Lesson Learned: The Kinder Morgan (KMI) Debacle (December 08, 2015)

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Today, Kinder Morgan (KMI) announced that it would cut its dividend starting in 2016 by 75%, down to $0.50/annually.

For income investors, this comes as a devastating blow at a time when it is very difficult to locate high yield in a Zero Interest Rate Policy (ZIRP) environment.

This news announcement hits home, since I had been a shareholder of KMI before in the past, and even most recently earlier this year…

I can’t say that I saw this news coming so soon, but one of the main reasons why I sold out of the stock was because of the company’s bloated balance sheetfar too much debt for my own liking.

Further, the company’s credit rating has been brought into question as of late with many fearing that a cut to junk bond territory might have been imminent. Hopefully, today’s dividend cut will help KMI shore up the balance sheet and get its house back in working order…

Unfortunately, many investors were burned in the process…

Commodities Still Suck

Recently, I wrote an article about why I think commodities make for lousy long-term investments.

I stand by that.

For whatever the reason, though, it has been especially popular these last few years for investors to chase oil, gas, and energy stocks (even near all-time highs).

But as we are all witnessing first hand, in a deflation of natural resources, no commodity is safe from punishment!

Gold, silver, copper, uranium, oil, gas, alternative energy, etc…, have all been annihilated… or are still in the process of being obliterated.

Right now, KMI is down about 63% year-to-date (YTD), and many investors are clamoring that it is now time to back up the truck!

Not necessarily…

Let’s examine this more closely…

Kinder Morgan (KMI):

KMI

Yes, being down over 60% in a given year is terrible performance… But objectively, in the world of commodities, these results actually aren’t so bad…

KMI would be the envy of many other commodity stocks out there!

Quite frankly, for me to be interested in purchasing shares of KMI, it would have to fall to about $4/share

The Plunge in Commodities

As I mentioned above, commodities suck! Historically, all that they do is boom and bust… and right now, we’re busting up like perhaps never before…

What have I learned from the KMI ordeal?

That a dividend does not insulate you from deflation…

You could just as easily apply the same lesson learned with KMI to other income producing commodity stocks such as: BHP Billiton (BBL), Freeport McMoRan (FCX), etc.

All these stocks have been terrible performers this year…

And because of such extreme volatility, I’ve learned that if I’m going to dare speculate in commodities, then I have to protect my downside risks as much as possible! This means ONLY playing when assets (companies) are being discounted for 80% to 90%+!

Screw the dividend! It will not save you from a 60% haircut… or more off of your principal… And let KMI be a lesson for all of us — When times get tough, and these commodity stocks sell off, to add insult to injury, the company will be forced into slashing the dividend!

Let’s not get delusional here — dividends are a function of free cash flow (unless the company is insane and using debt to service it).

In a deflation, there is NO FREE CASH FLOW!

So how on earth can you sustain it?!?

When it comes to commodities, the dividend becomes nothing more than a huge burden during a period of deflation. Ask any gold miner. So, again, why bother?

The company shouldn’t pay it.

The investors shouldn’t be out looking for it.

If you’re going to play in this commodity space, you’re really better off chasing deep value!

Deep Value

When it comes to deep value, I don’t see any to be found in the popular oil companies: KMI, Exxon Mobil (XOM), Chevron (CVX), ConocoPhillips (COP), etc.

Being down 20% or 30% is NOT deep value.

If you want to talk cheap, you’ll have to look into offshore drillers, perhaps…

For myself, I’m simply concentrating on other commodities that are simply more hated and where you will find tremendous deep value.

When it comes to: oil, gas, uranium, copper, gold, silver, etc., I really don’t care… I’ll buy the cheapest one(s) on the clearance rack.

Right now, I have to believe that it’s gold and silver (copper and uranium to a lesser degree) that offer the most bang for the buck.

Check out this Australian gold mining company:

Perseus Mining (PRU.AX/PRU.TO):

PRU

PRU.AX/PRU.TO is down 90% over these last 5 years… That’s the deep value that I’m talking about!

So, that must mean that the company is on the verge of bankruptcy, right?

Check out the valuation and balance sheet:

PRU_Key Stats

PRU_Key_Stats_2

In short, we have:

Current P/E of 2.4.

Price/Book of 0.38.

Enterprise Value/Revenue of 0.34.

The company generates C$249 million/year in revenue.

Market Capitalization is C$174 million.

Enterprise Value (EV) is C$85 million.

The company has C$89 million in the bank and ZERO DEBT!

 

And that’s why I’m sticking to precious metals stocks… You can find valuations like Perseus all day long across the sector; they are a dime a dozen. Everyone thinks that gold stocks are exceptionally risky, but really, how are they any riskier than oil/gas stocks?

