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Let’s look through Kinder Morgan (NYSE:KMI) and their Q2 earnings report, which came out on July 19. I listened to this live through the earnings call and want to bring some things to light. We’ll discuss the revenue/ distributable cash flow (“DCF”) miss, their reduction in outlook, and their new outlook. As well as the problems with the company, and why you may or may not be interested in them.
My thesis here is essentially that they’re large and immovable. KMI can’t really execute well on any growth opportunities, but by the same token they aren’t likely to really lose any market share. There’s an opportunity here for the pure income investor, but someone looking for capital appreciation may want to look elsewhere.
Before we get to the call, it’s necessary to explain a bit about the company so you understand all the variables in play – in case you aren’t already deeply familiar with it.
Kinder Morgan Overview
Kinder Morgan is one of the largest energy infrastructure companies in North America – and is in fact the largest energy infrastructure firm in the S&P 500 (SP500). Kinder Morgan is a midstream energy transport and storage company and has an interest in or operates approximately 82,000 miles of pipelines, 140 terminals, and 700 billion cubic feet of working natural gas storage capacity.
Kinder Morgan’s pipelines transport natural gas, refined petroleum products, renewable fuels, crude oil condensate, CO2, and other products. Additionally, the company’s terminals store and handle various commodities including gasoline, diesel fuel, renewable fuel feedstocks, chemicals, ethanol, metals, and petroleum coke.
Operations & Business Segments
Kinder Morgan is the largest independent transporter of petroleum in North America. The reach of Kinder Morgan is massive, with pipelines that stretch from the east coast to the west coast and from Canada to the Gulf of Mexico.
They have multiple business segments within the midstream sector including pipelines, treating facilities, terminals, LNG and RNG, and more. Additionally, the company has 7 major projects planned that will bring a large amount of additional capacity.
Products Pipelines
The company’s pipelines carry an incredibly diverse range of oil & gas products and deliver to just about every part of the country, transporting approximately 2.4 million barrels per day.
A great majority of these petroleum products are moved through the company’s products pipeline business, which moves gasoline, jet fuel, diesel, crude oil, and condensate through about 9,500 miles of pipelines.
On top of the impressive pipeline infrastructure, Kinder Morgan also has approximately 65 liquids terminals that store fuels and offer blending services for ethanol and biofuels.
Natural Gas
With approximately 70,000 miles of natural gas pipelines, Kinder Morgan owns or operates the largest natural gas network in North America. The company’s pipelines run to all the major domestic market hubs and Kinder Morgan impressively supplies around 40 percent of all the natural gas consumed in the United States.
Investors should note that the company’s pipelines are also connected to every important natural gas resource play in the U.S. – including the Eagle Ford Shale, Marcellus Shale, Bakken Shale, Utica Shale, Haynesville Shale, and Barnett Shale. In addition to the pipeline network, Kinder Morgan also owns around 700 billion cubic feet of working gas storage capacity.
Terminals
The largest independent terminal operator in North America is once again Kinder Morgan. The company has a network of 140 terminals that provide customers with storage, distribution, blending, and logistical needs.
The company’s terminals store and handle renewable fuels, petroleum products, chemicals, vegetable oils, and other products. Combined liquids storage capacity with the terminals is approximately 151 million barrels and Kinder Morgan terminals handle around 59 million tons of dry bulk materials annually.
In the event of a recession and declining commodity pricing, this storage capacity would become highly sought after and Kinder Morgan could easily charge a premium for it. This just adds a further bit of recession resistance to an already stout company.
Treating
Not only does Kinder Morgan have an enormous footprint in the transport of oil and gas, but the company also is a leading manufacturer of contract-operated natural gas treating plants in the United States. The company designs and manufactures treating and processing plants in its three shops in Texas.
These treating and processing plants are used to make the crude oil and natural gas that is coming out of the ground into sales pipeline specifications for downstream markets. In other words, these plants treat and process the commodity so the commodity will have the properties of whatever specification is required for refining.
Kinetrex Energy
Kinetrex Energy is a Kinder Morgan-owned company that provides renewable natural gas and liquid natural gas to customers. The company processes landfill gas (a natural byproduct of decomposing organic materials in a landfill) and processes it to pipeline grade for end-use. In other words, instead of the methane escaping into the air at landfills, Kinder Morgan captures the landfill gas and process it for end-use.
Customers might want RNG to meet sustainability targets as it is an effective way to reduce emissions and meet regulatory standards. Alternatively, the company also provides liquified natural gas for customers to use in their industrial facilities, transportation fleets, or even asphalt plants.
Kinder Morgan Q2 Earnings Call Analysis
Note: The following section was written while listening to the conference call, and without benefit of a transcript to refer to.
They started off the call talking about their revenue miss (-32% YoY) and drop in DCF (-8% YoY); it was caused because of reduced commodity pricing for the most part. They forecast revenue to be slightly lower than planned for the year due to planned revenue including crude pricing at $85/bbl and natural gas at $5.50 per MMBtu – prices which the commodities are failing to hit.
It’s obvious that commodity pricing is a serious headwind. Company executives suggested in the call that some of their good performance year to date has to do with their ability to take advantage of price volatility – for example, using their storage facilities (which they will continue to do). They were reluctant to specifically answer whether we’d see the same reduction in revenue in the back half of 2023 beyond the guidance in their press release.
