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


  1. Very smart move by the company - definitely needed. Glad to have sold last week though. I am not sure I am willing to trust management that promises 10%+ increases annually then does this though. While it could be argued that they didn't see this decline in oil prices coming, it's still kind of irresponsible to predict dividend growth that far into the future, in my eyes. Best of luck to all who kept and continue to own shares in $KMI.

    1. I closed everything - KMI and options today per the update below

  2. YAY! Okay, that sounds a little bit weird, but I'm glad to see the dividend cut so that debt can be addressed. Needed to be done. I'm not in a hurry to buy more shares, but might if the new yield gets over 4% (meaning a $12.50 share price).

  3. Hi DGI

    "However, after the ambivalent announcement on Friday, I concluded that a dividend cut was likely."

    I concluded the same and sold all my KMI shares today and then reinvest the money in OKE/WMB/PAGP.

    Maybe these GP go the same way as KMI but for the moment they seem a little safer because they are not at their Debt/EBITDA limit so they have flexibility to finish their inmediate CAPEX programs.

    Daunting times for income MLP investors.


    1. Tough times for KMI. The assets are there, the demand is there, but short term headwinds make this company unsuitable for dividend growth investors for the time being

  4. I believe this is one of the many cuts we will see in the energy sector, that includes majors as well. 2016 will be particularly tough when OPEC adds few more millions of barrels of oil to already flooded marked. Stay safe folks. Cheers

    1. I wonder if this will spread to other areas in the economy.

  5. i really like reading about your strategy in tax loss harvesting...is there more to read about this strategy on your blog? Or is there a "name" for the strategy you use? many thanks

    1. I call it tax loss harvesting for dividend investors ;-)

  6. I sold my energy position (AMLP) yesterday morning. I purchased $10,000 worth in December of 2013. Held and reinvested dividends through yesterday. Received about $7,000 for my shares. Basis was about $11,000, so a $4,000 tax loss. I decided to do some tax loss harvesting to offset gains elsewhere in my portfolio. Not encouraged with this sector after OPEC announced a free for all late last week. It will come back ... but when?

  7. DGI, hoping you can clarify your plans around KMI using call options. You state:

    "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."

    When you say you will hold on to those (call) options, do you mean that you're purchasing 30-day options and simply rolling them over near expiration, or are you purchasing longer-dated calls (maybe LEAPS?) which will enable you to purchase shares near the current price at some indefinite point in the future (unless it has dropped further at the point the company begins raising dividends again)? Thank you.

  8. I just hope to be able to raise enough cash in the next few months. Although the fossil fuel market has been hammered, things will get worse before they get better. Load you wagon at that point, whether it be KMI, CVX or CHK (if still around).

  9. Love to see the use of options. I continue to hold all my KMI shares. Richard Kinder is a very smart man who owns a ton of shares. He is doing what is in his own *long term* best interest. I like having my wagon hitched to that particular mule.

    1. I disposed of everything KMI related today ( ok I have a few shares left but immaterial to net worth). I will buy back some when the dividend starts growing again

  10. I think you should stay completely true to your investing principles.

    They cut the dividend, you sell their stock. They have clearly demonstrated that their business model can't withstand a crisis and downturn, so in my humble opinion they don't fit the bill for a company that you can rely on for growing your income for decades.

    I say take the hit and sell, allocate in other wonderful businesses that CAN grow dividends during a crisis, it will provide you with greater returns than focusing on a company that COULD be a good investment, in the future.
    Don't fall in love with a stock :-)

    Best of luck

    1. I actually decided to sell it all this morning, so that I can get to claim the full taxable loss for this year. Disposed of calls and puts too

      Though I did add some EPD

  11. At this point the only energy company I am willing to add on further weakness is XOM. XOM above a 4% yield is very interesting.
    My net loss on KMI has been $2400 so that was the bulk of my tax loss harvest this year, which helped offset a decent chunk of the Kraft special dividend Buffett paid out. I realize my loss is much smaller than others with much larger holdings and I feel the pain.

