Kinder Morgan (KMI) Can Be Kind To Our Portfolio As A Stable Income-Generator
10 Nov 2021 11:00 AM EST
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With the overall market at all time high, tech/growth stocks have been on a tear, we have been taking profits and now have a very heavy cash position. While we want to wait for a re-entry in the stocks that we sold high (Ford, AMD, Microsoft, Apple, Amazon, ...), we are also actively looking for alternative strategies to generate income. With that purpose, in today's post, we want to discuss more about our position in Kinder Morgan (KMI), an energy pipeline operator, and how this can be a stable income-generator for our portfolio.
Kinder Morgan (KMI) is one of the largest global midstream companies with a market capitalization of more than $40 billion. With shares sitting near the 200-day moving average, given the continued strong demand for energy in general, the company's strong management history and sustained commitment to return stellar dividends to shareholders, we are pulling the trigger to buy more shares of Kinder Morgan. At the end of today, we own 100 shares of KMI at an average price of 17.06$/share, weighing at 6.7% of our portfolio. We will be selling out-the-money, short-dated (monthly) call options against this position to generate monthly income of ~50$/month (3% of total cost to own this position). On top of this gain, we will also receive ~6% yearly from the company in the form of dividend.
Kinder Morgan
Kinder Morgan is a pipeline operator, which you can think just like operating roads, where they have very little exposure to the actual prices of the commodities they transport and charge a fee that's based on volume: the more oil and gas they move, the more money they make. Right now we're early in economic expansion and energy demand is here to last. Furthermore, the Biden administration is extremely anti building new pipelines, so the economy is stuck with existing pipelines. As a result, Kinder Morgan can raise costs without losing to competitors.
So there's huge demand nationwide for pipeline transport, which means toll-road-like earnings for years to come for KMI, which allow the company to give capital back to their investors through sky-high dividend that treasury yields can never beat (one of the highest among S&P500 companies).
Kinder Morgan Infrastructure
Kinder Morgan has unparalleled infrastructure highlighting the company's substantial strength within the markets. They have a massive 70 thousand miles of natural gas pipelines with ~700 billion cubic feet of working storage gas capacity and ~1200 miles of natural gas liquid pipelines. The company is also one of the largest refined product transporters with ~1.7 million barrels of refined products across a total ~6800 miles of refined products pipelines.
The company has significant terminals here as well with 144 terminals and 16 Jones Act vessels. The company is the largest CO2 transport company with capacity of ~1.5 bcf/day.
Kinder Morgan Acquisitions
On top of the company's standard operation, management is continuing to acquire businesses to seek growth.
Kinder Morgan has made two notable acquisitions to work on developing its long-term portfolio. The company is being notable about making intelligent decisions with reasonable perspectives. The company is making this $1.3 billion acquisition at ~10x EBITDA, a reasonable price for the stability of the acquisition.
The company has also made a $310 million acquisition of Kinetrex Energy, a new company in the renewable natural gas space. The company expects <6x 2023 EBITDA for the acquisition counting $150 million in development capital on top of the acquisition price.
Kinder Morgan Growth Projects
Kinder Morgan has a respectably sized $1.6 billion backlog it's using towards future growth. The company expects 20% of this to be in service before year-end, with 40% in 2022, and 30% in 2023. Overall, most of this is low-carbon investments at a low 3.6x EBITDA build multiple. That means that the build can add roughly $400 million in additional adjusted EBITDA.
The company is adding these growth projects with responsible acquisitions which will enable the company to drive substantial shareholder rewards.
Kinder Morgan Cash Flows from Financing Activities
Cash used in financial activities increased $1,446 million for the nine months ended September 30, 2021 compared to the respective 2020 period primarily attributable to a $1,403 million net increase in cash used related to debt activity as a result of higher net debt payments in the 2021 period compared to the 2020 period.
Total long-term debt has decreased from 2020 to 2021 and total short-term debt has increased. This means that the company does not need to issue more long-term debt which costs more interest. They have enough liquidity to pay off the short-term liability.
When the company has the capacity of both funding debt and raising dividends payments to shareholders, they have a steady performance over a period of time.
Kinder Morgan Forecasts
Kinder Morgan's new 2021 forecast, partially due to one-time benefits from winter storms, is $5.4 billion in DCF versus an original $4.4 billion forecast. In a normal year, the company should see more like $4.6 billion in DCF. The company is spending $2.3 billion in discretionary capital, ~6% of its market capitalization, with a focus on growth.
The company post DCF will see roughly $3.1 billion in DCF it can use towards shareholder rewards. That's roughly 7-8% of the company's market cap that can comfortably cover dividends. This highlights how, in a year with hefty investment, the company can still confirm double digit returns. Combining those double digit returns in a transition should help the company reward shareholders.
The Dividend Yield Story for Kinder Morgan
In 2021, Kinder Morgan is giving shareholders 0.27$/share/quarter, or 1.08$/share/year. With share price at 16.78$/share at the time of this post, the dividend yield is 1.61% per quarter, or 6.44%/year.
Take A Look At The Share Price History
On the left is the monthly chart of KMI dating back to 2011. You can see that we're pretty much at the low of the share price history. Taking a look at the trading range we're in (captured by 2 horizontal lines), we're right in the middle of the range. Going to the top of the range would be a 34% gain, and going to the bottom of the range would be a 41% decline. Top of the range was basically right before the pandemic, and bottom of the range was the pandemic's low.
Income-Generating Strategy: Introduction To Selling Upside Call Options
A call option is the right to buy 100 shares at a designated price, before a defined date. A call option is also a security, meaning it can be traded and has prices of its own. An example: I go on the market and pay 50$ premium to buy a call option in KMI with a strike price of 17$, with expiration on 23rd December 2021. This means I paid 50$ for the following right: if before or on 23rd December 2021, KMI hits or gets above 17$/share, I can buy 100 shares of KMI at 17$/share from whoever sold the call option to me. Even if shares of KMI are trading at 20$/share at that time, since I have the option, I can buy 100 shares at 17$/share. The other scenario call option is that KMI does not get above 17$/share before the expiration date (expires worthless). I don't get to do anything, and in fact I've wasted 50$ on that call option.
The above example is if I go and buy that call option. I can also choose to sell that call option to somebody else. That would mean someone else pays me 50$, they get the right to buy 100 shares of KMI from me for 17$/share if KMI hits or gets to above 17$/share before 23rd December 2021.
Let's say I sell such call option, and in the portfolio I own 100 shares of KMI at an average price of 16$/share. If I get exercised on, meaning I have to sell 100 shares of KMI at 17$/share, I would make 1$ profit/share x 100 shares = 100$. I also got paid 50$ for selling such option, which is 50% of my profit if I had just sold shares directly on the market.
But what if shares of KMI doesn't get to 17$/share before expiration: the option will expire worthless, but I get to keep the premium anyways. That's what we mean by saying a stable income-generating strategy. I can keep selling out-the-money, short-dated options (within 1 month), and generate ~50$/month based on the 100 shares of KMI that I own.
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