Kinder Morgan, Inc. (KMI) Earnings Call Transcript & Summary

Thanks for joining us today. I'm Jean Ann Salisbury. I cover natural gas and midstream at Bernstein. I am joined by Kim Dang, the incoming CEO of Kinder Morgan. Kim is going to make some opening remarks, and then we will go into Q&A. I have some questions that I'm excited to ask him. And then you can also ask questions via the Pigeonhole app, which there's a QR code here if you're interested in putting those in. So without further ado, I'll let him take over here. Thank you.

Okay, I'll just sit here if that's okay. So just a few things about Kinder Morgan before we get started to give people a little bit of context. We are a U.S. infrastructure company. We own pipelines and terminals primarily. We typically don't own the commodity. We provide logistics services on a fee-for-service basis. And right now, about 61% of our cash flow of our EBITDA comes from take-or-pay contracts, meaning that our customers pay for the capacity, whether they use it or not. And that is similar to what you'd have on like an apartment or an office lease, they pay for the capacity, whether they occupy the space or not. 26% of our business is fee-based, meaning there is some volume risk, but there is no risk to the price. 62% of our business is natural gas. About 27% of our business is products and terminals where we primarily store gasoline, diesel and jet fuel, 11% is CO2. The 11% that is CO2 also includes our ETV business, and that's our energy transition ventures, where we have made about $800 million in acquisitions associated with renewable natural gas. And so that's capturing and cleaning up gas coming off of landfills. We've got a very attractive backlog of projects that we're working on. The backlog right now totals about $3.7 billion, and the EBITDA multiple on that backlog is about 3.5x. About 86% of that backlog is in lower carbon fuels. And so to give its natural gas, it's renewable diesel, it's RNG, things of that nature. On the natural gas side, great opportunity there. Natural gas in the U.S., demand is expected to grow from about 106 Bcf to 127 Bcf a day by 2030. A lot of that incremental demand is coming from LNG exports. So about 14 of the 21 is coming from LNG exports. We have renewables projects, primarily in products and terminals where we're either storing the feedstock for renewable diesel or the renewable diesel itself. And then we've got our first CCS project in the backlog, which is relatively small. It's about a $50 million project, but the first one that we've done in that space. Our base business, especially natural gas, has some nice tailwinds as the capacity of natural gas pipelines, the utilization has just gotten higher and higher as demand has gone up over time. And so from 2015, we've seen about a 36% increase in volumes across our systems, and that's expected to continue to grow, as I just mentioned. And so that gives us the ability to increase price or increase term, a similar phenomenon happening on our storage assets. Our dividend, 6.5% yield, maybe a little bit better than that right now, is 1 of the top 10 in the S&P 500. It's very well covered. We've returned over $17 billion to shareholders since 2016. That's about 38% of our market cap. Most of that's come in the form of a dividend. Some of it from share repurchase. Our balance sheet is in good shape. We're about 4.1x debt to EBITDA, mid-BBB rated. Since 2016, we've reduced debt almost 20%. We were recognized as a leader in ESG. We're #2 rated at Sustainalytics, #2 at Moody's. And so people would think the challenge right now being in the fossil fuel business is really, what's going to happen to this business over time. And for sure, that's a concern and part of the way we're addressing that is through participating in the energy transition where we can do that on a profitable basis. But I think as we've looked into this more and more, as we've understand what's happened in previous energy transitions, I think, there's going to be a long tail on our existing business. If you look at previous energy transitions, what ends up happening is you actually add additional fuels you don't eliminate the existing ones. And so -- and they take decades. And this is a $5 trillion industry where you've got a huge installed base built around fossil fuel. So we think this transition will take decades. And so we'll turn the ship slowly with it. But the biggest probably challenge that we have in our business is related to just the regulatory burden, the regulatory compliance burden has increased meaningfully in the last couple of years. And so that is a -- that's the primary headwind that we have to manage at this point. Those things change as administration changes. But right now, it is pretty significant. So we've got nice tailwinds in our base business. We've got nice projects at good returns. We've got a nice, stable existing business, and so a nice dividend and potential growth in our business.

