Is Kinder Morgan Inc’s 7.5% Yield Safe?
Most high-dividend stocks don’t pay reliable distributions.
In fact, out of every 10 high dividend stocks that cross my desk, around nine end up in the wastebasket. These businesses usually suffer from a combination of falling sales, tight margins, and heavy debt load.
And, by and large, this tends to result in predictably bad consequences for shareholders.
Yet, every so often you stumble across an exception. And today’s high-dividend stock, which sports an impressive 7.5% payout, should inspire confidence, at least as far as the distribution is concerned.
Kinder Morgan Inc (NYSE:KMI) is a master limited partnership (MLP) that owns dozens of oil and gas pipelines, in addition to many processing plants and storage terminals.
This type of business has fallen out of favor with Wall Street, given the overall doom and gloom surrounding the energy patch. But the pipeline business has historically thrown off plenty of cash flow, which has resulted in ongoing dividends for unitholders.
But will the same thing play out in the current cycle? Let’s dive into the financials.
Admittedly, Kinder Morgan Inc had been struggling even before the recent downturn in the oil industry.
Management took on copious amounts of debt to finance an aggressive expansion plan. That bet backfired when cost overruns and lower volumes clipped profits.
As a result, executives slashed the distribution to shareholders. In 2015, management cut the dividend 75% in a bid to conserve cash. That soured the partnership’s reputation with Wall Street and put it on many income investors’ “Do Not Buy” lists.
But behind the scenes, Kinder Morgan Inc has quietly cleaned up its act.
Management has slashed costs and sold off underperforming businesses. Executives have also scaled back their expansion plans, focusing instead on only a handful of key projects and milking existing assets for steady cash flow.
The dividend cut has also allowed the partnership to tidy up its balance sheet.
At the end of 2016, Kinder Morgan Inc had a jaw-dropping $37.4 billion in long-term debt. But today, this figure stands at less than $31.9 billion.
This combination of lower costs, more cash flow, and smaller interest payments has turned the business into a money machine.
For 2020, management has estimated that the business would generate $4.59 in distributable cash flow. Over that same period, Kinder Morgan Inc is on track to pay out $1.05 per unit in distributions. (Source: “Kinder Morgan Announces $0.2625 Per Share Dividend and Results for Second Quarter Of 2020,” Kinder Morgan Inc, July 22, 2020.)
As a rule of thumb, I don’t like to see a business pay out any more than 90% of its cash flow as dividends. This leaves management with a little bit of financial wiggle room and ensures there’s enough money left over to invest and grow the business.
In the case of Kinder Morgan Inc, the partnership’s payout ratio comes in at less than 25%. This indicates that the business doesn’t just generate enough cash flow to continue paying shareholders; we could, in fact, see executives announce another distribution bump in the not-too-distant future.
That makes this high-dividend stock one of the few safe seven-percent yielders around.