Kinder Morgan: A 2015 Bear Selloff Redux Cannot Be Ruled Out

I have written a number of bearish articles on Kinder Morgan (NYSE:KMI) over the years, one of America's largest energy pipeline/transportation companies. My last effort in December 2021 is linked here. The problem child has always been management's aggressive use of debt. Luckily, profit margins of late have been high enough to keep things going, even as most all net cash flow after necessary capital expenditures is used to pay a 5% to 6% dividend yield annually to shareholders.

The huge spike in crude oil and natural gas prices during 2021-22 has faded over time. So, the company cannot count on any growth in sales, with energy prices moving in reverse and a recession in demand looming.

The newest concern is rising interest rates over the last 18 months are starting to pull net interest expense on debt issuance and rollovers on maturity in the wrong direction. Honestly, if interest rates stay at multi-year highs or go even higher in the U.S., Kinder Morgan will remain a meaningful investment laggard vs. the pipeline industry and S&P 500 in general. Let me explain why.

History of Weak Stock Performance

I know most writers on Seeking Alpha love the nice KMI dividend yield, and are always forecasting a turn toward higher income levels every year. But, the fact is Kinder has severely underperformed for investors, on almost any time scale. The truly rotten losses have come to those buying the stock a decade ago on promises of robust rates of business growth. All told, even with a decent cash dividend, KMI's total return has been NEGATIVE for the buy-and-hold crowd, measured from 2013.

I have drawn the awful -25% total return over the past decade below, with the S&P 500 equivalent and alternative gain of +231% pictured, alongside peers/competitors Williams Companies (WMB), Enterprise Products (EPD), Enbridge (ENB), ONEOK (OKE), Cheniere Energy (LNG), Energy Transfer (ET), MPLX LP (MPLX), TC Energy (TRP), plus the whole Energy Sector SPDR ETF (XLE).

On a 5-year historical graph, Kinder moves into a positive return at least. However, it has still lagged peers by a wide margin and the overall U.S. equity market by yet more.

On a 1-year total return basis, the same "underperformance" picture appears. For Kinder Morgan, weak relative equity performance is primarily the result of too much debt, plain and simple.

Valuation Review

When we include debt and equity capitalization minus cash holdings, the enterprise valuation of Kinder remains on the high end of the energy transportation peer group, on basic EBITDA. I prefer to buy businesses sitting on the low end of industry-wide valuations, with some sort of growth outlook.

Plus, the trailing dividend yield of 5% was actually on the lower end of the industry spectrum for investors. Why not just buy a Treasury security yielding 5% in the 1-year range, and leave price risk off the table?

The one saving grace for the stock quote during 2022 and early 2023 was slightly better-than-average margins of 14% on sales. The biggest ownership issue to be faced during the rest of the year is margins have likely peaked and are set to decline rapidly. Why?

The Debt Problem

Here's the rub. Interest rates are rising and such will add to Kinder Morgan's cost structure, all other variables remaining the same. But there's a double whammy also at play. Energy prices peaked in the first half of 2022, which should translate into declining sales at the company the remainder of 2023 and all of 2024.

Per usual, Wall Street analysts seem content overestimating the impact of each on future operating results. The consensus forecast is sales will stagnant, while earnings magically rise for no good reason into 2025.

One hint of trouble ahead is total interest expense is now on the rise with higher refinancing costs. Although total net debt has declined from $37 to $31 billion over five years, climbing interest expense won't improve margins for the company, just the opposite. You can review the substantial ramp in overall interest rates paid on debt from 4.5% a year ago to 5.2% today. The bad news is this rate squeeze on margins may continue for a few years, as debt matures and is refinanced at higher cost levels.

Debt maturing in 2023 amounts to $3.2 billion, with another $2 billion due to be refinanced or repaid in 2024. If you want to take a bullish slant, assuming the company has no new projects to finance (which they do), rolling the debt over to today's interest rate regime will only add $50 to $100 million in extra company expense per annum this year and next.

My biggest worry is holding one of the lowest ratios of cash flow coverage vs. debt is not the place to be going into recession. A major drawdown in margins will likely knock operating cash flows dramatically in the wrong direction, going into 2024, before the negative effect of rising interest expense comes into full view.

2015 Disaster Revisited Soon?

My thinking is we could be headed for a worst-case scenario for Kinder of falling sales AND rising interest expense. The last time such a situation unfolded was 2015.

You can review for yourself below how Kinder's share price cratered on far lower profitability. Basically, price imploded by greater than 60% into early 2016. For reference, company sales fell -20% and reported income by -80% between the end of 2014 and middle of 2016.

We could be in for a similar tough sled for the stock quote over the next 6-12 months, assuming energy prices do not recover and interest rates stay elevated. Don't say it cannot happen. The current chart pattern is showing truly bearish signals of late. Shares are sharply underperforming the S&P 500 in calendar 2023, with price now trading underneath the important 50-day and 200-day moving averages, as both MAs trend lower for direction.

Final Thoughts

All the negative forces that affected the business during 2015-16 may be reappearing in 2023. Of course, a deep recession and even lower oil prices would be horrific news for Kinder Morgan shareholders over the next year. The squeeze on profit margins could bring results back closer to breakeven for income rather quickly.

Q1 2023 results may be a harbinger of trouble ahead, with a -7% drop in sales and +2% increase in net income vs. the 2022 March quarter. Analysts are calling for a YoY drop in income for each of the remaining three quarters of fiscal 2023. Rising interest costs on debt and a material drop in energy prices are hurting margins.

With net income barely covering the dividend payout over the past year, a recession now could damage the stock quote more than competitors. Any downturn in operating profitability means management will have to borrow additional funds or sell assets to continue paying today's dividend rate (with little cash on hand and a negative number for working capital), similar to its mode of operation for years.

My view is Kinder is chock full of "risk" right now. I rate shares a Sell if you own a position, and an Avoid if you are contemplating buying the stock for its 6% forward projected dividend yield.

Based on rearview mirror stats, Seeking Alpha has a Quant rating slightly better than the average equity.

But, selling could erupt quickly on the likelihood of U.S. economic contraction, as natural gas & crude oil demand/prices have the potential to slide yet further. (My feelings are more neutral about immediate spot energy commodity pricing this summer, with bullish and bearish forces roughly equal in weight. But this forecast is subject to change, based on GDP direction.)

What could prove this bearish KMI forecast wrong? Basically, the opposite of current reality. Rising petroleum/gas prices in combination with a major decline in interest rates could support the Kinder share price in a $15 to $20 range. Nevertheless, this looks to be a unicorn-world type bet today. You may have stronger odds putting money down on the Kansas City Royals or Oakland Athletics to win a game, with the worst records in professional baseball.

Statistically speaking, Kinder is facing an uphill battle to generate a positive total return in my view, including both price appreciation and dividends, over the next 6-12 months. Significant total return underperformance of the S&P 500 over the intermediate term should continue.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.