So I'll start going into some questions. We can kind of start high level with the overall investment case. How do you think Kinder Morgan and maybe large cap midstream more broadly should fit into a generalist investors portfolio? And how would you weigh it pros and cons to utilities and large-caps E&Ps, which I would guess are kind of the 2 marginal competitors for investment for generalists.

Yes. Energy is a critical part of our economy. I think somebody told me it's the #2 industry probably behind healthcare. And so it's 4% to 5% of the S&P 500 right now, it's been higher than that in earlier decades. But I think when you start looking -- after you get past -- should you invest in energy, then it's where do you invest and you look at the upstream and the E&P and you look at the utilities. I think when you look at midstream compared to upstream, upstream is more of a commodity play, generally. And so you've got -- potentially you've got more downside, you also have more upside as you play that commodity cycle. I think that with utilities -- and I think the yield on some of the E&P when you look at some of the E&P indexes has ended around 3x, 3.5x and that's compared to ours of over 6.5x at this point. When you look at the utilities, you've got -- they have about, I think, 30.4% dividend is the yield on the UTY right now. And then they just have a very secure regulated business so they don't have as much potential growth. I think, as midstream house. So I think when you're in midstream, you're getting a higher yield, you're getting potentially more growth than utility. You also have a little bit more downside than a utility, but you don't have the volatility that you have in the upstream investment.

Makes sense. For a long time, the knock on Kinder Morgan specifically has been some version of it's a leaky bucket. It felt like you kept spending growth CapEx, but EBITDA didn't grow meaningfully. Do you think that, that's a fair characterization of the past for Kinder Morgan? And can you discuss some of the causes that gave this impression?

Yes. So if you look 2015, 2016 forward and look at our EBITDA, I think our EBITDA in 2016 was like $7.2 billion. This year, we expect it to be about $7.7 billion. So you've got about $500 million of growth there. But given the capital that we've invested, people would have expected that growth in EBITDA to be much higher. And so when you start looking at some of the specific reasons, there's kind of 3 or 4 reasons that, that happened. One is we went through a big build cycle in 2008, 2009, on what we call a lot of supply push pipelines, which were basins, we're increasing production and you needed to get the production out of that basin into the interstate gas market. And so you build these pipelines coming out of the basin, connecting into the interstate gas market. Well, a lot of that was coming out of the Rockies, it was coming out of the Barnett Shale, it's coming out of the Fayetteville Shale. Well, now there's more productive basins. And so when those contracts rolled after 10 years, we couldn't renew them at the same rate. And so that caused a step down in EBITDA from those pipes. You've also had different commodity prices during that market. And so in our CO2 business, and that's 6% of our business where we have that exposure to commodity price. Now on -- in that business, we hedge. But you can only take care -- generally, you're taking care of the near to medium-term risk there. And so you have the longer-term commodity risk on that 6% of our business. And so you saw some price degradation there. The other thing is we sold a number of assets. So as I said a minute ago, we've reduced debt by almost 20% since 2016. And so a lot of that debt reduction came from asset sales. So we had a Canadian business that we sold. We've sold interest in a couple of natural gas pipelines and so you see the degradation in EBITDA from those, but you also see an improvement in the balance sheet. So those were some of the reasons that we saw some degradation in that we didn't get the uplift that people expected from the projects because we had this degradation in some of our base business. Now when you look at the base business, as I said a minute ago, you've seen huge increases in natural gas flows, about 35% since 2015. And then we've got more coming. There's been natural gas capacity built in this country, but it hasn't kept up with the demand. And so -- what's happened as a result of we've seen average utilizations on our pipelines go up dramatically. And so for example, we've got a pipeline that goes from Texas out to California. The utilizations increase from somewhere in the 60s into the mid- to upper 80s, and that's on average utilization. TGP, which is a pipeline that goes from Texas, Louisiana, into the Northeast. Utilization went from the 80s into the high 90s, right? And so you've got a pipeline that on an average day is basically sold out. And so as a result of that, that gives you some pricing ability to increase prices, ability to increase length of contracts so that you're not faced with rolling contracts in bad markets. Storage is another example. Storage capacity hasn't increased, has not kept pace at all. I mean, storage capacity since 2015 has increased by like 1%. And so you're seeing nice increases in storage rates. And so that gives us some confidence about our ability to keep the base flat or grow it over time.

