A Close Look at Kinder Morgan Inc's Dividend Potential

Image source: Getty Images.

Investors who buy shares of Kinder Morgan (NYSE: KMI) at around the current price can lock in a roughly 2.4% dividend yield. While that rate is slightly better than the market average, it trails many of the company's closest peers. That said, the paltry payout, by pipeline company standards, could be in for a big boost come 2018 if everything goes according to plan. Here's a look at how much investors could be collecting in the future.

The pivot point

Kinder Morgan's dividend used to be much higher. However, credit concerns caused the company to cut its dividend by 75% late last year. The company chose to divert the cash it was sending to shareholders to pay down debt and fund its growth spending. That approach seems to be working. With the help of a major strategic joint venture, the company has cut its leverage from debt at 5.6 times EBITDA (earnings before interest, taxes, depreciation, and amortization) at the end of last year to 5.3 times as of the end of the third quarter.

While that is progress, the company's leverage ratio is still above its target of 5.0. According to analysts, Kinder Morgan can organically hit that goal by mid-2018, as a combination of incremental cash flow from new projects grows EBITDA while excess cash flow trims away at debt. What's more, the company could speed up the process if it signs another strategic joint venture agreement for one of its large capital projects. According to comments by its management team, Kinder Morganis currently considering joint venture options for both its $2 billion Elba Liquefaction Project and its $5.4 billion Trans Mountain pipeline expansion project. A joint venture of either project could bring in much-needed cash for debt reduction while freeing up cash flow that it would have earmarked for these projects, giving it the capacity to boost the dividend even sooner.

Image source: TransCanada.

Flipping the switch

While the actual timing of a dividend increase is uncertain, one thing that analysts agree on is that when Kinder Morgan raises its dividend, it will be a doozy. The consensus estimate is that the company will have the financial capacity to double its dividend from its current run rate of $0.125 per share each quarter ($0.50 annually) to $0.25 per quarter ($1.00 annually). Meanwhile, some analysts are even more bullish, with Raymond James, for example, forecasting a 130% increase in 2018, to $1.15 per share.

The conservative estimate that the dividend will double in 2018 implies that investors buying today could own a stock that yields 4.6% in two years' time. To put that in perspective, we will compare that potential yield with the 2018 dividend projections of Canadian rivals Enbridge (NYSE: ENB) and TransCanada (NYSE: TRP). Currently, Enbridge plans to grow its 3.7% payout by 15% in 2017 and then by an average of 11% annually through 2024, while TransCanada projects to grow its 3.8% yield by an average of 9% annually through 2020. Here's what those projections imply for the companies' respective 2018 payouts:

Data sources: Kinder Morgan, Enbridge, and TransCanada. DPS = Dividend per share.

As the chart shows, Kinder Morgan would basically pay an in-line dividend in 2018 if all three companies hit their current growth assumptions. However, it could start trailing its peers if it is not able to deliver double-digit growth in 2019 and beyond, which is what its rivals currently forecast.

Kinder Morgan's ability to achieve that high bar would be tougher to meet if the company did indeed sign one or more joint venture agreements to pay down debt quicker. That is because the company's current project backlog of $13 billion is much smaller than the more than $20 billion firm project backlogs of both Enbridge and TransCanada. Furthermore, both of those companies have a growing supply of visible potential projects in development that they can use to fuel dividend growth over the next decade, which is something Kinder Morgan does not have right now.

Investor takeaway

Given the way things look right now, Kinder Morgan has the potential to grow its dividend substantially in 2018. But even if it did, the company's payout would only be in line with its Canadian rivals, which are forecasting healthy growth over the next two years. In addition, they could outgrow their American rival over the next several years given their larger growth backlogs.

That said, while the visibility surrounding Kinder Morgan's dividend growth beyond a potentially big raise in 2018 is somewhat poor, that does not mean the company cannot find compelling growth opportunities to fuel robust dividend growth. A major acquisition or several significant project wins could tilt the balance in its favor.

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Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of and recommends 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.