Mis-pricing and valuation
We grade KMI’s valuation at B+. The price ran up a little bit on us while we were trying to get this report completed. Under $34, where Rich Kinder recently bought another $28 million worth, would be somewhere in the A range. Notwithstanding, the current price represents a sound bargain on a stock with a wide moat and great management team that could very reasonably occupy a spot in our portfolio for a decade or more as the United States capitalizes on its wealth of natural gas reserves. We expect Kinder Morgan to benefit from that. The recent drop in prices would suggest that investors are extrapolating the 2014 “pause” in distribution growth out forever. We don’t think that’s realistic as KMI’s size and experience gives them a seat at the table for every major energy deal in North America. If we assume only a 4% growth rate in distributions, we can very easily make the case that the stock is worth $40.
We mentioned these points in the previous section on “investing highlights and interesting data points,” but most apply as the reasons for their mis-pricing:
CUSH models that KMI is worth between $35 and $45. We use several valuation methods to define this range. Our dividend discount model produces a price target of $35 using an 8% discount rate and a very conservative 3% growth rate. Peer group analysis would suggest an EV/EBITDA multiple of 13.4 and implies a price target of $36. Our sum-of-the-parts model takes a closer look at the value of KMI’s Incentive Distribution Rights under various scenarios and produces a range of values from $35 to $45.
As with any investment, there are risks. For Kinder Morgan, these include:
To counter the Hedgeye analyst referenced above, we feel confident looking at a few key metrics. EV/EBITDA and ROIC have remained consistent over the years. Also, if you have a spare hour-and-a-half, you can listen to a special conference call that Rich Kinder and his management team held special on September 18, 2013, just to refute the charges, one-by-one, that that analyst leveled against Kinder Morgan.
The shale gas revolution is not a new story. KMI’s recent decline provides a great entry price to participate in one of the least risky ways to benefit from this trend. Growth opportunities have not dried up. As the company executes in coming quarters investors will realize this and the stock will re-price itself. We expect a total return of 15% to 30% in the next 12 to 18 months and see a high likelihood that KMI could be a core holding for many years.
The Market Realist Take
In the last few years, hydraulic fracturing and access to shale reservoirs has led to an increase in production of domestic oil and gas. The “Annual Energy Outlook 2014” report from the U.S. Energy Department’s Energy Information Administration predicted that oil production is expected to see an increase in the coming years, proving that the U.S. is witnessing an oil and gas revolution. An increase in production leads to a demand for transportation, storage, and fractionation. This bodes well for companies such as Kinder Morgan, which owns a huge network of pipelines and 180 terminals.
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