“We are not climate change deniers and we recognize the growing momentum of renewables in America’s energy mix. That said, there is a long runway for the products we handle, particularly natural gas.”
That’s a quote from Kinder Morgan Inc (KMI) Chairman Richard Kinder, delivered during his opening statement of the midstream company’s Q3 2020 earnings call this week.
Kinder went on to cite Pulitzer winner Daniel Yergin’s latest book, The New Map, as affirming the continuing importance of existing oil and gas transportation and processing infrastructure. And he highlighted his company’s leading positions in renewable diesel, green hydrogen, moving CO2 and providing backup supplies for wind and solar generation as pathways for growth in a long-term environment of reduced fossil fuel use.
Stability and sustainability were certainly themes of Kinder’s Q3 results and guidance. Despite the worst market conditions for US midstream companies in at least a generation, the company’s Q3 distributable cash flow per share was down just 4 percent from year ago levels, with EBITDA lower by 7 percent.
Those results kept Kinder well on track to comfortably cover all of its capital needs and dividends with internally generated cash flow for 2020. That includes some $1.7 billion of expansion capital, including completing the Elba Island LNG export facility and bringing the now 97 percent completed and contracted Permian Highway natural gas pipeline online in Q1.
So far this year, Kinder has wrung $118 million in “permanent” savings from its cost structure. Coupled with 30 percent lower CAPEX from “high grading” projects, the company’s free cash flow position has actually improved by $135 million versus pre-pandemic projections and by $600 million from 2019.
As for the balance sheet, Kinder has reduced net debt roughly $10 billion over the past five years. Debt-to-EBITDA is expected to come in at a steady 4.6 times, with $3.9 billion of the company’s $4 billion borrowing capacity available. And though management no longer promises a $1.25 per share annual dividend in the near future, it basically telegraphed another mid-single digit boost early next year.
There was weakness in operating results. The company’s Products Pipelines (15.3 percent of Q3 earnings before depreciation and amortization or “EBDA”) and Terminals (14 percent) suffered year over year declines of 20 percent and 17 percent in EBDA, respectively.
Both divisions were hit by sharp though now narrowing declines in refined products volumes, as Americans continue to drive and fly less than prior to the pandemic. Terminals’ reliance on fixed, capacity-based contracts limited the earnings impact, as did very strong available liquids storage utilization of 98 percent. But EBDA was reduced by the sale of Kinder Morgan Canada assets, as well as weaker petroleum coke and coal volumes.
Natural gas pipelines remain Kinder’s most important business by far, generating roughly 62 percent of Q3 EBDA. The segment took a 13 percent hit to gas gathering volumes and 2 percent in transportation throughput. Lower gas production in multiple basins and asset sales offset the favorable impact from startup of the Gulf Coast Express pipeline, Elba Island LNG export facility and other assets.
Nonetheless, gas pipelines EBDA was just 0.7 percent less than a year ago. That’s an improvement from the nine-month decline rate of 2.5 percent. And a further lift is likely heading into 2021, as new assets come on stream.
Management also cites improving trends for physical deliveries to LNG facilities, rising exports to Mexico, a “big comeback” in Bakken system gathering and increased gas flows to power plants. And the company now anticipates recovery in 2021 at what has been its weakest unit, the KinderHawk gathering venture in the Haynesville shale.
Ironically, Q3’s biggest positive surprise came from the division that’s historically been the company’s biggest albatross: CO2 manufacture, distribution and related oil production. Now just 8.8 percent of Kinder’s overall EBDA, the unit benefitted from management’s decision to maximize returns rather than production and an 11 percent lift in realized selling prices for energy output. Those positives more than offset 12 percent lower oil production and a 33 percent reduction in CO2 volumes.
There’s no more telling sign of trouble at a company than when management continually reduces guidance over several quarters. That’s not happening at Kinder: The projected -8 percent drop in EBITDA and -10 percent decline in DCF from the pre-pandemic 2020 budget are essentially the same as what was laid out when the midstream reported in July.
Not every assumption regarding the external market has played out exactly as management forecast then, and certainly not always as hoped. But Kinder is keeping its dividend well covered, its balance sheet strong and its long-term business health and strategy on track.
Those are the essentials for riding what now appears to be a nascent energy sector recovery. And coupled with the multiple avenues for capitalizing on the US energy transition and a growing 8 percent plus yield, they make Kinder a compelling buy for patient investors.
Over the next several weeks, we’ll see how other North American midstream companies are measuring up on those standards. The reduced year-over-year volumes Kinder reported in Q3 for natural gas gathering, gas pipelines, crude oil pipelines and refined products will certainly show up in rivals’ results as well. And companies will at least partly offset them with operating cost cuts, reduced CAPEX, higher storage capacity utilization and new contracted assets that enter service.
Kinder’s results do make clear that the big picture for North American energy is still improving from the early days of the pandemic. The key for other midstreams is whether they’ve done as good a job sticking to their overall financial guidance and strategy.
Our expectation is those that measured up in Q2 will do so again in Q3. But we will be on the lookout for any sliding guidance. This sector’s not out of the woods yet, and there are still likely dividend cuts and even bankruptcies ahead for some.