What Kinder Morgan’s second quarter says about the US midstream sector
Editor’s note: This is the first of three articles in which I will focus on Q2 results and guidance updates for recommended stocks which are also excellent indicators for their respective sectors. I hope everyone is having a great summer!—RC
“Fortune may not favor the brave so much as money.”
This is a direct quote from Executive Chairman Richard Kinder, spoken during Kinder Morgan
At the end of 2015, Kinder had to cut its dividend to deal with too much debt and a skyrocketing cost of capital. But since then, it has consistently reported stable financial results. And the second quarter 2022 figures were no exception, with management raising its full-year EBITDA guidance by 5%.
Second-quarter distributable cash flow per share increased 16%, covering the dividend with a solid 1.87-to-1 margin. And Kinder had $545 million remaining to fully fund its modest CAPEX plans, as well as reducing debt and $16.1 billion in stock buybacks year-to-date. Despite a rising interest rate environment, the company reduced its net interest expense by -5.8% from the prior year quarter. And management kept operating expense increases below inflation, including a -5% reduction in general and administrative expenses.
These are pretty impressive results from a cash flow perspective. And as management executes some $2.1 billion of fully pre-contracted projects over the next few years, investors can expect more reliable, more reliable single-digit percentage increases in the all-safe dividend. .
Kinder’s system volumes were a little less snappy. Gas Pipelines’ core business recorded a 6% increase in earnings before amortization (EBDA), of which it contributed approximately 60% of the overall company total. But transportation volumes were actually -2% lower than a year ago as “the continued decline in production in the Rocky Mountain basins” and a partial outage of the El Paso natural gas pipeline more than offset increased deliveries for LNG exports and power generation.
Products Pipelines’ EBDA (15.8% of the company’s total) increased 2% on favorable pricing, particularly in the Transmix business. But total refined product volumes fell -2%, as a 19% increase in jet fuel throughput was more than offset by declines of -3 and -11% for gasoline and diesel, respectively.
The Terminals segment (13.3% of EBDA) benefited from higher liquid volumes. But it also had to contend with lower utilization rates and moderate pricing pressure. And while Jones Act tanker activity saw sequential improvement, average charter rates were again below year-ago levels. Even the CO2 business (10.9% of EBDA) owes its 40% gain to higher realized selling prices as lower priced hedges expired. Oil, NGL and CO2 volumes all fell.
Kinder continues to expect solid growth over the next few years from its natural gas pipeline and gathering networks that primarily serve LNG exporters, indicating an opportunity to expand its current 50% share of the U.S. market. . LNG demand was the main driver of the 15% and 10% year-over-year increases in gas gathering volumes from Haynesville and Eagle Ford, respectively. And that undoubtedly contributed greatly to management’s decision this summer to continue its expansion into the Permian route, which is already fully pre-contracted.
Nonetheless, it is clear that Kinder is taking a conservative approach to expansion that promotes the generation of healthy free cash flow and modest CAPEX. And as management also noted on the earnings call, some 75% of projects in development are for “low-carbon energy services.”
This includes “responsible natural gas” harvested from farms, renewable diesel and associated feedstocks. The company also plays a leading role in facilitating the market for reduced CO2 emissions, forming the first Federal Energy Regulatory Commission-Approved low methane pooling service on its Tennessee gas pipeline.
Kinder isn’t launching the kind of large-scale projects that anticipate significant increases in conventional oil and gas production in North America, like those that drove cash flow growth over the past decade. And combined with the company’s exceptionally strong balance sheet, diversified operations and leading middle-market position in the United States, this makes it an exceptionally safe stock, suitable for even more conservative income-oriented investors.
We’ve seen other major US midstream companies over the past year. And we expect management teams to largely repeat that when they release Q2 numbers and update guidance in the weeks ahead.
Kinder’s generally stable throughput across operations shows that little has changed for what has been a lagging environment for mid-volumes in North America, relative to previous energy price cycles. Positives like the Permian Basin were more than offset by weakness in other places like the Rockies.
This reality reflects the continued conservatism on the part of producers, which we also expect them to reiterate with Q2 results and guidance. In fact, if anything, recession worries should make them even more cautious, as should uncertain federal regulations.
As with Kinder, the diversification of operations and the strengthening of balance sheets will remain huge advantages for the best intermediaries. And we might see some companies follow Enterprise Product Partners (EPD) are leading to an acceleration in the rate of growth of their dividend.
But equally, we probably won’t see any of the leaders announce another major expansion. Cash flow will instead be focused on hedging CAPEX and paying down debt to avoid accessing the currently expensive capital markets. And if there is enough surplus, it will be returned to shareholders in the form of dividend increases and share buybacks.
Kinder’s findings also point to a potential danger for smaller midstream companies, especially those with heavy debt loads. Primarily, with a recovery in real volumes still seemingly well into the future, the only way to cover rising debt service and operating costs will be to sell assets or cut dividends.
Now more than ever, investors need to stick with the best of the midstream greats. The good news is that there are plenty of great sector stocks yielding around 7%, as well as a few near 10%. The best places to look: our coverage universes and portfolios Conrad Utility Investor and particularly Energy and Revenue Advisor.