Note: This is not intended to be a detailed analysis of Kinder Morgan. It is a blog post in the truest sense: I’m simply thinking out loud, looking for answers admist the noise.
Barron’s really did a number on Kinder Morgan (KMI) this past weekend (see Kinder Morgan Could Fall Another 20% or More). Barron’s has been down on Kinder Morgan for more than a year and a half now, and some of their caution has certainly proved to be warranted in light of the share price declines of the past year. Kinder Morgan has a lot more commodity-price sensitivity than any of us bulls realized. But after the thrashing the stock has already taken, is more downside likely?
My instinct would say “no.” But let’s take a real look at Barron’s numbers to see if they hold water.
Barron’s Beef With KMI
Much of the arguments against Kinder Morgan focus on its use of non-GAAP accounting, which is typical of MLPs. Of course, Kinder Morgan is not an “MLP,” per se, but a corporation that happens to be in the same line of work, in this case midstream oil and gas pipelines.
Following MLP convention, Kinder Morgan bases its dividend payout on “distributable cash flow” as opposed to net income or free cash flow. Distributable cash flow (which is a metric unique to MLPs) takes net income, adds back in depreciation and other non-cash expenses, and then subtracts maintenance capital expenditures. The idea is that this is the cash profit thrown off by existing operations that can be paid out to shareholders. Capital expenditures for expansion are funded by new debt and equity issuance.
In contrast, the more conservative “free cash flow,” which (though also non-GAAP) is a more traditional way to measure a company’s ability to pay a dividend, makes no distinction between maintenance capex and expansion capex. Free cash flow is the cash left to payout to investors after all capital expenditures. (There are also other accounting differences, but for our purposes here this is sufficient.)
So, distributable cash flow might sound like dodgy accounting for a corporation, but we need to remember that Kinder Morgan is an MLP in all but name, so it makes sense to use the same accounting metrics.
Barron’s further takes issue with how Kinder Morgan allocates its capital expenditures between maintenance and expansion capex, essentially accusing Kinder Morgan of fudging the numbers, masking maintenance as expansion as a way of boosting the funds available to pay the dividend.
Barron’s failed to present a smoking gun, however. Kinder Morgan has consistently accounted for capex the same way for years, and the sort of short-termism that Barron’s alleges is very out of character for Kinder Morgan and its founder, Richard Kinder. If Kinder and his team were looking to inflate short-term results to boost the share price, then they wouldn’t be spending tens of millions of dollars of their own money buying shares on the open market. Richard Kinder and his team have an enormous chunk of their collective net worth in KMI stock. Sure, they can make legitimate business mistakes. Every executive team does. But it seems farfetched to accuse this executive team of running a multi-year pump and dump scam.
Much of this week’s hatchet job comes from Hedgeye’s Kevin Kaiser, a long-time Kinder Morgan bear. Kaiser values KMI at a ludicrous $13 per share, which would price it at less than accounting book value. The fact that Barron’s bothers to quote Kaiser here erodes credibility. Nonetheless, let’s dig into the numbers.
Comparing KMI to its Peers
By Barron’s estimates, KMI shares are trading at 14 times EBITDA. Using the current stock price of $26.82 and a trailing 12-month EBITDA of $3.04 (courtesy of GuruFocus), I get a multiple of just 8.8 times EBITDA. And using the more common multiple of EV to EBITDA, I get a multiple of 17.7. So, I’m really not sure where Barron’s is getting these numbers.
Ignoring that for the moment, let’s compare Kinder Morgan both to some of its large MLP peers and to some of the larger utilities, as Barron’s does:
|Stock||Ticker||EV/EBITDA (trailing 12 months)||Price/EBITDA (trailing 12 months)||Dividend Yield|
|Plains All American||PAA||10.9||5.9||8.8%|
|Energy Transfer Equity||ETE||17.0||6.1||5.3%|
The table above includes four of the largest and most widely held MLPs and the three largest American utilities by market cap. Does Kinder Morgan seem uniquely expensive compared to these peers?
Hardly. KMI’s EV/EBITDA multiple is in line with Energy Transfer Equity (ETE) and only slightly higher than Enterprise Products (EPD). Only Plains All American (PAA) is noticeably cheaper, and Plains has some highly-publicized growth issues.
The utilities stocks are significantly cheaper, but even Barron’s concedes that this should be the case given the typical slow growth of the utilities sector.
Now, I suppose you could argue that MLPs as an asset class are a bad bet. But it’s hard to credibly argue that Kinder Morgan is somehow uniquely overpriced or particularly risky. Yet that is precisely what the Barron’s article does.
What Are The Risks?
To be fair, Kinder Morgan is not without risk. Its ability to deliver on its growth targets depends on its access to capital. Because Kinder Morgan pays out most of its earnings as dividends, it has to issues debt or new stock to fund growth projects.
So, KMI’s biggest risk — in the circular logic of the market — is its low stock price itself. A low stock price makes equity issues extremely expensive and dilutive to existing shareholders. So, we could legitimately have the self-fulfilling prophecy unfold in which a falling share price actually causes growth to slow.
I don’t see that happening. In fact, I see shares doing quite well in the months ahead after the beating they’ve taken. But, unlike most of the financial press these days, I try to be balanced…
Disclosure: Long KMI, EPD, ETE