Yes. That makes sense. I might actually skip to a later question while we're kind of on the topic. It does feel like due to all of these very high utilizations of pipes and storage for gas going to the coast. It seems like you're just going to see continued volatility on a regional basis and time basis and storage. It feels like most of your large-cap midstream competitors either had gas marketing arms or if they didn't have them, they bought one. Kinder Morgan hasn't really yet. How do you -- do you feel like you're kind of missing out on being able to grab your share of the pie if that's really what's going to happen?

Yes. So let me talk about -- generally, our model is to lock up our assets on a fee-for-service basis under long-term contracts. We do have some places where take positions on those pipes. As you say, I don't necessarily consider it trade around, but my view is we're trying to maximize the value of that capacity. And so we have some of that on our crude systems, where we're actually -- we'll buy the gas, the crude at 1 end and sell it at the other and lock in the transportation spread on that. And by going out and gathering those volumes and aggregating them, we've been able to increase the utilization of that pipe basically take up more of the space and that pipe. And that's worked very well for us. But we're generally trying to lock in a transport spread on that. So we have places across our business where we have underutilized assets where we do activities like that to increase the utilization. We also do some butane blending and some naphtha blending on some of our clean products into the gasoline. And so that's a little bit more of a merchant business that we do. We've got some historical marketing activities that we inherited from El Paso on EPNG that where we're providing the natural gas to a storage plant we're the supplier. But generally, the things we do on what I'll call the merchant side, are around the edges, to increase utilization. And we do so on -- we do so making sure we fully understand what that risk is. And so I'm not saying that we would never -- we evaluate that. And so there are times when we play a little bit more in that and times we play a little bit less. But I don't ever see it being a huge portion of our business. I think it could be a small portion of our business in order to capture some of those opportunities.

That makes sense. How do falling gas prices affect Kinder Morgan directly or indirectly? And then same question within oil prices.

Okay. So when you think about our exposure to gas, it's about $0.10 for every dollar per MMBtu change, okay? And then our exposure to crude is $5.8 million for every dollar change in a barrel of crude. And those were -- that's a full year price exposure. So obviously, we're partial -- halfway through the year. So that price exposure at this point is much less, and we've laid on some additional hedges. So it's much less at this point in the year, but that's what it was going into the year. The crude exposure is primarily from our CO2 business. And so I think that when you have falling prices, we obviously have that direct commodity exposure, which is relatively small given the size and scale of our business. And then on an indirect basis, when you think about it on the crude side, what you would say is when you have falling prices that you might have less crude oil production and therefore, less volume flowing across your crude gathering assets. I think crude gathering is like it's 1% of KMI overall. So again, not a big impact there. natural gas gathering. So when you see reductions in natural gas prices, producers lay down rigs and you have lower volumes coming into your gathering assets. Natural gas gathering is about 8% of KMI overall. So you could have some volume impact on the natural gas gathering side. But overall, as I said, to start with take-or-pay contracts are 62% of our business. So we've got a very stable core business. And then 26% is fee for service. And so there, you're locked in on your fee. It's just a question of what your volumes are. A big piece of that volume is product pipelines and then a smaller piece is this gathering that's about 9% of KMI overall.

