Why Kinder Morgan's Dividend Cut Now Looks Brilliant

By Markets Fool.com

This past Thursday, Kinder Morgan Inc. shareholders got a strong indication that the company's recent dividend cut was the right decision. Canada's National Energy Board moved to recommend that the administration of Prime Minister Justin Trudeau approve Kinder Morgan's planned expansion of its Trans Mountain pipeline. The preliminary approval has been a long time coming, as the company put forth the initial application in late 2013.

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This is a big deal, as the proposed pipeline would connect Alberta's oil sands to the Canadian Pacific coast and, thereby, world oil markets. It also should encourage current shareholders that management is making the right moves amid the current energy downturn.

Here's why.

Never any spare capital lying around when you need it

Kinder Morgan made the extremely tough decision to cut its dividend some 74% back in December. To say this move hurt is to drastically understate the situation.

Executive Chairman Richard Kinder had long held KMI's dividend sacred.But he and CEO Steven Kean made the right move, especially if you truly believe in making smart, long-term-oriented business decisions.

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As Kinder noted in the announcement: "We evaluated numerous options, including significant asset sales, but ultimately concluded that these other options were uneconomic to our investors in the long run. ...This decision was not made lightly, but we believe it is in the best interests of the company, its shareholders and [its] employees."

There are only four ways to come up with the cash to make acquisitions or expand operations: issue stock, issue debt, sell assets, or retain earnings. The first three options are obviously non-starters in the current environment (do you want to be a seller or a buyer at the bottom?), which left only retaining profits as the only palatable option.

Canadian expansion

Kinder Morgan currently holds the crown for being the largest energy infrastructure owner-operator in North America. It controls some 83,000 miles of pipeline, dozens of distribution terminals, and two large Texas oil fields as icing on the cake. There is, however, room for expansion, particularly within the borders of America's neighbor to the north.

Last Thursday's announcement called for a tripling of Kinder Morgan's current capacity in bringing Canada's oil sands to market. Its existing pipeline, transporting some 300,000 barrels of crude, will be able to handle some 890,000 barrels per day under the planned expansion. This move will also not come cheaply, with a price tag estimated at some $4.1 billion, and only after some 157 conditions put forth by the Canadian National Energy Board have been met.

Assuming Canada's environment and energy market regulators can be satisfied, Kinder Morgan will need every penny of the money saved by cutting its dividend.

Investing is all about sacrificing today for a brighter tomorrow

When you invest, you accept short-term sacrifice for long-term gain. The Trans Mountain pipeline expansion will soak up an enormous amount of Kinder Morgan's excess cash flow, which, even at its peak, wouldn't be compatible with its previous dividend absent any debt issuances:

Metric

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

Cash from operations

$2.37 billion

$2.8 billion

$4.12 billion

$4.47 billion

$5.3 billion

Capital expenditures

$2.379 billion

$2.1 billion

$3.38 billion

$3.774 billion

$3.977 billion

Debt issued

$9.57 billion

$18.148 billion

$13.58 billion

$24.57 billion

$14.3 billion

Data source: S&P Global Market Intelligence.

Naturally, a good chunk of the debt issued in any given year by a company of Kinder Morgan's size (with some $84 billion in assets) will go toward paying down soon-to-be-matured debt. So debt issuances can be counted on to pay for some project expansions, but not all of it, especially in the particularly harsh capital-raising environment that exists today.

The dividend shall return

Kinder Morgan's dividend will be back, and probably bigger than ever. Management is doing exactly what it should be doing in a panicked environment -- picking up assets and expanding operations in anticipation of the inevitable rebound.

Wall Street simply isn't lending to energy companies right now (to be fair, can you blame them?), so Kinder Morgan had to go it alone to fund its capital expenditure budget.

Management could not have known whether its planned expansion of the Trans Mountain pipeline would gain approval, but this preliminary approval still validates management's apparent belief that retaining capital at a time like this would eventually bear fruit.

The article Why Kinder Morgan's Dividend Cut Now Looks Brilliant originally appeared on Fool.com.

Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has the following options: short June 2016 $12 puts on Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.