Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Kinder Morgan hasn't so much ripped off the Band-Aid as started tugging painfully at the edges.

Friday's announcement of a board review of dividend policy was couched in the neutral dialect that companies tend to lay on thick when bad news is in the offing. Investors, anxious since the company announced in late October that it was scaling back dividend-growth guidance, were having none of it: The stock fell 13 percent Friday and then another 6 percent on Monday morning.

The sooner that Band-Aid is off, though, the faster the healing can begin.

Kinder Morgan has long been a pioneer in the pipeline sector. If the company ends up flattening, or cutting, the dividend, it will be the clearest signal yet that the industry must heed the message coming from the public markets. Kinder Morgan's current dividend yield of 13 percent and the Alerian MLP Index's yield of almost 10 percent roughly translates as: We don't believe you can afford this.

Kinder Morgan's struggles were apparent not merely in scaled-back guidance, but also its resort to issuing convertible preferred stock at a nosebleed yield and repeated promises not to issue more shares for the foreseeable future. It all adds up to a tacit admission that the old model of funding growth and high dividends by using the equity market as an ATM has seriously malfunctioned for the entire industry.

The problem, a familiar one across most bits of the energy industry, is high leverage colliding with low oil prices. Kinder Morgan, like everyone else, must hunker down.

Prior to Friday's news, the math looked as follows: Kinder Morgan's Ebitda for 2016 is forecast by analysts to be $7.85 billion, according to numbers compiled by Bloomberg. Interest on net debt north of $42 billion and those new convertible preferreds adds up to about $2.34 billion. Maintenance capital expenditure is perhaps another $600 million to $700 million, leaving just under $4.9 billion. Now, based on the midpoint of current guidance, Kinder Morgan would raise its dividend by 8 percent next year, which would add up to almost $4.8 billion -- leaving $100 million or less of excess cash.

High Anxiety
Kinder Morgan's market capitalization has slumped
Source: Bloomberg

That is razor thin, especially in a world where OPEC just threw its hands up in the face of the global oil glut. It also looks like pocket change compared to Kinder Morgan's plans to spend another $2.1 billion on growth projects next year.

If it's a virtual certainty that even those reduced dividend promises from a couple of months ago are now doubtful, what isn't is whether growth guidance is merely being reduced again, or an outright cut is in the offing. Keep the dividend flat and excess cash might get above $220 million, all else being equal -- still below the $300 million cushion management was guiding to for this year. 

Now for the stuff investors have really been dreading. If Kinder Morgan cut the dividend by a third, excess cash flow would jump to almost $1.5 billion. It would also take the current dividend yield down to about 8 percent -- not cheap relative to even recent history, but still below the MLP index average. Cut the dividend by half, though, and excess cash would jump above $2 billion, enough to fund Kinder Morgan's expansion plans without tapping the markets. The implied yield at the current price would drop to about 6 percent.

That may sound apocalyptic. Yet absent a real signal that the company is determined to reduce its debt, any hope of growth rests on a sudden rebound in oil prices that looks ever less likely or a financing model that has clearly stopped working in the current environment.

It is worth noting that even as Kinder Morgan's stock has been falling, its bonds have shown some signs of rallying in the past few days.

Loving Some Dividend Cuts
Signs that Kinder Morgan might cut dividends sparked a rally in its bonds (performance indexed to 100)
Source: Bloomberg

Unlike investors in the shares, bondholders relish the idea of Kinder Morgan slashing payouts to fix its balance sheet. As Andy DeVries at CreditSights puts it, for the company's near-dated debt "the $4.5 billion dividend stream provides a very nice margin of safety." If the company does cut, it will surely flush out the last of the optimists from the stock but also go a long way to restoring what it really needs: credibility with public markets. Equally, investors elsewhere in the sector shouldn't expect Kinder Morgan to be the last to grit its teeth and do the unthinkable.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net