A couple of weeks ago a bunch of us felt a disturbance in the Force – sadly it was not the new Star Wars movie. Indeed, something terrible had happened. Dividend growth investor darling Kinder Morgan fell from its pedestal after its stock price declined for months. On top of that the company had to announce a dividend cut, basically right after I purchased my first shares.
From a forward dividend guidance of at least 6% annual growth at the end of October to a 75% cut at the beginning of December, that’s a tough pill to swallow for many investors, especially with an income stock like Kinder Morgan (NYSE:KMI). While I agree that it was the right move to make, because it limits the company’s need of external capital, I can’t wrap my head around the events that lead up to the actual cut.
Without going into too much detail, here’s the gist of it: Kinder Morgan sold debt at an unreasonably high rate of almost 10%, then acquired full ownership of Natural Gas Pipeline Company of America, a debt-ridden sinking ship, which in turn increased their leverage even more. This cocktail of bad decisions made Moody’s cut KMI’s rating, which further increased the cost of external capital.
I can live with a dividend cut, but not with bad management and conflicting communication towards shareholders. That’s why I decided to cut the ties and take my loss for what it was, as I’ve explained in the most recent net worth update.
Of course, the entire debacle lead me to re-analyse my previous decision on the company and rethink my dividend growth strategy. As such, the only good thing to come out of my KMI positions is a couple of lessons learned, like Lanny and Bert from Dividend Diplomats also noted.
So get comfortable and find out what my lessons learned are!
(Draw me like one of your French girls.)
The downside of a closely knit community is sheepish tunnel vision
Ah, finally, NMW! What’s up with the sheep plastered all over this post?!
Exactly, this is the main point I want to make because it’s what I blame myself most for in the Kinder Morgan story. Because I had been so busy working, I forgot my due diligence when investing in KMI.
Yes, I had looked at the company previously – around August, September – but I didn’t take the time to go over all the numbers again in November when I initiated my purchase. The fact that other community members were also buying, reassured me in my previous assessment.
I was a fool and I only have myself to blame. When you’re in the middle of a herd of sheep you can’t see the warning signs at the outskirts of the herd. I should have at least tried to see if there were any rather than mindlessly following the other sheep around me.
Green grass can be deceptive
Not too long ago I wrote a post on why the grass always looks greener on the other side of the fence. And boy, does it apply to this situation.
When your own portfolio is yielding a solid 2.6% after taxes, it’s very tempting to jump into a stock that offers you 6% after taxes. Who doesn’t like a return that’s 130% higher than you’re currently enjoying?
Don’t just jump into a stock because it offers a higher yield than others – there’s often a very good reason why the yield is much higher. Yield carries a price! And that price is called increased risk.
Personally, I can’t even rationalise why I would chase higher yield seeing that I smashed the dividend income goal I set for myself this year by a large margin. So this is strike two on my account.
Stocks are wolfs in sheep’s clothing
Don’t worry, this paragraph won’t go out on a tangent how stocks are bad, because they really aren’t. However, even the most stable and securest of stocks remain a wolf in sheep’s clothing.
Stocks fluctuate on a daily basis, but on top of that no single business model consists of a silver bullet to remaining profitable in the long-run. Just look at the difficulties that BHP Billiton (LON:BLT) is currently facing. Or even the (minor) issues that dividend aristocrat Procter & Gamble (NYSE:PG) is experiencing.
As investors we should never forget that.
However, what is clear to me from my experience with Kinder Morgan is the fact that I prefer business models that are more tangible. Yes, KMI’s pipeline operations are easy to understand – as is evidenced with the toll-road metaphor a ton of us DGI investors use – but it’s not as consumer-driven as I would like. Going forward I’m going to take that into account when deciding on investment opportunities.
There you have it, my three main lessons on investing and dividend stocks. Bottom line: I shouldn’t sheepishly run after the next big thing.
Four days before Dividend Growth Investor partly swapped out his KMI shares for Diageo (LON:DGE), I did exactly the same thing – again, be mindful of tunnel vision! This move is exactly in line with what I described above: Diageo is a mostly consumer-driven business with a pretty average yield and according long-term risk.
As a result, my forward dividend income decreased, but I once again sleep well at night. Besides, the additional shares of Diageo yield about €20 after taxes. Not too shabby!
Were or are you still a KMI investor? And how did you experience the ride of the past few months? Let everyone know in the comments.
I fell in the same trap you did with KMI! I am holding on to my shares for the long term though. I do not think they are out of the game yet. It just might be some years before they get back to what they were. I think they did what they had to do. I respect that because after all they have a business to run… Not just divis to pay out to people like me. Best of luck to you and thanks for sharing your lessons!
Good luck holding on to your shares! I sincerely hope they bounce back up quickly and that the dividend grows nicely over the coming years.
I just couldn’t get behind management’s actions of the past weeks – my trust as an investor was gone, which is far worse than the dividend cut (which I actually applaud them for).
