The Federal Reserve cut rates last week and could cut rates further in the coming months. Lower interest rates reduce the cost of capital and can increase returns on investment for capital-intensive projects.
Here’s how the Fed’s move could benefit the energy pipeline company Kinder Morgan (NYSE: KMI) and why high-yield dividend stocks are worth buying now.
There is room for further balance sheet improvements
Since the oil and gas crisis of 2014 and 2015, Kinder Morgan has worked hard to repair its balance sheet and restore investor confidence in its dividend. Over the past nine years, the country has reduced its total net long-term debt by 29% and lowered its debt burden. As you can see in the following chart, Kinder Morgan’s debt-to-capital (D/C) ratio is now just 51%, which is among the lowest among its peers.
The D/C ratio is a company’s total debt divided by total debt plus total equity. The lower the D/C ratio, the less debt-dependent the company’s capital structure.
Despite the improvements, Kinder Morgan still has high interest costs. Interest expenses for the last twelve months amount to $1.85 billion. For context, Kinder Morgan spent $2.5 billion on capital expenditures and $2.54 billion on dividends over the last twelve months.
The company has kept tight control on expenses as it prioritizes free cash flow generation, a low leverage ratio and dividend growth. A lower interest rate could help Kinder Morgan refinance existing debt or take on new debt at a lower interest rate.
Accelerating capital investments
At its core, Kinder Morgan’s business model involves building and operating infrastructure assets – such as pipelines, terminals and storage facilities – and then generating future cash flows from those assets. If discounted to account for capital costs, future cash flows should exceed the investment costs. A lower cost of capital or a higher amount of future cash flows can benefit Kinder Morgan and help justify expensive projects.
Infrastructure is needed to support growing U.S. oil and gas production. But Kinder Morgan is no longer solely dependent on domestic consumption.
Liquefied natural gas (LNG) is an important pillar for the industry. It involves the transportation of natural gas from production areas to liquefaction facilities at export terminals, which cool and condense the gas into a liquid state that allows transportation abroad. The US is now one of the largest LNG exporters in the world. A global market for LNG expands the pool of buyers for the natural gas that Kinder Morgan transports.
Another growth area concerns biofuels. Infrastructure will be needed to support increased demand for natural gas, diesel and other fuels produced from renewable feedstocks such as seed oils, sugar cane, corn, algae, food waste, cow manure, wastewater and landfill gas.
Natural gas is mainly used for energy generation. According to 2021 Department of Energy data, natural gas and biofuels made up less than 10% of the transportation sector’s energy mix. Compressed natural gas can be used for long-distance freight transportation or for blending natural gas and/or biofuels with diesel or gasoline to reduce emissions.
Like many other midstream companies, Kinder Morgan has recognized the potential role that natural gas can play in powering energy-intensive data centers. Artificial intelligence (AI) is increasing demand for electricity, which could herald a new growth direction for Kinder Morgan.
In short, Kinder Morgan has plenty of ways to put capital to work. A lower interest rate makes it cheaper to explore these options.
A passive income powerhouse
There are plenty of ways to generate passive income, from government bonds to high-yield savings accounts and more. High-yield dividend stocks are less attractive when the risk-free interest rate is higher. But when the risk-free interest rate is lower, there is more incentive to invest in dividend stocks.
Kinder Morgan has a yield of 5.3%, which is higher than the yield on ten-year government bonds of 3.7%. It’s also higher than the 3% yield investors can get from an exchange-traded fund (ETF) like the Vanguard Energy ETF or the yield of only 1.3% of the S&P500.
Kinder Morgan’s recent dividend increases have been quite small, but the company remains committed to growing the dividend gradually over time.
Switching to a new growth acceleration
Increased U.S. production and demand for the fuels and products that Kinder Morgan processes present an attractive growth opportunity for the company. However, it is of utmost importance that Kinder Morgan does not get ahead of itself by over-investing at the expense of its capital commitments to shareholders.
Investors should look to see if the data center opportunity is real, monitor progress with the energy transition and low-carbon fuels, and evaluate how Kinder Morgan balances these opportunities with the need for more LNG infrastructure.
In short, Kinder Morgan stands out as a solid dividend stock for generating passive income, but it also has plenty of ways to grow its business, boost free cash flow, and reward shareholders in a variety of ways.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool holds and recommends positions in Enbridge and Kinder Morgan. The Motley Fool recommends Enterprise Products Partners, Oneok, Pembina Pipeline and Tc Energy. The Motley Fool has a disclosure policy.
The Fed just cut rates. My best high-yield dividend stocks to buy now. was originally published by The Motley Fool
