Kinder Morgan (NYSE:NYSE:KMI) is one of the largest publicly traded energy infrastructure players with a market cap of roughly $44 billion. At its core KMI is rather similar to other midstream companies (or MLPs) such as Energy Transfer LP (NYSE:ET), Enterprise Products Partners (NYSE:EPD) and Enbridge (NYSE:ENB), where the bulk of cash flows are generated from relatively irreplicable and durable infrastructure assets. In KMI’s case there is a more pronounced exposure towards natural gas segment, which accounts for 64% of the EBITDA generation leaving the remainder for mostly refined products and RNG.
However, the chart below shows the clear correlation between KMI and the rest of the MLP and midstream segment players.
What this chart also shows is that starting from early 2023, there has been a significant divergence in the total return performance between the KMI and the broader midstream segment. While on a YTD basis, KMI has delivered almost the exact level of total return performance as the relevant index, it has still not managed to compensate the negative return delta.
The question is whether KMI has the necessary characteristics and momentum to (a) deliver solid returns on a go forward basis, and (b) recoup the negative relative returns that have occurred since the early 2023 (thus registering an alpha compared to the benchmark).
Let me know explain why I think that this is highly unlikely and why, in my opinion, investors should explore other midstream investment alternatives.
Thesis
There are a couple of reasons why I am relatively bearish on KMI, but everything starts with quite rich valuations. For example, currently KMI trades at a TTM EV/EBITDA of 11.9x, while for comparable peers that carry also investment grade balance sheets and operate in relatively predictable cash flow segments the relevant multiple is roughly from 10 to 20% lower (e.g., the TTM EV/EBITDA for ET and EPD are 9.0x and 10.3x, respectively).
The higher valuation quite naturally leads to a more depressed dividend yield, which in KMI’s case currently stands at 5.8%. This is circa 170 basis points below the sector average – as implied by Alerian MLP ETF (AMLP).
All of this introduces an unfavorable starting position for investors to expect a strong total returns performance from KMI relative to other midstream names that trade at lower multiples, while having rather similar business risk exposures and strong capital structures.
Now, if we look deeper into KMI’s profile, I see no major justification why this company should trade at a premium. Granted, the underlying fundamentals are strong and supportive of a continued EBITDA and dividend growth in a sustainable fashion. But, again, other comparables such as ET, EPD, ENB and Plains All American (NASDAQ:PAA) exhibit very similar dynamics.
For instance, a major theme that adds an element of positivity in terms of KMI’s growth prospects is the projected increase in the power demand associated with the build-up of many large-scale data centers. The argument here is that the electricity distribution and transmission grids will not be able to absorb the new capacities of power supply that will come online to facilitate the functioning of these data centers. An additional point is that the new power supply that would come from renewables would anyways not solve the demand given the intermittent nature of the energy generation.
So, this creates an opportunity for KMI to offer its natural gas infrastructure to accommodate the incremental energy supply that would come also from other non-renewable sources. In the most recent earnings call there was an extensive commentary provided by KMI on how the emergence of data centers will inevitably favor KMI’s business. This commentary Rich Kinder – Executive Chairman – summarizes the essence quite nicely:
All this means that natural gas must play an important role in power generation for years to come. I think acceptance of this hypothesis will become even clearer as power demand increases over the coming months and years and it will be one more significant driver of growth in the demand for natural gas that will benefit all of us in the midstream sector.
While this is indeed a good thing for KMI, it will also benefit other midstream players, which, in turn, implies that there is no pronounced competitive advantage for KMI in this context.
Looking at how the market has priced in KMI’s EPS growth, we will not see a huge deviation from the other mentioned peers. The 2024 double digit EPS estimate is indeed higher than average, but then starting from 2025 the estimated rate of change in the EPS is comparable and in some instances even lower than for, say, ENB, EPD and ET. In 2027 we see that two analysts have projected KMI’s EPS growth of 15%, but given the small sample of estimators I would not take this figure seriously.
Speaking of the capital structure, KMI is in a solid position given its strong investment grade credit rating and a notable momentum in bringing the leverage levels down to a more defensive level.
With that being said, the current net debt to EBITDA is 3.9x (based on FWD 2024 EBITDA), which is slightly above the sector average level that stands between 3.0 – 3.5x. The difference is not significant and it is highly likely that in 2025 KMI’s leverage profile will continue to improve. Yet, in the context of the above average multiple, the balance sheet factor is not providing any support for justifying the current premium.
The bottom line
In a nutshell, KMI is a sound business with a decent financial outlook to capture further EBITDA growth and deliver sustainable dividend.
The issue, however, is that the multiple is just too high rendering the FWD dividend yield unattractive and making it tougher for KMI to register stronger total returns than for the comparable but better valued peers. Plus, from the capital structure perspective, KMI is certainly not the safest midstream player out there with its net debt to EBITDA being ~ 1.0x above the sector average, which adds a further challenge in explaining / justifying the existing premium.
As a result of this, in my view, investors should consider avoiding Kinder Morgan and search other midstream alternatives instead.
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