KMI - Kinder Morgan

[Patmo]

Don't know why anyone tries or tried to value this on the dividends. That's irrelevant. When someone tells me the right EV/EBITDA multiple for this business I'll start to get interested. So far everyone is still stuck in investing kindergarten thinking this is about the dividend yield.

 

What makes EV/EBITDA as a standalone valuation metric relevant in KMI's case? And why is dividend yield irrelevant? From your comment it seems like you are just trading one cookie cutter for another, no?

[Palantir]

 

Looks like the dividend was cut by more than 50%. Would you maintain that the larger than expected cut is good for forward prospects and maintain your $11 target, or do you think this should go to $6-7 as implied by 9% on the new dividend schedule?

 

Indeed the cut was quite aggressive, good for maintaining operations, not so good for the guys who didn't expect a cut.  Right now a $0.125/q dividend places them at a current yield of 3.4%, which would only be justified for a very fast growing name. If price doesn't move, then either the market expects uber growth, or it hasn't been truly priced in.

 

Can they achieve growth?

 

Just some back of envelope calcs - 50% cut would save them about $2.3B, and this 75% cut will save them $3.4B. They will need about $2B of that for capex just for 2016 and $1.4B to pay down debt, which is really not enough. When 2017 comes around and they need $5B in capital, it is unclear where that will come from. They could cut capex, which of course would hurt longer term growth expectations.

 

If they grow the dividend from the .125/q base rate, then they're going to cut into that $3.4b cushion earmarked for investment and debt reduction, so they cannot do all three. So I am suspicious about how much dividend growth can be generated. They need to reduce debt by about $10B to reach some semblance of normality, after which they can grow again.

 

Since the cut was aggressive, I think a lower target yield is justified. I think a 7% yield is pretty reasonable, but even that only puts it at $7 or so...

[Picasso]

Don't know why anyone tries or tried to value this on the dividends. That's irrelevant. When someone tells me the right EV/EBITDA multiple for this business I'll start to get interested. So far everyone is still stuck in investing kindergarten thinking this is about the dividend yield.

 

What makes EV/EBITDA as a standalone valuation metric relevant in KMI's case? And why is dividend yield irrelevant? From your comment it seems like you are just trading one cookie cutter for another, no?

 

EV/EBITDA for a business this levered is a much, much better starting point to getting comfortable with any valuation.  It could trade for 8x EBITDA and have a stock trading like a worthless option with only time value. 

 

Let's say you want to value this based on dividends.  Okay fine.  We have $0.50/year for the next five years and then maybe $1/year for the next five years after.  How much do you want to pay for $7.50 of levered dividends over five years?

 

EV/EBITDA at least gets you to a conversation where someone could make an unlevered bid and you can explain the value.  Otherwise we're just talking about how much cash the equity stub can spit out before the bondholders decide enough is enough.  That's not margin of safety investing.

[scorpioncapital]

On a sidenote does it make sense to compare return on invested capital to yield on purchase price? My theory is that you have a gradient between ROIC and yield but perhaps the gradient should be between ROE and yield.

E.g

 

A company has a ROIC of 15% but uses debt. Your yield if you buy the stock today is say 10%. You are going in the right direction.

 

However, that same company may have an ROE of 30%. Should you compare the initial yield of 10% against 30% or 15%? Seems the direction is the same but the magnitude is substantially different.

 

I'm thinking of this as a bond with an expanding coupon. Expanding at 15% vs 30% is a big difference.

[Palantir]

Who is going to make an unlevered bid for KMI?

[Picasso]

Probably no one. But that doesn't mean you should ignore the cash flow to the enterprise value. If it's not worth it to an acquirer to take on all that debt then why would a minority equty investor feel okay paying 12x EBITDA?

[Palantir]

Who is ignoring the cash flow to the bondholders? The people valuing it by dividend yield are surely not.

[Picasso]

The dividend yield on this levered entity is like being long the worst tranche of a deteriorating bond.  A yield of 7%, 10%, 15%, 30% doesn't tell you your risk.  Knowing the full value of the entity versus the crappy part of the capital structure is going to tell you what this should be trading for.

 

Again, target dividend yields on this stock tell you close to nothing about where it should be valued.

[rpadebet]

Not sure of the value at these levels,

 

If bonds are yielding 9%, why should equity stub yield less? Especially when growth is some ways off in the future and the structure is so levered?

 

I think an EV/EBITDA of 9-10x should be base (or even optimistic) case. It would have to trade lower for this to be value.

