Why Kinder Morgan Just Took a Big Analyst Downgrade

Shares of Kinder Morgan Inc. (NYSE: KMI) set a new 52-week early in Thursday’s trading session, and the end is not yet in sight as the stock continues to slide. Investors have sent the company’s shares tumbling to new lows routinely over the past several weeks, and this latest dip was certainly helped along, if not caused by, a downgrade on the stock.

Analysts at Argus dropped the firm’s rating on Kinder Morgan stock from Buy to Hold. The short version of the driving force for the downgrade is doubts about the company’s ability to pay its dividend given recent earnings that have been short of expectations, as well as Kinder Morgan’s future ability to get financing for $21.3 billion of backlogged projects. Argus also noted that Moody’s Investor Services cut its rating on Kinder Morgan debt to Baa3, only one notch above junk, and cut the company’s outlook from stable to negative.

Kinder Morgan’s strategy has not changed since it rolled all its MLP assets into a new C-corporation: growth at all costs. Without growth, the company cannot continue to raise its dividend, nor can it afford to finance its growth projects. Kinder Morgan’s protestations that the majority (87% Argus says) of its revenue comes from fee-based contracts has not resonated with investors who see falling oil and natural gas prices as demand killers that will affect Kinder Morgan’s ability to grow.

When the company reported third-quarter results in October, the share price carnage began. Kinder Morgan lowered its dividend growth guidance for 2016 from 10% to a new range of 6% to 10%. The company said it needed the flexibility, but that’s not how investors saw it. Argus said in the report it released Thursday morning:

[B]ecause the company pays most of its available cash flow out as dividends, it must rely on external financing to fund its hefty five-year project backlog, currently valued at $21.3 billion.

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Thus, if spending on growth can only be met by reductions in payouts to shareholders, well, shareholders see little reason to stick around:

KMI’s options to fund its hefty five-year project backlog while growing its dividend are shrinking. Issuing additional debt would endanger KMI’s investment-grade credit rating, now at the lowest level assigned by Moody’s. Issuing additional equity would further dilute earnings and compound the negative impact of the falling stock price.

Kinder Morgan is stuck between the proverbial rock and hard place. The convertible preferred equity offering of $1.54 billion the company announced in October could turn out to be a bargain if the company’s share price can rise above $32.38 by the end of the three-year conversion period.

But Argus reckons that capital raise will only fund ongoing projects through the middle of next year. Then what? It’s not a pretty picture, according to Argus, especially if the company’s debt is downgraded to junk.

Argus sums up the dividend picture:

Kinder Morgan’s dividend yield is 630 basis points above the 10-year Treasury, compared to a five-year average of 312 basis points. Relative to a group of comparable MLP peers as measured by the Alerian MLP index (AMZ) the dividend yield is within seven basis points, compared with its five-year average discount of 210 basis points. This well-above-average yield profile for KMI represents risk, in our view.

In other words, if something cannot go on forever, it won’t.

Kinder Morgan shares posted a new low of $19.91 Thursday morning. The 52-week high is $44.71 and the consensus price target is $36.25.

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