It is a hard lesson, but it is good you’ve learned this lesson early in your investing carreer. I never bought KMI. I do have BHP but their balance sheet is solid and they will probably cut the dividend so they can keep their balance sheet healthy. Fluctuating profits is one of the risk from investing in a cyclical company but if you have a good entry point you will have decent returns in 10+ years.
You’re absolutely right! It has been a valuable lesson for me.
KMI and Billiton are two completely different stories. The problem with BHP is that the price of commodities has dropped so much that their profits have shrunk way too much. The company itself is doing good all things considered (e.g. its balance sheet is rather great, as you mentioned).
For BHP I think a dividend cut would do the company much good and actually bolster its position worldwide in the upcoming years. Too bad I’m already heavily invested in them or I would increase my position.
The KMI cut reminds us all that no dividend, no matter which company pays it, is ever guaranteed. Just a few short years ago GE, WFC and many other “high quality” companies cut their dividends that was unheard of before the cut. It happens. Just be sure that any buy you make is for the right reason and not simply because other DGI bloggers are buying. I hold zero energy names in my portfolio, not because I’m a great investor or have some keen insight, rather I’m just not comfortable owning companies in highly volatile commoditized sectors no matter how many buys I read about in KMI, BBL, CVX, XOM, COP or whatever. Thanks for sharing your KMI experience.
Right, you’re one of the few bloggers that doesn’t have any energy at all. I think that speaks volumes to your thought-process and defensive strategy.
It’s true that no dividend is every truly safe, so I’m rather happy I get to experience my first dividend cut so early in the game – even though I never actually received any KMI payments.
Dividend cut sucks. I faced a few over the years and have leaned a few things. Very good points in your post. This just reminds us that nothing is guaranteed, we all need to do our due diligent when investing and always think about what the downside could be.
Absolutely, nothing is certain in life. The only thing we can do is research as much as possible, apply our knowledge and hope for the best.
The lessons I learned will be invaluable to me later in life!
I was very close to buying a handful of shares when the stock prices plummeted and everyone in the DGI community got in on it. Luckily I had very little cash then, due to my recent change of country (moving is SO expensive…). Talk about a silver lining!
A dividend cut was always gonna happen in the life of a DGI, so I wouldn’t worry about it. You’ve learned from it, so that’s probably worth the money you lost (which I guess wasn’t all that much, since you bought fairly recently).
I also really agree with you when it comes to replicating what others in this community buy – I’ve done it too! We just gotta make sure we understand the main points of the business and the numbers – whay most people would call “the boring part”, but I know we love
Take it easy NMW, glad to read you again.
Guess you were lucky, buddy! I think a ton of people wish they were you right now. 😉
I read you moved back to Spain, awesome. Enjoy the nice weather in Barcelona, I’m sure you’ll have a great time!
The dividend cut itself doesn’t hurt as bad because I never actually received any KMI dividends, but the lessons I learned will prove invaluable to me later on, I’m sure.
guess we were “lucky”, as we did not end up buying Kinder Morgen, but bought TransCanada Corp instead (High Yield @ 5%, Low Chowder (9.5), Low Payout Ratio (20%), Higher PE (28)). Has a 14 year streak of dividend increases. Hope that this one will work out in the long run.
Guess this is a good lesson learned, but don’t forget that the herd often moves in the right direction as well (lots of smart people)!
Love the sheep 😉
Haven’t looked at TransCanada Corp yet, but I certainly will after seeing the track record you just mentioned.
Sometimes we make mistakes and I’m very happy to have my first one happen this early in my investing carreer. I took away a couple of valuable lessons and the entire process put my feet back on the ground.
As to the herd also moves in the right direction: that’s absolutely true. There’s often a reason why a lot of people buy into the same business. However, what I don’t like is when it becomes mindless wandering instead of well-thought purchasing of companies and businesses.
Ah well, everyone has their misses.
I recently thought Delta Lloyd (Dutch insurer) couldn’t go any deeper, but they did and now they have to issue even more shares (EPS dilution) and skip their final dividend for 2015.
Worst thing (biggest lesson?) is that my analysis informed me to not buy them, but this looked just to good of an oppurtunity to miss out on. Hence, I ignored my own strategic evaluation and lost about 50% of the money.
My biggest lessons were; 1) stick to your strategy (this one buy, messed up my performance for the whole year) and 2) if you feel the need to not stick to your strategy, put a stop-loss in place.
You live and learn…
Ouch, that’s also a very painful experience! Sorry you had to go through it, but I’m also glad you learned a lesson there.
I had been watching Delta Lloyd just out of interest to see what would happen next, but I also never expected the stock to sink this low. I’m sure they’ll come out ahead in a couple of years, but it might take some time.