[scorpioncapital]

I'm just trying to understand the inherent return here. I mean it seems to be 5b DCF into 80 billion invested capital or 6.25%. Only marginally above the cost of debt. Of course all utilities are leveraged, but for example electric utilities have such dependable cash flows investors don't mind the low returns. Companies like Berkshire Energy also earn a low return but can deploy large amounts of (low cost?) debt to make the return attractive. What does Kinder Morgan bring to the table?

 

[Sunrider]

 

Looks like the dividend was cut by more than 50%. Would you maintain that the larger than expected cut is good for forward prospects and maintain your $11 target, or do you think this should go to $6-7 as implied by 9% on the new dividend schedule?

 

Indeed the cut was quite aggressive, good for maintaining operations, not so good for the guys who didn't expect a cut.  Right now a $0.125/q dividend places them at a current yield of 3.4%, which would only be justified for a very fast growing name. If price doesn't move, then either the market expects uber growth, or it hasn't been truly priced in.

 

Can they achieve growth?

 

Just some back of envelope calcs - 50% cut would save them about $2.3B, and this 75% cut will save them $3.4B. They will need about $2B of that for capex just for 2016 and $1.4B to pay down debt, which is really not enough. When 2017 comes around and they need $5B in capital, it is unclear where that will come from. They could cut capex, which of course would hurt longer term growth expectations.

 

If they grow the dividend from the .125/q base rate, then they're going to cut into that $3.4b cushion earmarked for investment and debt reduction, so they cannot do all three. So I am suspicious about how much dividend growth can be generated. They need to reduce debt by about $10B to reach some semblance of normality, after which they can grow again.

 

Since the cut was aggressive, I think a lower target yield is justified. I think a 7% yield is pretty reasonable, but even that only puts it at $7 or so...

 

Sorry Palantir - maybe I didn't follow this properly: prior to the cut, they said they can cover the dividend and maintenance capex. They cut because of rating agency concerns and will use this to pay down debt (and possibly fund growth investments, since they can't increase leverage). So in your calculation, why do you say they need 2/3.4bn for maintenance capex? What is the 5bn in 2017 you're referring to? My understanding was that they entire amount of dividend saved can be used to reduce debt or fund growth investments (or both) as it is already after all their required maintenance. What am I misunderstanding here? Thank you. C

[Palantir]

The dividend yield on this levered entity is like being long the worst tranche of a deteriorating bond.  A yield of 7%, 10%, 15%, 30% doesn't tell you your risk.  Knowing the full value of the entity versus the crappy part of the capital structure is going to tell you what this should be trading for.

 

Again, target dividend yields on this stock tell you close to nothing about where it should be valued.

 

Not true. If you model out the company, you are able to take all these risks into account.

[Palantir]

Sorry Palantir - maybe I didn't follow this properly: prior to the cut, they said they can cover the dividend and maintenance capex. They cut because of rating agency concerns and will use this to pay down debt (and possibly fund growth investments, since they can't increase leverage). So in your calculation, why do you say they need 2/3.4bn for maintenance capex? What is the 5bn in 2017 you're referring to? My understanding was that they entire amount of dividend saved can be used to reduce debt or fund growth investments (or both) as it is already after all their required maintenance. What am I misunderstanding here? Thank you. C

 

So they may cover dividend and maintenance capex, but they can't cover dividend, maintenance capex, and growth capex, which is around a $2B plan for 2016. So where will they raise the money for growth? Equity financing is ruled out, so is debt financing. Only option is to use the cash saved from not paying dividend - about $3.4B or so. They need to do two things with the cash - pay growth capex and reduce debt levels. (Good target for Debt/EBITDA is <4x, right now they are above 5x). In 2017, I believe their capital program is $5B, so that problem gets bigger...hope you see the issue.

[Sunrider]

Ok thank you - understand what you're saying now.

 

Sorry Palantir - maybe I didn't follow this properly: prior to the cut, they said they can cover the dividend and maintenance capex. They cut because of rating agency concerns and will use this to pay down debt (and possibly fund growth investments, since they can't increase leverage). So in your calculation, why do you say they need 2/3.4bn for maintenance capex? What is the 5bn in 2017 you're referring to? My understanding was that they entire amount of dividend saved can be used to reduce debt or fund growth investments (or both) as it is already after all their required maintenance. What am I misunderstanding here? Thank you. C

 

So they may cover dividend and maintenance capex, but they can't cover dividend, maintenance capex, and growth capex, which is around a $2B plan for 2016. So where will they raise the money for growth? Equity financing is ruled out, so is debt financing. Only option is to use the cash saved from not paying dividend - about $3.4B or so. They need to do two things with the cash - pay growth capex and reduce debt levels. (Good target for Debt/EBITDA is <4x, right now they are above 5x). In 2017, I believe their capital program is $5B, so that problem gets bigger...hope you see the issue.

