3 Important Takeaways From Kinder Morgan’s Q2 Results (NYSE:KMI)

Kinder Morgan, Inc. (NYSE:KMI) recently reported Q2 results. Overall, results were solid and the outlook for the company is positive. In this article, we share 3 important takeaways from the report and earnings call.

#1. Inflation Is A Tailwind

The first big takeaway from the earnings report was that inflation is largely a tailwind for the company. While this should not be surprising given that energy has proven to be arguably the best inflation hedge there is, KMI’s structure as a midstream company means that it is largely immune to commodity price movements.

As a result, it is encouraging to see that KMI is still able to benefit from inflation for the following reasons:

(1) First and foremost, the little bit of commodity price exposure the company does have is helping them. This is largely reflected in the strong growth numbers that were reported during the quarter with distributable cash flow per share up 16% year-over-year, though some of this was also due to growth projects coming online. As a result, management increased its full-year guidance for EBITDA and DCF 5% higher.

(2) They are managing inflationary headwinds quite well. As management stated on the earnings call:

We’re facing some cost headwinds, mostly because of added work this year. While costs are up, we’re actually doing very well in holding back the impacts of inflation. It’s hard to measure precisely, but based on our analysis, we are well below the headline PPI numbers that you’re seeing. And actually, we appear to be experiencing less than half of those increases. That’s due to much good work by our procurement and operations teams, and much of this good performance is attributable to our culture. We are frugal with our investors’ money.

(3) Their cash flows are largely indexed to inflation. As management stated on the earnings call when asked about inflation impacts on cash flows:

we implemented the rate increase on July 1st of 8.7% across our assets. And based on where it’s tracking right now, I think that assuming PPI continues where it is and that we would implement the full thing, which is what we would expect, it’s somewhere in the neighborhood of 15% next year.

This indicates that the best is likely yet to come concerning inflationary tailwinds to cash flows.

#2. Growth Opportunities Are Abundant

On top of inflationary and commodity price tailwinds for the business, KMI is still finding plenty of places to invest capital at very attractive risk-adjusted returns. With a balance sheet that is finally underleveraged based on their 4.5x long-term leverage ratio target after reducing net debt by $185 million year-to-date, management stated that they have “capacity to take advantage of opportunities.” Management also highlighted that they have some “line of sight” for some growth acquisitions as well as organic growth investments in the near future that they plan to take advantage of.

Richard Kinder clarified their conservative risk-averse approach to these investments, stating:

we approved new capital projects only when we are assured that these projects will yield a return well in excess of our weighted cost of capital. Obviously, in the case of new pipeline projects, most of the return is normally based on long-term throughput contracts, which we are able to negotiate prior to the start of construction. But we also look at the long-term horizon, and we’re pretty conservative in assumptions on renewal contracts after expiration of the base term and on the terminal value of the investment. That said, we are finding good opportunities to grow our pipeline network as demonstrated by our recent announcement of the expansion of our Permian Highway Pipeline, which will enable additional natural gas to be transported out of the Permian Basin.

KMI plans to invest about $1.5 billion into expansion capital this year despite applying rather strict investment criteria, which implies just how plentiful their growth opportunities are. The idea that midstream growth is dead is being challenged by KMI.

#3. KMI Stock Is Cheap

Last, but not least, management spent a considerable portion of the earnings call belaboring the point that they believe their stock is so cheap. For example, Richard Kinder near the beginning of the call said:

So, if we’re generating lots of cash and using it in productive ways, why isn’t that reflected at a higher price per KMI stock? Or to use that old phrase, “If you’re so smart, why ain’t you rich?” In my judgment, market pricing has disconnected from the fundamentals of the midstream energy business, resulting in a KMI yield — dividend yield, approaching 7%, which seems ludicrous for a company with the stable assets of Kinder Morgan and the robust coverage of our dividend.

I don’t have an answer for this disconnect. And it’s easy to blame factors over which we have no control, like the mistaken belief that energy companies have no future or the volatility of crude prices, which, in fact, have a relatively small impact on our financial performance.

Then a bit later on in the call, management discussed the fact that since they now expect to end the year below their 4.5x leverage target, they can be a bit more aggressive with share buybacks. In fact, despite not doing any material stock buybacks since 2018, management bought back around $270 million worth of shares over the past month. Management highlighted on the call that they did it because they had the cash to do it and were convinced that the stock was opportunistically priced. They also mentioned that they expect to have the opportunity to continue buying back stock on an opportunistic basis moving forward in 2022.

When looking at the valuation multiples, we can see what management is talking about. Despite the balance sheet being as strong as ever, the cash flow profile looking very stable, share buybacks arriving back on the table, continued attractive growth projects being available with pipeline contract expirations largely having rolled off, and inflationary and commodity price tailwinds boosting the business even further, KMI is still trading at a clear discount to its five, 10, and all-time EV/EBITDA multiple averages. Its current EV/EBITDA multiple is 9.6x, whereas its five-year average is 10.33x, its 10-year average is 12.03x, and its all-time average is 12.62x. The value here is clear.

Investor Takeaway

KMI just reported very strong Q2 numbers. However, even better were the facts that low-risk growth projects remain plentiful, buybacks are back in a meaningful way, and leverage is at a point now where KMI can play offense more aggressively if it sees the chance to do so. Meanwhile, the stock remains clearly undervalued, presenting shareholders with an opportunity to invest and lock in attractive current income and long-term appreciation potential.

While there are numerous other attractive opportunities in midstream as well, KMI is certainly worthy of consideration.