Energy stocks have hurt investors in 2020 due to low crude oil prices and tepid demand amid the COVID-19 pandemic. While broader markets including the S&P 500 have staged a comeback in the past few months, energy companies continue to trade at multi-year lows. However, this also provides an opportunity to buy quality stocks at beaten-down valuations.
Here we look at one such stock that is trading at compelling multiples. Kinder Morgan (NYSE: KMI) is one of the largest providers of midstream energy infrastructure in the U.S. The company transports products like crude oil, refined petroleum, natural gas, CO2, condensate, and other products through its pipelines spread across 83,000 miles.
Kinder Morgan also houses other liquefied chemicals and petroleum products in its 147 owned terminals. Nearly 40% of the natural gas that the U.S. consumes is transported through Kinder Morgan pipelines and additional expansion is underway. To date, the energy giant has invested close to $32 billion on establishing an extensive network of natural gas pipelines.
Business model centered around natural gas and LPG
Though Kinder Morgan stock has lost more than 38% since January 2020, it has a strong business model and is worth holding on to. The company’s focus on natural gas is its biggest strength and should keep it relatively safe from the prevailing energy market volatilities. Kinder Morgan undertakes a lot of long-term contracts that result in recurring revenue and stable cash flows.
Due to the unusually warm weather, there is increased demand for electricity and coolants like air-conditioners. Natural Gas and liquified natural gas (LNG) are the most desired fuel for this reason in 2020. The exports of these two forms of energy products have climbed and Kinder Morgan is well-positioned to capitalize on it.
In August, the company purchased Movable Modular Liquefaction Unit 7 as a part of its Elba Liquefaction Project. It's total capacity of LNG for export stands at 2.5 million tons per annum.
Long-term contracts in the pipeline
Talking of long-term contracts, Kinder Morgan’s proposed project, Permian Highway Pipeline (PHP) holds immense potential. The company has pinned high hopes from this $2 billion pipeline project.
The PHP project is expected to provide surplus transportation of natural gas to the U.S. Gulf Coast. The capacity of transportation for this project is pegged at 2.1 billion cubic feet and is set to commence in the initial months of 2021. The long-term agreement project is already fully-subscribed and has created prospects for predictable cash flow streams, helping Kinder Morgan sustain its dividend payout of $1.05 per share.
Maintaining balance sheet strength is challenging
As the energy sector is going through a phase of low demand, Kinder Morgan has to address a set of challenges. The company looks over-leveraged at this point. At the end of the second quarter, the company’s cash and cash equivalent stood at $526 million, which is insufficient to service its short-term debt at $3 billion. Its long-term obligations at the end of June quarter is also a whopping $ 30 billion.
Due to the outbreak of the COVID-19 and subsequent lockdown measures, energy demand has dwindled globally. The industry is impacted by oversupply which means Kinder Morgan has to resort to lower investment on its projects, at least in the near term.
As a result, its fee-based revenue is most likely to be impacted. Kinder Morgan expects a 9% drop in its EBITDA in 2020. Its distributable cash flow (DCF) is also likely to show an 11% decline for this year owing to the industry weakness.
However, it is noteworthy that Kinder Morgan is aware that it is walking a tightrope and plans to take action accordingly. The company has indicated that it wants to focus on a stronger balance sheet to retain investor trust and continue paying dividends. The midstream giant also plans to stay away from any acquisition currently.
With a dividend yield as high as 8%, Kinder Morgan is an attractive bet for income investors. The company aimed to pay $1.25 per share dividend in 2020, but its annual payout stands at $1.05 at present.
It is unlikely that Kinder Morgan would be able to fulfill its objective. However, it is praiseworthy that the company has still been able to raise its dividend by 5% annually.
Kinder Morgan's focus on natural gas and LPG will help it weather the ongoing storm. The company is taking concrete steps to preserve its cash balance for repaying debt and dividends. With robust long-term contracts under its belt, Kinder Morgan will gain momentum over the long-term.
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