4 Reasons Kinder Morgan's Stock Could Fall

By Markets Fool.com

A pipeline under construction. Image source: Getty Images.

Continue Reading Below

Pipeline giant Kinder Morgan (NYSE: KMI) had a rough ending to 2015, shedding more than half of its market value between the middle of October and the end of December. The driver behind that decline was Moody's warning of a potential debt downgrade that would have moved Kinder Morgan's debt into "junk bond" territory. That move would have likely significantly increased the costs of or even restricted Kinder Morgan's ability to refinance existing debt or take on new debt to continue its expansion plans.

In response, Kinder Morgan cut its dividend, scaled back its expansion plans, and pledged to reduce its need to access the capital market. While that was a prudent move to protect the company from the damaging blow of a debt downgrade to junk status, it upset shareholders who had come to expect both a high and increasing dividend. While those changes made today's Kinder Morgan less risky than it was this time last year, the company still faces risks that could make its stock fall again.

Risk No. 1: Intensifying competitive pressures

Kinder Morgan is currently the largest energy infrastructure company in North America, but it is at substantial risk of losing that title in the not-too-distant future: Enbridge (NYSE: ENB) is in the process of merging with Spectra Energy (NYSE: SE)in a deal that could make that combined company North America's largest.

Scale is important in the energy infrastructure business, given the heavy investments needed in securing rights, building, operating, and maintaining pipelines, terminals, and other similar equipment. That makes the emergence of the combined Enbridge and Spectra business a substantial shift in the competitive landscape. In addition, as Enbridge is based in Canadaand Spectra is based in the United States, the combined company may have a better chance of getting cross-border projects approved.

Continue Reading Below

Risk No. 2: Slower projected growth

Prior to last year's Moody's downgrade threat, Kinder Morgan identified a five-year growth plan of over $21 billion worth of investments. In a more recent presentation -- after its access to the debt market was curtailed by Moody's concern for its existing leverage -- that five-year plan was down to $13.5 billion. With its ability to tap the financing market reduced, fewer projects look economically attractive, thus lowering the company's potential growth rate.

As stocks are valued based on their expected future cash flows, less potential growth translates directly to a lower fair value estimate for a company. While Kinder Morgan's current share price is substantially below its year-ago level, any further cuts to its growth estimates driven by financing or other concerns could cause its shares to drop further.

Risk No. 3: Rising interest rates

Kinder Morgan currently carries almost $42 billion in debt on its balance sheet. All of that debt is either floating-rate debt -- and thus directly exposed to rising interest rates -- or fixed-rate debt, in which case it's exposed to interest-rate risk at the time it matures. After all, when debt matures, a company can either pay it off (if it has cash available) or refinance it at the then-prevailing interest rates.

If Kinder Morgan pays off its maturing debt, it reduces the cash it has available for additional expansion projects. If it refinances the maturing debt in a time of higher interest rates, it has to pay more in interest on the same amount of outstanding loans, thus reducing the cash flow available to cover operations and expansion. Either way, rising rates translates to less cash available for a company that carries debt, which would complicate the company's attempts to return to faster growth.

Risk No. 4: Political uncertainty

About 40% of Kinder Morgan's identified expansion budget involves Canada -- in particular, Canadian oil sands. Environmentalist groups have long been opposed to oil sands development because of the emissions and chemicals involved in extracting and refining that particular source of energy. On top of the political risk to that supply Kinder Morgan is looking to take to market, there's the additional potential of backlash even if the oil sands projects continue to be built out.

It wasn't that long ago that the U.S. government refused to green-light the Keystone XL pipeline expansion spearheaded by Canada's TransCanada (NYSE: TRP). Canada might wish to retaliate against the U.S.-based Kinder Morgan by making it impossible or prohibitively expensive for the American company to build and operate those oil sands related pipelines.

While Canada's Prime Minister Trudeau has signaled support for at least one Kinder Morgan expansion project, the winds of political approval can be fickle. It's not as if Kinder Morgan is Canada's only choice for oil sands pipelines. Both TransCanada and the expanding Enbridge & Spectra business are formidable pipeline companies based in Canada. Either or both might wind up as beneficiaries of any Canadian retaliation over the U.S.'s Keystone XL denial.

Despite the risks, Kinder Morgan remains an incredibly solid company

Every company faces an uncertain future, and the key risks called out above that Kinder Morgan faces for its future represent very real possibilities. Still, thanks in part to the adjustments Kinder Morgan made after its debt warning from Moody's last year, the company is on much more solid financial footing.

With operations that generate around $1 billion in operating cash flow each quarter and a less onerous debt load that Moody's now rates as investment grade and stable, Kinder Morgan is moving in the right direction. And while Kinder Morgan's dividend cut late last year stung shareholders, that lowered payout gives the company all that much more financial flexibility in how it invests for its future. All told, these are the signs of a company that has positioned itself to handle the risks it faces.

The $15,834 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: One easy trick could pay you as much as $15,834 more...each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

Chuck Saletta owns shares of Kinder Morgan and his wife owns shares of Spectra Energy. Chuck also has the following open options positions on Kinder Morgan: Synthetic Long January 2018 @ $17.50 and Short Strangle January 2017 @ $20/$24.. The Motley Fool owns shares of and recommends Kinder Morgan and Spectra Energy. 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.