KMI Lessons Learned

[KenBob]

While I didn't own any shares in KMI, the recent 75% dividend cut made me think of where my portfolio is vulnerable.

My conclusion was that KMI relied heavily on borrowing due to its very high free cash flow payout ratio.  The BBB- credit rating then made the company financial balance vulnerable to a potential credit rating reduction.

I have changed my investment policy in two respects:

First, shares will not be bought of a company with less than a BBB credit rating.

Second, a free cash flow payout ratio of more than 80% will not be allowed.  I have been more lenient with REITs than common stock due to the law requiring distribution of 90% of earnings.  80% is the payout ratio of Reality Income, which is well run to maximize shareholder return, so I use them as the benchmark for REITs.

[Caversham]

Even though I did not own any KMI I'm definitely taking a closing look at quality and debt metrics since its meltdown.


Here is a good recent Seeking Alpha Article about buying quality companies.  One of my favorite quotes from it (by John Tus of Honeywell) is:
"The economic downturn has underlined the importance of maintaining a good credit rating. During good times, ratings determine what you pay for capital. In bad times, they determine your access to capital."

Bad times came for KMI, and KMI's access to the debt/equity markets dried up so they couldn't continue paying their dividend.


Another lesson I learned after reading about people losing 25%+ of their income overnight is: portfolio position sizing. I only started DGI earlier this year, and so far I've been determining portfolio position size based upon the amount of capital invested in a company.  In the future, I plan to base portfolio position size on the amount of income a company generates, and not the amount of capital invested.

[Dividend Watcher]

(12-20-2015, 06:41 AM)Caversham Wrote: Another lesson I learned after reading about people losing 25%+ of their income overnight is: portfolio position sizing. I only started DGI earlier this year, and so far I've been determining portfolio position size based upon the amount of capital invested in a company.  In the future, I plan to base portfolio position size on the amount of income a company generates, and not the amount of capital invested.

Good point, Caversham.

I look at both but didn't have anything in my investment plan specific to income source diversification. When Encso (ESV) cut the dividend earlier in the year, the income stream in my wife's portfolio still went up over the year because of all the other players. However, she's still building the portfolio. If we were relying on every penny of that income stream in the distribution phase, it would have been a bigger concern.

[DividendGarden]

(12-20-2015, 06:41 AM)Caversham Wrote: Here is a good recent Seeking Alpha Article about buying quality companies.  One of my favorite quotes from it (by John Tus of Honeywell) is:
"The economic downturn has underlined the importance of maintaining a good credit rating. During good times, ratings determine what you pay for capital. In bad times, they determine your access to capital."

Great quote, and it's true.  I sleep well at night knowing that the majority of my portfolio is in solid companies like XOM and JNJ.  I have a stake in KMI, but it's a fraction of the size of my core positions.

[DividendPlanet.com]

Most people were buying Kinder Morgan because of the yield. Last year, the yield became too high, which should have tipped us off, that something was wrong. Not only was the yield very high, the dividend payout ratio was equally disturbing. There was no way that KMI could deliver on their promise to raise the dividend for a 6th year.

Furthermore, research has shown that companies that have raised their dividends for mange decades are much less likely to cut their dividends compared to those who's track record is only a couple of years, like KMI. One of the reasons is a culture in the management, that develops in these companies. For instance, Procter & Gamble have raised their dividends for 59 consecutive years. Who would want to be the CEO to cut the dividend after 6 decades? Most of PG's shareholder are in it for the income, so if PG were ever to cut, the stock price would fall a lot.

With this in mind, the 5 year dividend increase streak of KMI was not very impressive. One could have bought one of the following stocks, that have raised their dividends for multiple decades:

Best dividend growth stocks with the highest dividend increase history

There are of course no guarantees that they will keep raising those dividends, but I would sleep better knowing that the risk of a cut is much smaller than Kinder Morgan.

[cannew]

Gee no Cyclical stocks on the list, wonder why?

[DividendGarden]

I have owned KMI for many years, and I think that the dividend cut is a good reminder to constantly look at the overall portfolio every now and then. KMI was a small (~3%) portion of my portfolio, so a 75% cut really only cut my dividend income by 2.25%. The majority of my portfolio is made up of the solid companies, like XOM and JNJ which were mentioned above. These companies increase their dividends each year by more than 2.25%, more than offsetting the KMI reduction.

One good thing for KMI is that they can pay down debt quicker now, with less cash going out the door to dividends. Over the next few years, their financial position will improve as debt declines.