Kinder Morgan: Why Credit Suisse’s Neutral Rating Sounds More Like a Buy

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Kinder Morgan Inc. (NYSE: KMI) is one of the most widely followed companies in the energy sector. It would be among the best of the best master limited partnerships (MLPs) if it had not changed its corporate structure and tax structure back to a corporation. Credit Suisse has an unusual call, with a Neutral rating — but a call that has all the hallmarks of a Buy rating elsewhere.

One thing that needs to be considered here is that Credit Suisse often has large upside price targets for stocks and similar structures, even when it has Neutral as its official rating. This is due to its rating universe being on a peer-versus-peer metric rather than a company-versus-market metric.

Credit Suisse’s John Edwards reiterated his Neutral rating on Kinder Morgan on Tuesday, July 12. He raised his price target to $23 from $22. That was 19.6% higher than the prior closing price of $19.22, and that does not even include the 2.6% dividend yield.

Calling for an implied total return of 22.2% is typically higher than most Buy and Outperform rating upside calls seen elsewhere among the large cap oil and gas segment. Those upsides are currently running 8% to 15% on average, which is admittedly a rather wide range.

The impetus for the call made on Tuesday was Kinder Morgan selling 50% of its Southern Natural Gas to Southern Company (NYSE: SO). Only on July 10 Kinder Morgan announced that it had entered into an agreement in which Southern Company will acquire a 50% equity interest in Kinder Morgan’s Southern Natural Gas pipeline system. What matters here is that Kinder Morgan will continue to operate this pipeline system.

The agreement committed both companies to cooperatively pursue specific growth opportunities. Perhaps more important is that the transaction equated to a $4.15 billion in enterprise value. That was $1.47 billion for Southern Company’s 50% equity interest, which together with Credit Suisse’s $398 million 2017 EBITDA estimate for the asset implies a valuation of 10.4 times.

Edwards noted specifically that this transaction was a positive for Kinder Morgan’s balance sheet. He said:

The deal enables Kinder Morgan to reduce leverage to ~5.3x in 2016, and we model the company reaching the targeted 5.0x by 4Q17 (a 0.2x improvement from our prior forecast), a milestone management said would be required before considering dividend growth resumption and/or share repurchases. The deal also weds Southern Natural Gas’s largest customer to the system and its development, and provides an additional source of funding for the planned capital spend. Though the 10.4x multiple may seem a bit light at first blush, management noted that value additive projects are expected to move the multiple closer to the mid-12s though it’s unclear what Kinder Morgan’s incremental share of capital spend and corresponding EBITDA would be.

Tuesday’s price target hike also was accompanied by estimate changes. For the firm’s 2016 estimates, their EPS target moved up by $0.03 to $0.73. The distributable cash flow per share estimate was also moved higher by $0.05 to $2.06 per share. Credit Suisse’s 2017 EPS actually ticked lower by $0.01 to $0.84 (DCF per share down $0.01 to $2.27) as the interest savings are offset by the lost EBITDA for the Southern Natural Gas deal. The $1 price target hike to $23 per share was derived from a weighted average of DDM, P/DCF and EV/EBITDA methodologies. That target implies a 2.2% yield, based on the higher share price target.

Kinder Morgan shares were last seen up 2.7% at $19.75 Tuesday morning. The 52-week trading range is $11.20 to $38.39, and the market cap is $44 billion.

24/7 Wall St. recently showed how some investors are treating Kinder Morgan like a value stock. Admittedly, that remains up for debate. Credit Suisse downgraded Kinder Morgan to Neutral from Outperform back in March, but our take there was that this downgrade was not anywhere as bad as it sounded, based on much of the same upside views.

Thomson Reuters shows 10 analysts with Buy or Outperform types of ratings on Kinder Morgan, versus 11 Hold and Neutral type of ratings.