, initiating a position for a total investment of $442.35.
Let us first take a quick look at the qualitative aspects of the company before we dive into the numbers. As described by Morningstar:
“Kinder Morgan is the largest midstream energy firm in North America, with more than 80,000 miles of pipeline and 180 terminals. The company is active in the transportation, storage and processing of natural gas, crude oil, refined products and carbon dioxide, and is the largest handler of ethanol in the country. The vast majority of Kinder Morgan’s cash flows stem from fee-based contracts that provide insulation from commodity prices.”
That last sentence is important, so it bears repeating: “The vast majority of Kinder Morgan’s cash flows stem from fee-based contracts that provide insulation from commodity prices.”
In other words, the company makes money by charging fees for the use of its pipelines, terminals, and other infrastructure. This makes its revenue more volume-based, which means that the volatility of commodity prices doesn’t directly affect it like it does other energy companies. In 2015, 87% of Kinder Morgan’s cash flows were fee-based, which is about as robust a shield against commodity volatility as one could ask for. For this reason, I feel as though the company’s price has been unfairly dragged down along with the rest of the energy sector. Oh well, one man’s trash is another man’s treasure, yeah?
Beyond that, Kinder Morgan is just, well, fucking huge (that’s what she said, haha!). After last year’s massive consolidation of the general partner with all its underlying MLPs, the new company is effectively the largest midstream energy firm on the entire North American continent. This gives it a virtually unchallenged economic moat, as it would be nigh impossible for any challenger to assemble the massive amount of infrastructure that would be required to even make Kinder Morgan flinch. If anything, Kinder Morgan would most likely end up acquiring and merging any rising contenders into its own assets. It would go town on the competition like Pac-Man gobbles up pac-ghosts for breakfast.
Alright, let us now look at the numbers. As always, all the data I use to calculate shit is pulled from Morningstar.
When looking at a company’s revenue growth, I like to compute the compound annual growth rate over 10-year, 5-year, and 3-year periods. This allows me to see whether or not the business has been growing over time and it also shows me whether the growth has been accelerating or decelerating in recent years. Morningstar only provides data going back to 2008 for KMI though, so I’ll just cover 5-year and 3-year CAGRs:
Double-digit revenue growth that only seems to be accelerating? Me like. Me like very much.
Kinder Morgan’s payout ratio lied at 138.7% in 2014, and clocks in at a staggering 252.6% over the TTM. While this might seem alarming, the problem is that due to KMI’s past structure with MLPs, calculating the payout ration with the EPS is misleading. The FFO (funds from operations) is what we need here in order to get an accurate picture. Unfortunately I couldn’t find numbers for the FFO online (FFO is usually hard to find), and I have no desire to sift through quarterly reports to calculate it myself. I’m sure that the payout ratio based on the FFO is a lot more reasonable, and likely no higher than 60%.
Check out my analysis of Spectra Energy, another natural gas midstream company, if you are interested in seeing an example of the payout ratio based on FFO worked out.
The debt-to-equity ratio will tell you if a company has been using a lot of leverage to finance its growth. Acceptable numbers here will vary depending on the industry you’re dealing with, with some sectors like the financials sector being notorious for their high levels of debt. Kinder Morgan’s debt-to-equity ratio registered at 1.18 in 2014, slightly below the industry average of 1.4. Nothing to really worry about here.
Interest Coverage Ratio
Another important ratio I like to look at is the interest coverage ratio, which you get by dividing a company’s earnings (before taxes, interest, rainbows, etc.) by its interest expenses. I usually like to see a number above 5 here, preferably even 10, though again this can vary significantly depending on the industry we’re dealing with.
Kinder Morgan’s interest coverage ratio comes out to 2.52 over the TTM, which isn’t very high. With that being said, KMI is known for using leverage to fund its growth, and given its unmatched economic moat (as discussed above), it’s honestly not too concerning.
The yield currently floats right above 7%, which is very high and would normally definitely make me raise an eyebrow. In this case, however, the yield has simply been super-inflated due to the overblown fall of the stock price in a short period of time.
Dividend Growth Rate
Dividend growth rate is one of the most important factors to look at as a dividend investor. Since Kinder Morgan only became a publicly-traded company in 2011, I can only compute a 3-year CAGR for the DGR, which comes out to a whopping 31.95%. To say this is excellent growth would be an understatement.
Of course, there is no telling whether or not KMI will be able to maintain such phenomenal growth over the long run. However, seeing as the company boasts a project backlog of over $20 billion, I think it is safe to bet that it will be able to maintain a DGR at the very least in the low double-digits well into the next decade.
I used a DDM (Dividend Discount Model) with a discount rate of 12% and what I consider to be a very conservative dividend growth rate of 8% to valuate the stock. Even with such a huge margin of error built in, the fair value still comes out to $52.92, which means that I purchased the stock at a ridiculous 45% discount (not that I’m complaining). Lol.
This right here is a prime example of the collective stupidity of the stock market (and people’s inability to think long-term), as there is no way that Kinder Morgan, which was priced close to $45 just over 4 months ago, would have lost nearly HALF of its value in that time frame. I don’t care how low oil prices might have fallen, there is just no way that the largest natural gas midstream company in North America, which functions largely on a fee-based system, would actually be worth half of what it was worth 4 month ago.
Think about that for a minute.
Kinder Morgan is a beast of a company that you can own in your portfolio while sleeping well at night. At current prices, it’s an absolute no-brainer to buy up some shares, and then some. I just wish I had more capital to invest. Hopefully, people will continue to be dumb and drag its price further down over the next few months so that I can continue to accrue some absurdly discounted equity in this wonderful business.
Heck, Richard Kinder, the co-founder and executive chairman of the company, has a yearly salary of $1. That’s right, one buck. He believes in Kinder Morgan so much that he is the largest single shareholder, owning millions of shares and living off of his dividends entirely.
And if you’re still not convinced, then consider the wise words of the great Oracle of Omaha himself:
“Be fearful when others are greedy, and greedy when others are fearful.”
Now go buy some KMI.
What’s your opinion of Kinder Morgan? Feel free to share your thoughts in the comments.
Disclosure: long KMI