Best of luck with future purchases,
I like the honesty in your lessons learned. I’ve been analysing KMI several times due to the traction it got in the DGI community, but actually i found it quite a difficult business to understand. For me the “toll-road” comment was not easy to understand when really analysing the company information. Anyway, the reason i never bought it was the financial leverage that scared me away. That’s a really important metric for me and like Geblin i’ve been building up a position in BHP over the last year. They have a strong balance sheet, but it’s not known whether we’re at the bottom of the cycle and therefore it’s either unknown whether the dividend is protected. Although they have a strong balance sheet, it still means they needs to do proper capital allocation and so far the most deciding factor seems to be their investment grade status (just as KMI!). So to protect their (low) cost of debt its important for them to don’t let the debt rise by too much and therefore might need to decide to cut the dividend.
Anyway, thanks for you insightful lessons learned and i’ll guess we’ll keep learning more and more!
Thanks! To me this article is very important because it shows that DGI is not wonderful all the time. Setbacks can and will happen, so it’s better to be honest about them and learn from them.
The toll-road comment is indeed not very clear from the company information or website, but when analyzing the different income streams it’s pretty clear where KMI’s money comes from.
You’re right that the financial leverage was high, but not overly so for a utility-like company. I do however prefer a balance sheet like BHP’s: very strong with very little debt to withstand most economic cylces. It’ll be interesting to see what management decides on with regards to the current dividend. Part of me hopes they cut it in half – then I’ll be buying again.
I fell in the trap, too. And I fell hard. I had bought 400 shares at a price of 20 dollars and decided to sell as well, taking a big loss. Fortunately, this has taught me A LOT.
Thanks for sharing your experience and my Best wishes for 2016,
Sorry to hear you lost so much in a single trade. It’s quite a large sum of money you had put towards KMI too! I hope you recover your losses soon.
Best wishes and good luck for the next year!
Sorry for your loss, but I agree with you: better to have this lesson early on in your investment career. It is something that will help you going forward.
I did the opposite from you: after the divide d cut I bought shares of kmi. They are allocated to my “need for speed” part of my portfolio. This is where I hold my side bets and my option positions. Let’s see how it goes.
Best wishes for 2016
Thanks! It’s best to learn this lesson early on as to avoid it in the future with a much bigger impact on my progress towards FI.
Interesting that you decided to add KMI to your portfolio right when I exited. It could be a good long-term holding, but I don’t want to have my trust in management violated a second time. I hope your acquisition works out good for you!
I didn’t buy KMI, but I’m surprised that few people are talking about the fact that free cash flow hasn’t covered capital spending since 2009. I’m looking at Morningstar’s numbers. Also, I’m not a master at accounting, but I’m learning, and looking for these kinds of patterns.
What I saw with KMI is free cash flow going down, debt going up, cap spending going up, outstanding shares going up (dilution).
On the other hand, I think BHP Billiton is starting to look interesting. If they cut the dividend, I might buy a few shares.
Thanks for writing, and sharing your thoughts. Cheerio!
For capital intensive businesses cash flow v. capital spending isn’t the most important factor, but you’re right in a sense. Many utilities, oil companies, pipeline operators, telecoms fund their growth through external means (debt) rather than use their free cash flow.
I believe you are 100% correct on BHP. Although I wouldn’t mind the dividend remaining the same (because it nets me a big fat dividend check), I think it would be in the company’s best interest to cut it in half. Then I’ll possibly purchase more because management still has my trust. You just can’t keep up the current business practices and dividend with the low commodity prices we’re experiencing.
Ah, good points. Thanks for sharing. But you did see the debt levels get a bit alarming with KMI, right? Although I see that with other companies as well, and it seems somewhat normal during these downturns in the oil sector. You ever consider writing a post about the warning signs of KMI? Kind of a debrief of a ‘disaster’. I’d definitely be interested in reading that.
Re: BHP — I personally don’t mind either way. What seems to happen is that if they cut the dividend, we may see faster div growth in the coming decade. If they don’t cut, we may see slower growth, so I have a feeling it evens out for long-term owners.
Debt levels of KMI were certainly high, but nothing unmanageable before the NGP acquisition – at least in my opinion. Whenever oil revenues decline it’s normal that the debt of these companies weighs more heavily on their business model. What’s important is being able to ride the storm out.
I won’t write an entire report on the KMI disaster as you like to call it. I nearly haven’t gotten enough time to do so! 🙂 Besides, this blog is not an investing blog, pur sang. There are other people way better at analysing everything that went wrong, just beware of falling for the hindsight bias. It’s very easy to say “oh, right, that’s what went wrong” after the facts.
BHP is going to be interesting to watch over the coming months. Either way I’m happy to own them, although I of course wished my initial position was a bit lower than it currently is, haha. 🙂
So far KMI is also my biggest dividend investing mistake, I’m still kicking myself for ignoring all the warning signs for so long. It was a nasty experience but a good lesson.
At the end of the day it’s only money. You’ll recover, learn from this experience, and move on.
Best of luck in 2016,
What are you thoughts on buying BHP shares right now now that they are at a low levels? I also heard they cut their dividends which was expected…