    From this experience I've learned the risk of chasing high yield, that past results don't predict future results, that management's words are not a guarantee, that high debt is bad, and that companies that are hard to evaluate (like MLPs and KMI) are not for me.

    I will stick with boring understandable stocks like Colgate, Pepsi, Johnson, or Southern whose earnings and metrics and product offerings are more transparent for me.

    Best of luck to all

    1. Young -

      Couldn't agree more. I got into KMI also and will hold on because my timeline is still very long but never again will I jump into something I don't completely understand. I can value a Colgate better than an KMI. And who are we kidding, a company like Colgate is a compounding machine and in 30 years there is almost no scenario I can think of where I won't jump for joy at the results. Boring does not mean a bad investment, especially after seeing KMI take a beating lately.

    2. I want to hold companies that will pay me a dependable dividend no matter what happens in the world. Turns out KMI was not one of those companies.

      Which is interesting, because the legacy KMP paid rising distributions for 20 years. KMI only grew them for 4 years.

  12. Even if every investment doesn't end up like we want it to, you are always attracted to quality assets, and I appreciate that, D!

    1. Yes, KMI is quality that went from raising dividends and discussing 6% - 10% annual dividend growth to cutting the dividend by 75% in one month.

      If they start growing the dividend, I may buy back a portion of the shares I sold. I did buy a little EPD though.

    2. I hear you there, D. As I mentioned in my comment on your article, think about it, but I don't think you'll think too long- you didn't think too long:)
      Nice job on sticking to your principles.

      I am feeling a bit weird on the subject too. I was fairly comfortable holding, but now I am a bit queasy. What if somehow the idea was to drive down the price to take private?
      If that is impossible to fathom/execute because of the high debt, the only other alternative here is increasingly poor corporate governance (as you pointed out in a previous blog about being dissatisfied with management lately). It could be that one man was pretty much running the whole show, and could essentially vote down anyone else's objections.
      It seems like management has indeed been acting pretty willy-nilly lately.
      I guess their trump card is, "We know about pipelines, and you don't". It also seems like, to their defense, they could be saying "we are so keen on the future of the company and natural gas, that we must grow at any cost".
      The problem is, two days removed from the happenings in the company, I am beginning to mistrust management now. How do we know increasing the NGPL interest was really a good deal? How do we know anything?

      Thus, I respect your being the butcher in this case- the only thing we can know or trust is the dividend, and if the dividend is cut, off with his head.

      So we come full circle and it is about principles, it would seem, at the end of the day.

      Tuesday morning before the cut announcement I bought small positions in WPZ and ETE on margin to dull the hit to my income. I am still holding my KMI.

      I guess the one thing I can see happening is, if it is a private buyout, I hope it might be higher than $18.

      I guess things don't make much sense for me right now, so I will have to consider it further.

      But thank God for diversification- as Peter Lynch said, diversification is the only free lunch.

      Thanks for updating.

      Also note I said the "assets" were high quality (the pipelines)- not management. :)

    3. Hi Joe,

      I somehow missed your response from Dec 9.

      I am beginning to think that I should be more skeptical and less trusting.

      Know that I get to think about it with a clear head, I see some items that I dismissed before. First of all, the pass through entity model can get broken in a hurry. That includes REITS.

      Now that I think about it, Richard Kinder has exhibited behavior before that is meant to enrich Richard Kinder. I may have been incorrect to believe before that he is doing things in the interest of shareholders.

      For example, he bought out the promising general partner interest in 2006, enjoyed a lot of growth in IDRs and plenty of dividends in the process, and took the overleveraged entity public in 2011. So with this move he screwed up the shareholders holding the GP interests from further income.

      Then in 2014, he converted KMP and EPB units for shares, triggering massive tax liabilities for long-term unitholders who held on and believe the Richard Kinder story. This effectively punished those holders who risked their capital to build out the empire.

