Kinder Morgan(NYSE: KMI) pays one of the highest-yielding dividends in the S&P 500. At 6.1%, it's several times above that broad market index's average of around 1.4%. The big-time payout is on a very firm foundation, thanks to the company's steady cash flow and conservative financial profile.
The natural gas pipeline giant recently showcased its commitment to maintaining a conservative financial profile by adjusting its targeted-leverage ratio. Here's why that move could pay big dividends for investors in the future.
Adjusting the target
Kinder Morgan unveiled in its first-quarter earnings report that it's adjusting its long-term leverage target. It's moving the goal from around 4.5 times net debt-to-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to a range of 3.5 times to 4.5 times. The company noted that this change is more of a reflection of how it has operated over the past several years. It believes this is an appropriate target range for a company that operates high-quality energy-infrastructure assets that produce stable, fee-based cash flow supported by long-term contracts.
The company ended the first quarter well within that range at 4.1 times. That's despite borrowing money to fund most of its $1.8 billion acquisition of STX Midstream. That deal, which closed at the end of last year, will add roughly 0.1 times to its leverage ratio this year. However, despite that debt-funded deal, Kinder Morgan expects leverage to end this year at around 3.9 times, driven down by its rising earnings and excess free cash flow.
That year-end target assumes the company won't opportunistically repurchase shares or make another acquisition. While it didn't buy back any stock during Q1, it repurchased $522 million of its shares last year. It currently has $1.5 billion remaining on its share-repurchase authorization.
Why keeping leverage lower could pay big future dividends
Kinder Morgan's management team made it clear on the Q1 conference call that the adjustment in its targeted-leverage ratio wasn't due to a strategy shift. CEO David Michels stated, "We think that this 3.5 to 4.5 is more reflective of where we've been operating and how we'll continue to operate the company going forward."
However, publicly lowering its stated leverage target could have a couple of notable benefits. Michels noted on the call that rating agencies and some of its fixed-income investors likely viewed the 4.5 times target as a goal the company intended to reach. In other words, they thought Kinder Morgan would eventually increase leverage to that targeted level. By adjusting the target to its current operating range, the company believes rating agencies and fixed-income investors will view it more favorably. The lower range suggests the company will continue to be more conservative. That could help decrease its borrowing costs. It might also boost its valuation since it implies its high-yielding dividend will remain on rock-solid ground.
Meanwhile, the company's decision to continue operating in a lower range ensures it will maintain ample financial flexibility. That means the company will have the capacity to flex up if a compelling opportunity presents itself, like an acquisition or large expansion project. Kinder Morgan could pounce on a sizable opportunity without significantly impacting its financial position.
That was the case last year when it bought STX Midstream. It acquired the Texas natural gas pipeline portfolio from NextEra Energy Partners, which needed to sell to help shore up its financial situation. Kinder Morgan was able to use its ample financial capacity to buy assets that are an excellent strategic fit. The deal is also immediately accretive to its cash flow and will be even more so over the long term as the company captures commercial synergies. Meanwhile, it still has plenty of flexibility to make another acquisition.
Fiscal conservatism should continue paying off
Kinder Morgan is publicly adjusting its stated leverage target. While it's not changing its strategy, the range will make it abundantly clear that the company plans to remain conservative. Emphasizing that it will only flex up if the right opportunity presents itself could help lower its borrowing costs and lift its valuation. Furthermore, it suggests that the company will have the capacity to pounce when the right opportunity arises, while also giving investors confidence that its big-time payout will remain on a very firm foundation. As a result, Kinder Morgan should have enhanced appeal to more conservative, income-focused investors.
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Matt DiLallo has positions in Kinder Morgan and NextEra Energy Partners. The Motley Fool has positions in and recommends Kinder Morgan. The Motley Fool has a disclosure policy.
