It would be hard to blame you if you thought Kinder Morgan Inc. (KMI) was the only stock on the planet this week. Financial media, analysts, and pundits have been talking about the controversial and shocking dividend cut, credit downgrade, and collapse in the stock price.
Beyond the hype of this much-loved high dividend stock, many are also quietly pointing out that the dangers of the company’s dividend were evident months before the dividend was actually cut, so both the cut in income and in stock price are the logical result of a balance sheet that spiraled out of control.
Smoking Gun #1: The Acquisitions
KMI has been on a shopping spree while commodity prices have fallen and made energy companies cheap. In August 2014, KMI bought out its master limited partnerships. After that, it bought interests in many pipelines even as natural gas and oil prices fell and the market got more fearful about energy companies in general.
Then it bought NGPL in a leveraged buyout, although NGPL was a distressed company that many analysts criticized as offering no cash flow and little potential upside. In fact, by taking NGPL, Kinder Morgan became responsible for its huge debt load—on top of the massive dividend requirements from its expanded shareholder base after the MLP acquisitions.
With these issues, Moody’s downgraded the stock at the beginning of December. KMI began a steep decline, and then Fitch released a note warning that the credit default swap market is implying a weaker credit outlook.
The Drama
The drama really heated up when analysts began arguing that dividends should be drastically cut or halted altogether. Bond holders were likely urging something similar, to ensure their payouts are secure. At the same time, KMI announced that its internal analysis believes it’s well-positioned to keep current dividend payouts and to grow them by 6%-10% in 2016, as suggested in its last earnings call.
Then just four days later, KMI cut its dividend by 75%.
This once favored stock amongst income-hungry retirees in a ZIRP climate lost 62% of its value from the beginning of 2015, obliterating many energy portfolios. Other stocks in the sector faced similar declines in sympathy.
Smoking Gun #2: The Balance Sheet
Frankly, what is happening to KMI now is a nightmare. It was easy to avoid, however, with a bit of due diligence.
Total debts owed by KMI have held steady at a little over $50 billion throughout 2015 and most of 2014. The debt-to-asset ratio has stayed at around 50%, and is actually lower than it was a few years ago. However, a lot of KMI’s assets are fixed and illiquid—their value comes from the income stream they provide. On top of that, KMI has been swapping out liquid cash for fixed assets through its aggressive acquisitions. This is why cash and cash equivalents has fallen by 43% over the last four quarters, after already falling 56% from 2012 to 2014.
Additionally, cash flow from operating activities, which was $969m last quarter, was less than investing activities, of $978m. Most quarters over the last few years, KMI’s cash flow from operations has been less than its outgoing cash from investments. The result is a company with weaker liquidity to pay its growing debt load.
This is a complicated accounting story, but it is clear from analyzing the company’s 10-Ks and 10-Qs. The story also became clear in 2014, but was apparent earlier. Energy prices were high and desire for high income yielding assets was strong, so many overlooked this simple analysis. More astute analysts, though, recognized a problem and avoided KMI—including the 70% losses from this year.