In midstream, they’re seeing the worst demand issues going on in the Haynesville. In that play they’re seeing a lot of producers reduce drilling and production – but they see the producers continuing to expect increasing NG prices in the future (something that the contango in NG futures currently would support). In other shale plays, like the Eagle Ford, they’re beating transport numbers.
Interestingly, despite the drops in overall revenue and DCF, their natural gas segment has actually seen some increases in transport and gathering. From the press release:
Natural gas transport volumes were up 5% compared to the second quarter of 2022, primarily from increases on EPNG due to returning a pipeline to service and the retirement of a coal-fired power plant, and on our Texas Intrastate system across a variety of existing shippers and new contracts, partially offset by reduced volumes on TGP. Natural gas gathering volumes were up 19% from the second quarter of 2022 across most of our systems.
Of course, being that this is a midstream company, the overall revenue results don’t matter all that much. We’re a bit more interested in distributable cashflow, since most people buy these things for the dividend. So is that DCF drop of 8% worrisome? Personally I don’t think so, it’s explainable and unlikely to continue in 2024.
They’ve had numerous projects come into operation – projects from Kinetrex, for example, although slightly later than planned. They expect a good return, even though it’s later than expected.
It’s worth noting that they have a large backlog of projects at the moment. They don’t expect to catch up on that backlog any time soon, and are strategically choosing which to pursue in order to maximize returns in this current environment.
Now that backlog of projects is an issue. They’re spending so much on CapEx trying to get these things done that it’s a drain on their balance sheet and DCF.
To round out the call, it’s worth noting that the dividend continues to increase at +2% YoY. They also continue to repurchase shares, with 20M shares repurchased so far this year. They plan to continue repurchases opportunistically. They still have ~$1.73B of repurchase authorization remaining.
Conclusion
Kinder Morgan is vertically integrated within the midstream sector and is one of the “majors” in North America. The company has an enormous footprint and is quite literally too big to fail. Not only does Kinder Morgan transport crude oil and natural gas from the wellhead to refineries, but the company also delivers end-use products to customers all over the country.
With a diverse yet complimentary range of services, products, and infrastructure, the company is well positioned in the midstream market to absorb any potential effects of an economic downturn.
In the event of a recession, the company should be more shielded from negative effects than most oilfield companies, as Kinder Morgan’s services and infrastructure are mission-critical to virtually every consumer in every part of the country, and most of the company’s revenue is fee-based.
In the event of commodity price drops, investors can expect the company’s vast storage facilities to be used even more, with the increased storage revenues likely offsetting any decline in transport revenues.
Furthermore, Kinder Morgan dominates the natural gas world in the midstream sector, and with the pricing and global demand for natural gas expected to continue to increase over the next 10 years, the company is in a fantastic position for continued growth.
Make no mistake, Kinder Morgan is here to stay and they aren’t going anywhere.
So far, they probably sound pretty great. But underneath the shiny exterior there are some problems with Kinder Morgan.
First off, their overstated guidance for the year. That can be chalked up to simple error in commodity pricing forecasting, but out of every other company I’ve researched in O&G, KMI has had the highest forecast that I’ve seen recently. If we get a recession, then it’s highly unlikely we’ll see an $85/bbl average this year for crude.
Even without a recession, it’s a touch on the high side. Whenever I do projections for clients, I always understate what I believe will be produced in order to ensure my clients are taken care of. If they need $X a month to live, then I get them to that point with a 3% return projection – then nail it out of the park with a much higher return in their income portfolio. That sort of thing. You always want to guess low and that’s what most of these companies do in their forecasting.
By putting so much weight on an oddly high forecast, they really overstated where they expected to go for the year. Now, with lower pricing, they’re seeing lower demand for their services and products.
Now, here’s the thing. There’s a big contango in Henry Hub futures right now, with it predicted over $4 by the end of 2024. I think that’s very accurate. So while their forecasting for 2023 was wrong, it might be right for next year.
Kinder Morgan has everything in place to see good growth. Their trouble is execution. They haven’t shown that they have the ability to execute on that growth potential and have remained stagnant for many years.
That doesn’t seem to be getting any better at the moment. The project backlog is still huge, and doesn’t seem to have any big game changers in the works (like Energy Transfer’s Lake Charles facility, which I previously wrote about and gave a buy rating).
Now, is Kinder Morgan going to fail? Nope, not at all. As I stated, I think they’re way too big to see any sort of decline in the long term. But they are also stagnant, and are not growing. So when I say they aren’t going anywhere, I really mean it.
If you want a company that will reliably pay the dividend over time, then I think Kinder Morgan is fine to add to a portfolio. But I also don’t expect to see any capital appreciation here. Not until they can ditch the backlog of projects and focus their CapEx to really get some growth.
Until they can properly execute, I don’t think the stock price is going back above $20 for any length of time. Investors want to see something really happening here, beyond the dividend payments and share buybacks (which are a nice touch).
If all you want is a company to pay dividends, then KMI is a good choice and that’s why I give it a buy. If you’re looking for capital appreciation to go along with your dividends – or you’re purely focused on capital appreciation with no regard for income – then you should look elsewhere.