Perseus has no debt! Further, other gold producers such as: Teranga Gold (TGZ.TO), Klondex Mines (KLDX), McEwen Mining (MUX), etc., all have outstanding balance sheets, minimal debt, and can generate free cash flow in a low priced ($1,000/oz) gold environment…

In fact, I would argue that precious metals stocks (as a whole) are actually less risky because anyone buying into them would be doing so AFTER they have already crashed by 80% to 90%+.

I am not in any way, shape, or form suggesting that Perseus, or any other gold company is a “safe stock”, but it is an absolute fallacy to assume that a given company is superior and “safer” just because it issues a dividend…

Today, KMI reminded us of that.

When it comes to commodity stocks, point blank, they are ALL RISKY!

But as it pertains to oil/gas stocks, the price of oil has crashed hard, but the stocks have not! This runs counter to gold and silver stocks, which have fallen much further than the underlying physical metals have.

Please note, I have NOTHING against oil/gas stocks!

As I mentioned earlier, if KMI was trading for $4/share, I would probably also start backing the truck up in the same manner in which I have for gold and silver mining stocks!

Stick to Safe Income

Again, commodities SUCK! If you’re gonna play, you have got to buy at the bottom and chase after deep value or you will be burned badly.

For me, deep value means buying merchandise at 80% or 90% off, no exceptions.

As an example, speculators can use indexes such as: HUI, GDX, GDXJ, etc. as barometers…

GDXJ:

GDXJ

Of course, there are no guarantees, but I think a speculator can protect themselves more so going the deep value route as opposed to settling for a commodity stock that has only come off by 50%, yet still offers a crappy dividend…

With commodities, you simply make more money by trading them, as opposed to Buying and Holding Forever.

In my own mind, anyway:

Commodities are not suitable long-term investments… They are far too volatile to be reliable.

Even within the best names: CVX, XOM, COP…

Instead, I would much prefer to buy far cheaper commodity stocks at the bottom of a bear market, sell when they get really expensive, and then use the proceeds to buy more reliable income producing assets.

Cycles repeat.

Over and over again.

When it comes time to sell?

I’ll transfer those proceeds from commodity stocks back into ACTUAL reliable income producing assets: real estate, Johnson and Johnson (JNJ), General Mills (GIS), 3M (MMM), Pepsi (PEP), etc.

 

That’s the gameplan, anyway…

 

Did I mention, commodities SUCK?

 

Happy Hunting!

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Dangeorge puckAgnesBeSmartRichFI Fighter Recent comment authors
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mike
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mike

I’m pretty sure I mentioned dividend cutting in the energy sector was virtually inevitable and the havoc it would cause on share prices. Kudos to those who listened. Shame on those who didn’t.

Rick
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Rick

Very good points, although I disagree with one of your statements…

“Commodities are not suitable long-term investments… They are far too volatile to be reliable.

Even within the best names: CVX, XOM, COP…”

Investors who bought CVX or XOM at ANY point over 10-40 years ago and have held and reinvested have done EXTREMELY well. Yes, these stocks have far more fluctuation than others, but they are superior businesses due to their size when compared to other “commodity” businesses, and thus, have excellent long term track records.

That said, I get your point on commodities as long term buy and hold investments, but when you study the returns, XOM and CVX have been excellent long term investments.

BeSmartRich
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KMI dividend cut was expected. It was issuing stocks and debt to fund dividends when the company already had close to 50% of debt to asset ratio. How would any company to be sustainable?

Your take on precious metals sounds really great. I have been buying mining companies for a while and will see whether I can start adding precious metals soon in the new year. Thanks for sharing!

BSR

Agnes
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Agnes

Hi,

Just wondering, what do you use for your stock stats?

Best,
AJ

Dan
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Dan

Yes, I am also curious, what software do you use for that Chart?

george puck
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KMI is a huge discount.

Rich Kinder is easily one of the best investors in the world. I know there is a bad rap about them selling stock to pay dividends.

And people are comparing its debt to equity ratios as though its a regular company. KMI is mostly a utility.

THe market didnt like the NGPL purchase, but it has for decades been the best pipe to get natural gas into the midwest. and I know things have changed with all fo the new shale plays. But NGPL has EASILY the best storage assets in the country and ties into most of the salt dome storage plays in Texas. For coal power plants being shut down and replaced with natural gas turbines, NGPL will be the most important asset.

Did KMI get caught short with the plunge, and has the bond market over reacted? yes, it did. But you watch, these assets that Rich Kinder has put together are unique in the space. The cash flow is going to return, and it will be really easy to buy up shares.

After tax loss season, KMI is going to be a great buy. I might look at the preferred shares, collect the 9-10% dividend and covert the shares in the future.

People dont understand the pipeline business, its not a commodity play. Its a thru-put play outside of some of the CO2 assets.

You watch, this is going to be a really great stock.

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