Tuesday, December 8, 2015

Kinder Morgan Cuts Dividends

This just in, Kinder Morgan (KMI) announced it was cutting its quarterly dividend by 75% to 12.50 cents/share ( 50 cents/year). Source: Press Release

I have changed my mind from my article from last week. I believe that Kinder Morgan will be a good long-term holding. However, after the ambivalent announcement on Friday, I concluded that a dividend cut was likely. As a result, I made a decision that is somewhat in line with how I approach dividend cuts.

I sold most of my shares today, and bought an equivalent amount of calls. When I say that I sold shares, I mean that I performed some tax-loss harvesting as described before. For each 100 shares I owned, I sold one call to lock in the sale price and bought one put to protect from further downside. When those contracts expire in a little over 1 month, I will close the call, the put and sell the shares. Instead of buying more shares however to maintain my position, I bought calls.

For example, for every 100 shares that I held originally, I bought 1 call. This was meant as a way to limit risk. I will reconsider holding the stock when the dividend starts growing again. Until then I will hold on to those options.

Cutting the dividend seems like the smart move here, because it conserves cash. Putting the financial house in order for Kinder Morgan means that the company reduces its need to access capital markets. This is a good thing, because the cost of capital is high today. If the credit rating is preserved, this reduces the risk of things getting out of control and potentially impacting the company's ability to operate as a going concern ( meaning that the chance of the company going bankrupt is low).

While today we have a lot of potential opportunities, and in retrospect plenty of companies may look like the deal of the decade by 2025, I would advise people to be at least somewhat cautious. It is possible that we have not seen the worst yet.

I see some parallels between the credit boom that ended in 2006 and the credit crisis from 2007 - 2009 and the current environment. The downside was long and painful in both situations.  Back in 2007 and even early 2008, the impact of the credit crisis was not well known. Things really cascaded down quickly between September 2008 and March 2009, before rebounding somewhat in 2009.

With energy, first we had an energy boom up until 2014. While oil prices have collapsed since the Summer of 2014, there are a lot of entities that do not seem affected. For example, shares in companies like Exxon Mobil (XOM) have not dropped as much as I would expect given the decrease in near-term profitability. In addition, Canadian Banks have not done as bad as I thought they would. So far, the energy collapse has been spreading slowly. I will be first to admit that the declines in pipelines has taken me by surprise. I also wonder what the effect on certain corporate debt will be, if we get problems in the energy sector and some corporate failures.

This makes me wonder whether we still have more problems down the road. If it takes time for problems to appear, and spread to the overall economy, this might mean that today might not be a good time to buy. On the other hand, it is possible that the weakness in the energy sector will not spread to the overall economy, and will have a limited impact. However, if things do not turn out to be as bad as I think they could, we may be close to a bottom.  That being said, I want to reiterate to readers to tread with caution.

I would not be surprised if other MLPs follow through and cut dividends.

Update 12/09/2015: I sold all shares, and disposed of all options contracts related to Kinder Morgan after the actual cut. I have a few Kinder Morgan shares remaining in a retirement account, which I will keep because it would be expensive to sell and buy something else. I will consider adding back to Kinder Morgan when it raises dividends again. At this point, the company does not fit my idea of an entity that produces dependable dividend income to live off in retirement.

Full Disclosure: Long KMI, and Long KMI calls, XOM

Relevant Articles:

What should I do about Kinder Morgan?
Three Investing Lessons I Learned the Hard Way
Tax Loss Harvesting for Dividend Investors
Dividend Cuts - the worst nightmare for dividend investors

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