[frommi]

There is a lot of misinformation here. They don`t plan to pay down debt, they will simply grow EBITDA to delever. This is the malone playbook and the way Kinder has created 20% CAGRs with KMP.

Their plan for 2016 is to delever to around 5.5 x Net Debt/EBITDA without issuing more stock or debt. With 44 billion in debt that means they plan to have EBITDA of ~8 billion in 2016.

 

So we can calculate owner earnings:

 

8000 EBITDA

- ~2000 interest

- 500 taxes

- 500 maintenace CAPEX

= 5000 million owner earnings

 

This is exactly what they talk about when they mention DCF. Since this number will not grow without further investments (or max @ GDP growth) a fair multiple is around 8-10, which gives a fair price of 40-50 billion $ in 2016. But this ignores that they can create value by investing @ 13 % returns and take on debt @6%, so the real value is maybe 20-30% higher.

 

Other pipeline companies (ETP,MMP) trade @ EV/EBITDA multiples of 14-15. At 8k EBITDA this gives 14x8=60 billion fair value for the equity for next year when everything goes according to plan. Even at 12 x EV//EBITDA this is a 60% return. And since 85% of KMI is not a capital intensive business (they build pipelines that last for decades...) i don`t see that as expensive.

 

Somebody sold me a big chunk of his shares @ 14.4$ in pre hours, i have now skin in the game.

[Palantir]

How exactly are they going to grow ebitda? Take on more debt? How much more ebitda do you think they need to bring the multiple down to a reasonable number?

[frommi]

How exactly are they going to grow ebitda? Take on more debt?

 

They just reinvest the part of the owner earnings that they are not paying as dividend?

[Palantir]

^ What do you estimate retained earnings to be? How much incremental ebitda do you expect to accrete from that reinvestment?

[frommi]

^ What do you estimate retained earnings to be? How much incremental ebitda do you expect to accrete from that reinvestment?

 

5k - 1.1k=3.9k x 11-13% = 400-500 million incremental EBITDA.

[Palantir]

That makes basically no impact on leverage. This thing is levered 5.5x. Lowering to something reasonable needs at least ten times the ebitda you calced.

[frommi]

That makes basically no impact on leverage. This thing is levered 5.5x. Lowering to something reasonable needs at least ten times the ebitda you calced.

 

rough calc:

 

2017: 5.2 44/8.5

2018: 4.9 44/9

2019: 4.6 44/9.5

 

This is the magic of increasing EBITDA with leverage, it decreases the leverage at a faster rate than paying down debt.

[Palantir]

Sigh...

[RRJ]

+1.  Thanks.

 

That makes basically no impact on leverage. This thing is levered 5.5x. Lowering to something reasonable needs at least ten times the ebitda you calced.

 

rough calc:

 

2017: 5.2 44/8.5

2018: 4.9 44/9

2019: 4.6 44/9.5

 

This is the magic of increasing EBITDA with leverage, it decreases the leverage at a faster rate than paying down debt.

[thefatbaboon]

Does anyone remember how they justified not factoring a depreciation charge against dcf for the Tankers? 

 

 

[awindenberger]

+1.  Thanks.

 

That makes basically no impact on leverage. This thing is levered 5.5x. Lowering to something reasonable needs at least ten times the ebitda you calced.

 

rough calc:

 

2017: 5.2 44/8.5

2018: 4.9 44/9

2019: 4.6 44/9.5

 

This is the magic of increasing EBITDA with leverage, it decreases the leverage at a faster rate than paying down debt.

 

I personally think that KMI could still go cheaper, but why do you two disagree with Frommi? KMI management said they plan to use the $3.9bil in 2016 to fund almost all of their $4.2bil in growth capex projects. If they do actually get 13% return on their new investments, EBITDA would climb almost $500mil, with debt moving up incrementally. Maybe its not exactly what Frommi used, but wouldn't it look something like this:

 

2017: 5.25  44.6/8.5

2018: 5.00  44.9/9

2019: 4.75  45.2/9.5

 

The Debt/EBITDA ratio doesnt move down quite as fast as Frommi suggested, but it is being reduced.