Does Kinder Morgan Canada's Decision to Remain Independent Make It a Buy?

Kinder Morgan Canada (TSX: KML) has had lots of twists and turns in its short life as a public company. It took its latest one last week after concluding a multimonth strategic review of its options. In the end, it decided to remain a stand-alone public company.

With its near-term course set, investors might be wondering if the high-yielding Canadian midstream company is now worth buying. Here's a closer look at the bull and bear case for Kinder Morgan Canada.

A businessman looking at a stock price chart with the words "buy" and "sell" on it.
A businessman looking at a stock price chart with the words "buy" and "sell" on it.

Image source: Getty Images.

How we got here

U.S. energy infrastructure giant Kinder Morgan (NYSE: KMI) initially formed Kinder Morgan Canada in 2017 as a vehicle to help finance the Trans Mountain Pipeline expansion. However, due to continued delays as a result of opposition to that project, the company sold the entire system to the government of Canada last year. This decision left Kinder Morgan Canada with an uncertain future.

That led the company to undertake a strategic review. Among the options it evaluated was an outright sale, a merger with another Canadian midstream company, or remaining a stand-alone entity. After thoroughly analyzing each alternative, it determined that the best option was to continue as a publicly traded entity focused on operating its remaining assets.

The bull case for Kinder Morgan Canada

Kinder Morgan Canada currently operates several energy transportation and storage assets in Western Canada, which include oil storage terminals in Edmonton, the Canadian portion of the Cochin Pipeline, and the Vancouver Wharves Terminal. The company has secured long-term, fee-based contracts with customers for capacity on these assets, which pay it a steady stream of cash. Kinder Morgan Canada currently estimates that it will generate about $109 million, or $0.90 per share, in distributable cash flow from these agreements this year.

The company expects to pay out $0.65 per share of that money in dividends, which implies a 5.2% yield at the current stock price. That's a solid payout for income seekers, since it only consumes about 72% of Kinder Morgan Canada's cash flow. The company further supports the dividend with a strong balance sheet, backed by an ultra-low 1.3 times leverage ratio.

With Kinder Morgan generating some free cash flow after paying the dividend, it has plenty of financial flexibility to invest in expansion projects, especially when factoring in its ability to borrow more money. The company currently has one project underway, a $32 million diesel storage expansion at the Vancouver Wharves Terminal, that should provide some incremental cash flow when it comes online in early 2021. In the meantime, however, the main draw for investors is Kinder Morgan Canada's high-yielding dividend, which appears sustainable for the long term.

The bear case for Kinder Morgan Canada

While Kinder Morgan Canada operates a strong set of assets, it lacks visible growth prospects outside of that one storage project expansion in Vancouver. It's not yet clear whether the company will have the opportunity to expand any of its other legacy assets. That's because it completed the final phase of the Baseline terminal expansion last year and finished up the Cochin pipeline reversal project in 2014.

Because of that, the company will likely need to look elsewhere for growth. That means it will need to partner with another midstream company on a project they developed or acquire assets from third parties. While the company certainly has the financial capacity to pursue either option, it doesn't seem like it has opportunities in the pipeline given that it recently completed its strategic review and didn't announce any growth-focused initiatives. Because of that, Kinder Morgan Canada's cash flow might not grow for quite some time, which could weigh on its stock price.

Verdict: Kinder Morgan Canada isn't a buy

Kinder Morgan Canada operates a solid set of assets that generate steady cash, which gives it the money to pay a high-yielding dividend. On top of that, it has a strong financial profile, which provides it with the flexibility to pursue expansion opportunities. That makes it a potentially attractive option for income-seeking investors.

However, the company currently has limited visibility into future growth because it just has one small expansion project lined up. That lack of apparent upside could cause its stock to underperform. Because of that, investors might want to put Kinder Morgan Canada on their watchlist until there's more clarity on its future growth potential. In the meantime, they could consider buying its parent, Kinder Morgan, which not only offers a similar 5%-yielding dividend but has solid growth prospects.

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Matthew DiLallo owns shares of Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.