Kinder Morgan Stock Downgraded: What You Need to Know

Thanks in part to support from Warren Buffett's Berkshire Hathaway(NYSE: BRK-B), shares of natural gas pipeline operator Kinder Morgan (NYSE: KMI) have climbed 43% since 2016 began. For the most part, analysts have cheered the rise of Kinder Morgan stock. But could it be that Kinder Morgan's run is done?

According to one analyst, it is.

Ranked in the top 10% of investors we track here at Motley Fool CAPS, Stifel Nicolaus last recommended buying Kinder Morgan stock on Jan. 28. According to data from StreetInsider.com, Stifel has maintained its buy rating all year long -- or at least, had done so up until yesterday. Because on Tuesday, Stifel removed its endorsement of Kinder Morgan stock. It downgraded Kinder Morgan to hold, while maintaining its price target at $24 a share.

Here are three things you need to know about that.

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Kinder Morgan's pipelines seem to have no end -- but the same can't be said for the run-up in Kinder Morgan stock. Image source: Getty Images.

1. Bigger is better

With84,000 miles of pipeline crisscrossing the continental United States, Kinder Morgan controls the largest network for transporting oil and gas products in the U.S. It's also the nation's largest independently owned terminal operator. According to data from S&P Global Market Intelligence, Kinder Morgan does nearly $13.7 billion in business annually.

2. Smaller may be worse

But according to Stifel Nicolaus, as big as Kinder Morgan is today, it's not growing particularly fast. In June, Kinder agreed to sell a 50% stake in its Southern Natural Gas pipeline to Southern Company (NYSE: SO). The deal brought Kinder Morgan $1.5 billion in cashthat it can use to pay down its debt load, and followed a similar deal to sell a 50% stake in Kinder's Utopia ethane pipeline to private-equity company Riverstone Investment a month earlier.

Taken together, these deals promise to reduce Kinder Morgan's capital spending requirements and lighten its $43.6 billion debt load somewhat. Stifel praises these and similar moves "to improve the company's balance sheet." But at the same time, Stifel warnsthey will reduce growth in earnings (technically, EBITDA, or earnings before interest, taxes, depreciation, and amortization) at Kinder Morgan to just 2% in 2017.

3. And anyway, Kinder Morgan stock is fully valued

Given the slow pace of growth it expects to see -- and the mammoth gains the stock has already enjoyed this year -- Stifel fears that Kinder Morgan stock's "current valuation and Kinder's strong performance since early 2016" have squeezed most of the profit potential out of this stock already. While the analyst is sticking with its $24 price target set back in January, Stifel Nicolaus is forced to conclude that "the current valuation largely reflects the positive attributes of the KMI story."

I agree.

The most important thing: Valuation

While a dominant force in gas transport, and a strong revenue generator, Kinder Morgan stock is not so hot when it comes to earning profits for its shareholders. Net income for the past 12 months was a mere $178 million, and on $13.7 billion in revenue, that works out to a net profit margin of just 1.3%.

Additionally, although Kinder Morgan has cut its dividend payout, the company is still on the hook for $0.50 per share, per year. That's more than 17 times the amount of net profit the company earned over the past year. Unless profits perk up promptly, the company may be forced to cut its dividend again. So can Kinder Morgan recover?

Maybe.

Valuation-wise, the stock sells for more than 700 times trailing earnings -- an admittedly scary figure, but one based on the stock's $0.03 in trailing-12-month earnings. 2016 earnings are expected to rise several-fold to $0.67, however. Assuming this is how things work out, it will yield a less-scary-sounding 33 price-to-earnings ratio for Kinder Morgan by year end. Additionally, analysts who follow the stock predict strong 14.5% annualized earnings growth over the next four years -- a far more encouraging number than the 2% one-year EBITDA gain Stifel is talking about.

Of course, in the final analysis, this still leaves us looking at Kinder Morgan trading for a 33 P/E (maybe), growing at 14.5% (also maybe, because the future is uncertain), and paying a 2.2% dividend (assuming they don't cut the divvy again). While Kinder Morgan may not be as overvalued as its 700-plus trailing P/E ratio makes it seem, it still looks like no bargain to me.

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Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he currently ranks No. 282 out of more than 75,000 rated members.

The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Kinder Morgan. The Motley Fool recommends Southern Company. 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.