Earlier this year I cut all exposure to energy except for one company…
A few month later, I started cutting back on all companies that were highly leveraged with debt because I could see the turn in the credit cycle coming and I knew that companies that were relying on the ability to access the debt markets for new funds, or more likely to rollover existing debt, were going to get squeezed out. I kept one company that was highly leveraged…
Those companies were the same company: Kinder Morgan – one of the major energy pipeline operators in the US. I thought their business model was insulated, to a degree, from the drop in energy prices because a lot of their business is based on fixed fees not related to the price of oil and gas. They’re basically a toll road that collects fees.
The problem was that Kinder Morgan was using the debt and equity markets to fund all future growth projects (new pipelines, takeovers, etc.), and their projected dividend increases were largely based on their ability to access the capital markets for this funding. Once the debt market soured, Kinder Morgan lost the ability to access the markets at a reasonable price which left them unable to fund both the dividend and new projects. Well…last night they chose to cut the dividend…by 75%. They feel that the best long-term use of their cash flow for shareholders is to continue with their backlog of expansion projects instead of maintaining the current dividend payout.
The stock has been absolutely crushed since May (along with most energy companies), basically predicting that this would happen. Looking back, I was confident in my assessment that the business was relatively insulated because the stock had held up so well from July 2014 through April 2015, the period when oil first rolled over and hammered all energy related names (highlighted in the chart below). Then the next wave brought the pipelines down with the rest of the industry and Kinder Morgan collapsed rather quickly. The difference? 2014 hit companies exposed to the price of energy. 2015 pulled in anyone relying on the debt markets.
Energy ETF (Black) vs. Kinder Morgan (Blue) – 2 year chart
I’m glad that I was able to avoid much of the widespread pain by exiting a lot of positions earlier in the year that have come under the same pressures but I’m really kicking myself about this one. I don’t take losing other people’s money lightly. Now, I understand that losses are part of investing; you’re not always going to be right. But this one definitely hurts because I saw the issues in the energy and debt markets coming but thought Kinder Morgan would be safe despite my concerns.
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-Nick
What people do not realize is that pipe line carriers suffer no loss of revenue when oil stocks go south. Producers pay rent to the pipe line companies for a period of time( one year, 2 years etc.) whether oil flows or not. The problem surfaces when its time to re-new the contracts and the oil companies either do not re-new or strive to re-new at lower rates or for lower volumes of product. Thus, effecting the pipeline rates and, subsequently, profits.
Marc
Thanks Marc! You’re right, and the scary thing is that Kinder Morgan’s profits haven’t been hurt that much yet, which is only additional headwinds.