Yes. I think this all kind of feeds out of all of the things that we've been talking about. But in my mind, Kinder Morgan's probably the most defensive energy stock for oil and gas, at least in recession. Is that how you think of it as well? I think just due to having very little GMP exposure, very little basis exposure from not having marketing and hedging most of your direct commodity exposure. There's really not...

Yes. So when you further -- so you say you take the 26% of our business that's fee-for-service, that has some volume exposure. So it's 62% on the take-or-pay, 26% on the fee based. You have 6% that is hedged, right? And then you have 7% where you've got potentially both price and volume risk. So on the 26% that is -- on the 26% that's fee-based, Think about that, that's 2 things. That's the products pipelines volume, and then that's the gathering volumes. So the 2 primary components of that 26%. So -- and then on the on the 7% that is unhedged. It's really price exposure there. It's not so much volume because that's in our CO2 business, unless prices, it's pretty economic at very low oil prices. So unless you get oil prices that are below $40, you're going to continue to produce there. And so I don't see a lot of volume exposure there. So if you say, okay, your gathering business is probably going to be down, probably a little more than 10% if you get a big commodity hit. On the other hand, on your refined products volumes, that's going to be down well less than 10% on that 26%. So just say, okay, that 26% is down 10%. That's 2.6% on KMI overall. And then on the 7%, if you say, that's 20% price hit, something like that. where you get is maybe a 4% or 5% change in KMI's overall business. So pretty well protected in some type of recession.

Makes sense. So there's a lot of talk right now about that midstream sector being on the cusp of a major M&A wave where the big 7 or 8 companies roll up all the little MLPs that are still hanging around. I was reminded when I went to the energy infrastructure conference last week that like all these small GMPs still exist and they're definitely all kind of pitching that thesis now. So I'd be interested in what you think. Are we -- or is it finally here...

M&A is very easy to imagine and hard to accomplish is what I would say. So I think that when we think about M&A, there's 4 or 5 criteria that we use. It needs to be DCF accretive -- DCF per share accretive. From a balance sheet perspective, we prefer if it's neutral, maybe slightly positive. It needs to have a reasonable IRR. So we look at the IRR in addition on an unlevered basis in addition to the accretion on a levered basis. And it needs to be a good strategic fit. And so those are the 4 hurdles that you've got, primary hurdles you have to clear before we're going to consider any M&A. Those are 4 criteria that are pretty hard to satisfy all at the same time. We have a discipline around corporate M&A, where we look at it on a constant basis, have done so for the last 21 years. But it's sporadic. What I would say right now is a lot of the companies in our space are trading at pretty tight multiples. That makes it hard to get a lot of DCF accretion. And so the only way to get a much accretion when you're trading at very tight multiples is to have synergies. And I don't -- synergies is generally not a primary rationale to me -- for us to do an acquisition. We will -- I mean, we will consider synergies where we are fairly certain about them. But we have to feel very certain about them. And I think they're just an adder to the deal, not necessarily the reason to do a deal.

That makes sense. So moving into some of your business lines and getting a little more specific about them. Another thing at the Energy Infrastructure Conference that I was surprised by was -- so you kind of go in and you sign up for all the meetings you want and you sometimes add more meetings than you actually need just because it's really easy to check them. So I signed up for a couple of meetings with carbon companies that I hadn't heard of. And then I was given one-on-ones with these carbon companies, like, I don't know anything about these, but I will find out on the plane. So then I go to their website, like ready, turns out there's no investor deck or anything for either of them. It's just the website. So you go into my meeting, like I read some news articles on you. But basically, there's kind of all these start-ups that are looking for PE money for -- and they're trying to do big projects like $500 million to $3 billion. They want to do 10 to 15 MTA projects. They've submitted Class 6 well applications. And actually, in some cases, they've signed contracts with like real people like with Energy Transfer and others. Do you think that there's a chance that these now very -- these people with the website will sort of become the giants of the space. I'm surprised that they've made so many more moves than the traditional energy companies that I would have expected to be the natural owners of sort of carbon pipeline and sequestration?

