Kinder Morgan: when will the falling knife land?

I’ve been learning a bit of a lesson in the need to analyse stocks recently. The teacher? Kinder Morgan Inc (KMI).

There’s been a lot that I like about KMI which means I’ve been taking opportunities in recent weakness to top up. Things I like include:

• Its founder and Exec Chairman Richard Kinder is a big shareholder. He takes $1/year. This means he really likes dividends.
• The company’s business model, operating energy infrastructure like pipelines (it has 84,000 miles of them), is very stable and cash generative. This thesis has been tested recently due to very low commodity/energy prices, but in theory KMI’s revenues will be almost unaffected. It is a ‘picks and shovels’ business, helping ‘gold diggers’, i.e. not affected too much by ‘the price of gold’. Its recent results illustrate this nicely; natural gas sales have fallen by a third year-on-year, to 20% of total revenues, but its services revenues, which account for 60% of its business, have fallen by only 2%.
• Very strong dividend policy. The company increases its dividend every quarter. And has been committing to 10pc annual increases until 2020.

So far, so good. So why has the stock price fallen almost in half, to a level where its dividend yields 9pc? I recently went through the annual report looking for answers.

I found a pretty clear answer for why the stock has been pummelled. In a word, cashflow. The recent dividend cost $3bn. And the company funded it how? By selling $3.8bn of shares, and issuing $0.5bn of net debt. Its operating cash flow of $3.5bn covered the $3bn of capex couldn’t then also fund the $1.8bn of acquisitions.

The underlying operating picture looks OK but the optics of selling shares to pay a dividend suddenly make Richard Kinder’s dividend policy look not so much textbook shareholder alignment as a way of shifting money from new shareholders into his pocket.  It also means that conventional metrics of dividend yield and earnings cover tell you almost nothing about the business.

Caveat emptor.