Kinder Morgan: Becoming A 'Dividend Aristocrat' With An Excessive Valuation Premium

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Natural gas has become the dominant power source in the US, with Kinder Morgan benefiting from stable production and higher export demand.KMI's stock price has risen 40% this year, outperforming its ...

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It has limited growth potential and more focus on dividend stability and cash flow.Although reasonably priced, KMI's lower dividend yield makes Energy Transfer a more attractive investment for higher returns and similar risk.Expectations of higher natural gas consumption due to AI seem quantitatively unfounded. Nuclear plant closures and slow renewables adoption will likely improve natural gas consumption by 2030-2040.wolv Kinder Morgan (NYSE:KMI) announced its Q3 earnings Wednesday afternoon with a small $0.02 EPS miss at $0.25 and a revenue miss of $360M, down 5.6% YoY. As of Thursday morning, the market reacted fine to that news, with KMI rising 1.1% at the open. On the positive side, its dividend is now $1.15 annualized, up 2% YoY, while its gross margin is up 7% from last year. Its forward guidance is essentially unchanged, with the company expecting to maintain its CapEx budget, leverage, and growth targets over the next year, reflecting a continued trend toward fewer acquisition and development projects and greater free cash flow. Despite minor improvements to natural gas fundamentals in 2024, KMI has broken sharply to the upside, rising over 40% this year, with a staggering 16% rise over the past month. As a result, its forward dividend yield has compressed to 4.6%. Midstream MLP ETF (AMLP) has only increased by 10% this year. Although strong, the C-corp KMI has dramatically outperformed its primarily MLP competitors. Accordingly, KMI deserves closer analysis to determine if its breakout is founded on a growth or value opportunity or is based on excess investor speculation. Natural Gas Midstream's \"Stability Era\" Natural gas has become the dominant power source in the US. Since June, the fuel source has accounted for 46% of all US electricity supply as demand accelerates faster than expected, likely due to higher interest rates. Generally, higher borrowing costs promote natural gas generation, while renewables benefit from low rates due to higher upfront costs. At any rate, the long-term \"energy transition\" trend is primarily from \"dirty\" fossil fuel sources like coal toward more efficient natural gas. This transition was extremely rapid during most of the 2000s and 2010s, with production growth slowing markedly since 2020. This is seen in both production data and the natural gas rig count, which indicates future production growth levels: Data by YCharts Although it may be surprising, the 2010s period was not ideal for most natural gas companies, such as producers and midstream firms. Midstream companies, like Kinder Morgan, profit from transporting natural gas through pipelines across North America. Although the 2010s saw immense expansion of the North American natural gas pipeline network, that created a tremendous glut in the broader fossil fuel market, leading to lower fee revenues and volume volatility. Further, the race to expand quickly led many, such as Kinder Morgan, to take on excessive leverage, often at abnormally high interest rates. The slow-growth period since 2020 has led to maturity and stability for Kinder Morgan and most midstream firms, despite the sharp decline in natural gas prices since 2022. That is partly due to consistently higher US natural gas exports to Europe, offsetting lost Russian supplies. Given the state of the sabotaged Nord Stream Pipeline and global relations, I expect this to be a semi-permanent change that continues to benefit midstream firms. Kinder Morgan is not solely a natural gas transportation company. That accounts for around 57% of its business, while 26% comes from refined products. The remaining split is between CO2 transportation (as a byproduct of extraction) and natural gas gathering and processing. Roughly 68% of its contracts are \"take-or-pay,\" while 27% are fee-based. The remaining 5% are the riskier commodity-price-based contracts. \"Take-or-pay\" contracts are the most stable because they do not lose revenue if volumes decline; they're essentially \"rent\" for a specific capacity level. In contrast, fee-based revenues will rise and fall with fuel production and consumption levels. The relationship between natural gas prices and midstream revenues is often misunderstood. Historically, this is a positive relationship wherein higher natural gas prices promote production growth, improving transportation demand. However, low natural gas can encourage more utilities to seek natural gas, increasing demand, even if that hampers supply growth. I believe we're now in the latter situation, as the natural gas supply is not growing in the US. Still, demand is due to higher interest rates, slowing renewables, and ultra-low natural gas prices. Thus, the correlation between KMI's returns and natural gas, through the fund (UNG), waxes and wanes depending on market