Yes. So when you do the carbon capture, I generally think about that's going to have to be whoever owns that facility. So if it's Exxon's refinery or Shell's refinery or if it's whoever's ammonia plant, they're going to have to really build the capture equipment because they're going to build it on their existing site, potentially attached to their existing facilities. So I generally don't think of that as a space we would play. Now if they want us to participate in that, that's something that we're willing to consider. But I generally think that they're going to be more the driver of the bus on that. Where I see us playing is really on the pipeline side and then on the sequester side. And so when you think about the pipeline side, you really need purpose-built pipe to take CO2 any reasonable distance. Because CO2 has to flow, to flow efficiently, it needs to flow at very, very high pressures. And that's higher than generally the pressures that a natural gas pipeline can accommodate. So you can move them in a natural gas pipeline, it's just pretty inefficient, right? So if you have to move them over any significant distance, it's going to make more sense to do purpose-built pipe. And so there aren't a lot of people out there that have built purpose-built CO2 pipe. Obviously, we've built a fair amount of it. And so we've got that expertise. And then when you think about the sequester side, you've got to put those molecules in the ground and you've got to make sure they stay in the ground. Well, we've been in the CO2 business for decades now. And we have a good idea about how CO2 moves and flows through reservoirs. We have a good idea of what it takes to contain the CO2 in that reservoir because when we flood our oilfields, we certainly do not want our CO2 leaving to go to somebody else's oilfield, right? And so we know if you need a water curtain in the field, we know what types of technology is necessary to contain that. And so you would think that the emitter who is going to get the tax credit would be very focused on who is the operator of that facility and what their expertise is because of the downhole facility, the sequestration site because their tax dollars are at risk if you don't keep the CO2 in that reservoir, right? And the other way that this can work is that they can put the obligation on the sequester to do it and say, you're in charge of that. And if I lose my tax credits, then you have to indemnify me, well, you're going to need a very creditworthy counterparty on that end that you know is going to be there 20 years from now, right, or 12 years from now. So I think that over time, it will migrate to some of these -- to the larger companies that have the expertise and to have the credit and the balance sheet to be there for the long term.

That makes a lot of sense. Looking at renewable natural gas, how much larger could RNG grow in Kinder Morgan's portfolio? And do you think that there's going to be enough support from the voluntary market to support that growth? Or are investors going to need to depend on the RIN market holding up?

So RNG, as I said, we've made about $800 million in acquisitions in that space. And this is gas coming up off of landfills that you're capturing and then cleaning up into pipeline quality to put it into the pipeline. And then when you sell it into the transportation market, you get around which -- and so -- which vary and value, okay? And so one of the things that we've looked at in this is let's have a portfolio of where we're selling into the transportation market where you get this RINs benefit and you sell into the voluntary market. People who don't necessarily have to use renewable natural gas, but maybe they want it for ESG reasons, want to use renewable natural gas to run their whatever facility, the industrial facility that they have. And there, those are generally long-term contracts for a fixed price. And so what we want to do over time, is we want to develop a portfolio so that we have some that we're selling in the RINs market. So that to the extent that RINs increase in value, you can capture that upside. But we want to secure a certain amount of that income stream. So right now, when the projects that we have under development come on, we should have a little bit less than $200 million of cash flow coming from these opportunities. I think there's the opportunity to grow that over time. Landfills are limited, right? I mean there are only going to be so many landfills. There's a lot of them out there, but there's only so many landfills and so many landfills of sufficient size. So I don't see this being our only ETV business. I see it kind of being a leg in the stool of our overall ETV business. Right now, we've got 3 facilities under construction and all those facilities, all the output of that is sold to a transportation counterparty, okay? And so that is going into the RINs market and those deals have been done for a long time. And so really, in order to get the portfolio that we want to have, we're going to have to continue to develop facilities because we need more supply in order to be able to sell into the voluntary market. And so that is our goal as we add supply to sell a portion of that into the voluntary market to get that portfolio.