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Revival of Kinder Morgan’s stock still has a long way to go

An oil tanker arrives at the Kinder Morgan Westridge marine terminal in Burnaby, B.C.

Rafal Gerszak/The Globe and Mail

It's almost exactly a year since Kinder Morgan informed shareholders it was having a bit of a problem raising new equity. Since then, it has slashed its dividend, cut costs and capital expenditure, sold off assets and embraced a relatively novel mantra of living within its means.

That mantra will have to keep the stock going for another year.

On Wednesday evening's conference call to announce third-quarter results, CFO Kimberly Dang recalled those turbulent times in late 2015:

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The reason that we decreased the dividend primarily a year ago had to do with inefficient capital markets, and not wanting to fund expansion capex in a market that wasn't rationally pricing debt and equity securities.

It's funny how memories of anything -- even a capital crunch -- can fade into a golden haze. From another perspective, markets actually regained their rational mojo a year ago and decided that a pipeline business burdened with net debt of 5.8 times trailing EBITDA in the midst of a once-in-a-generation energy crash was perhaps not the surest thing going. Kinder Morgan, having tried in vain to get around this with a convertible preferred offering, finally cut its dividend to appease creditors and rating agencies.

The restoration of that dividend -- and, whisper it, buybacks someday -- is all shareholders really care about. Chairman Rich Kinder has spoken before about getting to that "happy sunlit meadow" of payouts and reiterated on Wednesday his optimism about raising the dividend. The stock is down roughly a third from a year ago but, like many other pipeline stocks, has rebounded from the depths plumbed at the start of 2016. Maintaining momentum, however, will require determination on the part of both the company and its investors.

The problem for Kinder Morgan is that, while it is moving in the right direction, it is pulling a load built up through years of excessive spending (back when markets really were being irrational with pipeline stocks).

Consider, in the past 12 months, Kinder Morgan has taken two drastic steps: cutting its dividend by three quarters and reducing its 2016 growth capex budget from $4.2-billion to $2.7-billion. Even with all that (and some asset sales), its net debt has dropped from 5.8 times EBITDA to just over 5.3 times.

If Kinder Morgan is to reach its target of below 5 times, raising the dividend looks unlikely through 2017. The consensus estimate for EBITDA next year is just under $7.4-billion, according to data compiled by Bloomberg. Take off $2.8 billion for interest, maintenance capex and preferred dividends, and that leaves $4.6 billion. Common dividends, at the current reduced level, swallow up about $1.1-billion, and growth capex -- again, maintained at the current reduced level -- takes another $2.7-billion or so.

All of which leaves about $750- to $800-million of free cash flow, which is great but only brings that net debt down to a projected $38 billion at the end of 2017, or about 5.2 times EBITDA.

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Roll the estimates forward another year and things look better: Using consensus estimates and the same capex figures, Kinder Morgan could afford to double its dividend in 2018 and still bring leverage down to 4.9 times. Granted, a buck a share would still be only half the level prior to last December's dividend cut, but the implied yield of 4.7 per cent would at least resemble a sun-dappled glade for most shareholders.

Ever the masters of anticipation, investors bid up Kinder Morgan's stock by about 2 per cent Thursday morning as several sell-side analysts issued upgrades.

Yet, given how finely balanced Kinder Morgan's leverage math is around that magic level of 5 times, it would be prudent for the company to perhaps overshoot to the downside, in the interests of supporting sustained dividend growth once higher payouts resume. Energy remains a volatile sector working through the excesses built up in the boom, and profit expectations can't be taken for granted. Estimates of Kinder Morgan's's EBITDA over the next 3 years have, after all, fallen by $5.8-billion, or 20 per cent, in aggregate over the past year.

We're a long way from October 2015, but there's still a ways to go before Kinder Morgan puts its past behind it fully.

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