      Now in 2014, we had promises of double digit dividend growth for years and optimistic projections. And yet they ended up actually cutting the dividend by 75%. The lesson is that management should not be trusted when they provide great projections. Remember how IBM was promising $20/share in earnings by 2015 and how it missed epically? KMI did the same thing.

      If you read the conf call transcript, they are not talking about growing the dividend again for at least two years. They are thinking about share buybacks – meaning Richard Kinder’s stake will increase at the shareholders cost. I am also not sure how the volume of items transported will be affected from those low prices, how transportation contracts will be renegotiated, what will happen if counterparties go out of business etc. What would be the end result if they spent so much money on infrastructure, but their projections turn out to be off and not generate the cashflow they expected? So perhaps, the best thing for KMI is not to go for growth at the moment, but to go for paying off the debt. They have maturities coming, and they are effectively shut out of the equity/debt markets. Yet, they keep talking about growth - this doesn't reconcile with me.

      I am now starting to get convinced that others like OKE and WMB and EEP will likely cut diivdends too. In particular, WMB and ENB/EEP seem to be copying KMI to a certain extent. My question is whether I want to wait for the companies to actually cut the dividends, or whether I sell most today.

      Oh and happy holidays!


  13. One of my investing principle is to sell a stock the moment it cuts the dividend. I just applied it not so long ago with a play on BDI.TO (also somewhat related to the oil industry). KMI lost 60% this year and now cuts its dividend by 74%. There are no reason why I would keep this stock in my portfolio. This money is gone, you will not recuperate it from staying in KMI. I think it would be better to move along and find another strong company instead.


    1. Hi Mike,

      Selling after a dividend cut is my hard and fast rule. I decided to be disciplined and sold after the cut. I decided to sell after the fact, rather than stay and wish for something better. When I see better results, I will get back in.

      I will probably buy back when the company raises the dividend. I did buy some EPD today, though not a lot.

      Cheers to you!

  14. So let me get this straight... The company makes a prudent move to preserve its credit rating and get its "house in order" to weather out the current weakness in the energy markets by making TEMPORARY reductions to its dividend payout, and achieving this without further diluting the shareholder base.... and you SELL your shares? This is the time that you should be deploying any free capital you have to load up on this position! And there are not many businesses out there with a simpler business model than KMI... a tollbooth operater for oil companies. And they are the largest of all of the pipelines, giving them scale and pricing power.

    Just my 2 cents I suppose.

    1. So how much did you invest in Kinder Morgan? What % of portfolio did you invest in this quality company that went from raising dividends and promising a 6% - 10% annual dividend growth to cutting the dividend by 75% in one month?

      Actually, the company already diluted existing shareholders by issuing mandatory convertible shares yielding 9.75% to buy a higher stake in NGPL that itself is overleveraged. This reckless move is the thing that set the whole issue in motion to begin with.

      And when you say "temporary" dividend cut, did you even read the conference transcript between Kinder Morgan management and Wall Street Analysts? I bet you didn't.

      It is so easy to be anonymous on the internet and provide your advise when you have nothing at stake.

    2. 133 shares bought the day after the cut. (I'm not rich!) And Im not trying to be a jerk on this, but watching everyone turn 180 on a stock that 2 months ago was the darling in every DGI bloggers portfolio is unbelievable! This wasn't because of NGPL, but rather because everyone is hammering the O&G stocks right now due to cyclical trends. NGPL was the catalyst for everyone to turn bearish on KMI more so than other pipelines.... and for once a management team knows when to pull out the white flag and put long-term profitablity over the short term benefits of staying the course! KMI will emerge a stronger company for this, so I would strongly advise you still keep it on your radar, even though it may "only" be yeilding mid-single digits at this point.

    3. I have written several articles this month discussing KMI. I have nothing further to add - read those articles and comments on why I am doing what I am doing.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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