Kinder Morgan’s growth engine is running out of gas
North America of the energy sector the growing days seem to be in the rearview mirror. At least that’s the opinion of the leaders of the pipeline giant Kinder Morgan (NYSE: KMI) as they discussed what they saw in the future during his second quarter conference call. This grim prospect of organic expansion will likely force the company to consider alternative strategies to create shareholder value in the years to come.
Reach the top faster than expected
Kinder Morgan founder Richard Kinder provided investors with a frank view of what the company now envisions:
Beyond 2020, we believe that we are operating in a mature industry and that our opportunities for viable expansion projects will likely be significantly less than we have seen in recent years. If this expectation turns out to be correct, it will likely reduce our growth potential, but allow us to manage significant cash flow that we can use to increase our dividend, pay down debt and / or buy back stocks on the right terms.
As Kinder notes, the company does not plan to move forward with as many organic growth plans in the future compared to the recent past. This is due to a combination of factors, including an overabundance of supply and a series of legal setbacks that have delayed projects and caused several cancellations.
CEO Steven Kean noted that the company “has previously spoken of being in the range we’ve been in for about 10 years of $ 2 billion to $ 3 billion per year in capital expansion opportunities.” However, due to the slowdown in the energy market, it only plans to invest $ 1.7 billion this year. While the company isn’t sure yet on next year’s figure, Kean suggested it might “stay at the level we’re seeing in 2020, maybe a little less.”
With the company generating $ 4.5 billion to $ 5 billion in annual cash flow and paying out about $ 2.5 billion to shareholders via dividend, it is on track to produce significant free cash flow next year after funding investment projects. As Kinder pointed out, he could return those funds to investors or pay off the debt. The problem with either scenario is that investors place a high priority on growth, which Kinder Morgan will struggle to deliver given its dramatically reduced growth spending rate.
As North American oil and gas production peaks, Kinder Morgan is running out of organic growth opportunities in the middle sector. However, this does not mean that the business will not grow at all in the future.
One option he will likely consider is acquisitions. Kinder noted that the company’s size, attractive assets and relatively strong balance sheet position it to be a “potential consolidator in the middle zone.”
For the business to take this route, a target would need to meet two main criteria. First, Kinder said it would not pursue a merger and acquisition transaction “to the detriment of our balance sheet.” Thus, it would either have to push its leverage ratio below its target level before making a deal, or find an under-indebted rival. Second, Kinder said that a transaction “should be profitable for our distributable cash flow.” While these are significant hurdles, Kinder Morgan could use acquisitions to increase profits and dividend going forward.
Another potential option the company might consider is to invest in renewable energy, either by acquiring or developing power generation assets or transmission lines that connect these projects to the power grid. Two of his biggest rivals, TC Energy (NYSE: TRP) and Enbridge (NYSE: ENB), have major energy companies. While TC Energy has sold its renewable energy assets in recent years to help finance further expansions, it continues to invest in the electricity sector, primarily nuclear and natural gas power plants. Meanwhile, Enbridge has a growing renewable energy business focused on developing offshore wind farms in Europe. It currently plans to invest Can $ 1 billion ($ 750 million) per year in renewable energy. While the global economy should spend billions of dollars building new renewable energy capacity in the years to come, there will be no shortage of investment opportunities for a company like Kinder Morgan that has the cash to invest.
Kinder Morgan needs a new growth strategy
Kinder Morgan initially expected that she would have no problem finding $ 2-3 billion in organic expansion opportunities each year, which would give her the fuel to continue growing her cash flow and its dividend. Unfortunately, that is no longer the case, as North American oil and gas production has peaked in the near term. It is also becoming nearly impossible to move forward with new pipeline projects, leaving Kinder Morgan’s growth engine to run on steam. It will either remain in a low growth state or will have to change its fuel source. While on a brighter note, though it may not appeal to growth-oriented investors, its dividend of over 7% should more than satisfy income investors in this low interest rate environment.
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