dynamics. The correlation has been positive since 2022, when natural gas export demand rose markedly, but has fallen toward zero since lower natural gas prices have only hampered supply growth, but not overall supply, and have likely further improved demand. See below: Data by YCharts I believe this situation may be the \"new normal\" for natural gas. The immense production growth period of the 2010s is firmly over, replaced by stability as natural gas becomes the dominant power source. I expect this trend will continue as coal continues to be phased out and potentially accelerated by nuclear power plant closures. As Kinder Morgan points out, natural gas demand may rise due to AI improving electricity demand. I am not convinced of that, as AI currently uses just ~8 TWH, or around two-thousandths of the US's overall 4K TWH demand. I estimate that it would require a 100X increase in AI power consumption to materially increase electricity demand enough to generate notably higher revenues for KMI. That would take time, likely offset by efficiency improvements that lower electricity demand. For me, the aged nuclear power plants and efforts to reduce coal consumption are the most apparent positive catalysts for growth in natural gas consumption. Of course, natural gas consumption can only rise as pipelines continue to be expanded. In recent years, we've seen increased pushback against pipeline construction, most recently in Tennessee's Kinder Morgan project. Although this directly hampers KMI's growth efforts and increases its costs due to regulatory requirements, I do not think anti-pipeline efforts are necessarily bearish for Kinder Morgan as they might increase market power. Of course, the regulator FERC mandates minimum and maximum fees to limit KMI's ability to raise rates given a pipeline shortage; however, fees are still rising due to higher inflation, while FERC has arguably reduced the ability for shippers to contest rate increases by changing how it accounts for abnormal rates. The impact is negligible, indicating higher fees likely account for more significant costs. KMI's operating income is relatively stable and is no longer rising. Despite reductions to its overall debt leverage, its total interest costs still absorb around 44% of its operating income. See below: Data by YCharts Importantly, because the market is slowing and stabilizing, Kinder Morgan is spending less on capital expenditures and growth, which often require external financing. As a result, its revenue per share has stagnated, but its cash flow per share is rising: Data by YCharts KMI is not an MLP, so it need not pay its cash flows out as dividends. Hypothetically, that may allow KMI more significant growth potential by reinvesting its dividends. Its dividend per share is around $1.14 annually, which could be doubled or more without compromising its cash position. That said, its depreciation is about $2.3B TTM or just over $1 per share. Realistically, the company cannot pay out all its cash flows as some of its income must go to maintaining its physical capital. The Bottom Line Compared to past years, I think it is best to see KMI as more of a dividend aristocrat than a growth company. There is still some potential for growth in the natural gas industry, but far less than there was two decades ago. The analyst consensus does not expect substantial revenue growth from KMI over the coming four years, with the most growth potential likely coming from creative acquisitions. That said, acquisitions can only improve KMI's income if they lower costs compared to sales, as its ability to exercise market power is limited by FERC. Still, its EPS is expected to rise to ~$1.60-$1.70 by the decade's end, giving it a long-term forward \"P/E\" of ~15X. Though its sub 4% dividend yield is better than most stocks, it is lower than the 7.7% found in the midstream MLPs of (AMLP). Those firms must pay higher dividends; however, I think that points to KMI being potentially overvalued as it does not fundamentally differ significantly from its peers. KMI is more extensive but does not substantially improve its market power. In my view, its valuation premium may be justified by its greater ability to exercise economy of scale by reducing costs on acquired and developed pipelines. Yet, it has not significantly improved its margins or interest cost over recent years.  Although I believe KMI is roughly fairly valued, I think most investors are better off in other midstream investments with higher dividend yields. Energy Transfer (ET) has a 7.8% yield with nearly identical stock price volatility and size as KMI. Indeed, of the oil and gas transportation and storage companies with market capitalizations over $10B, KMI is among the most highly valued. Even then, many midstream stocks seem to rise due to the AI buzz around natural gas demand. To me, that is poorly grounded, given AI power use is still extremely low. Thus, I am neutral on KMI but see it as a decent long-term portfolio investment, with Energy Transfer likely a better bet.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.0","shortVersion":"4.29.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2476107922"}