Kinder Morgan’s third-quarter results were solid, with its natural gas business leading the way. 2022 guidance was unchanged from last quarter, and we continue to expect about $7.6 billion in EBITDA. We think the firm has done a very good job managing costs in this inflationary environment, as management pointed out that its cost increases are much lower than the producer price inflation indexes. After updating our model for minor adjustments, we maintain our $17.50 fair value estimate and narrow moat rating.

With the business performing well, the larger insights are more on the capital allocation side this quarter, where we think Kinder is making good decisions. Kinder continues to add renewable natural gas assets via acquisition, adding North American Natural Resources and related companies for $135 million in August. The acquisition includes several landfill-to-gas power facilities, and Kinder plans to convert several to renewable natural gas by 2024. The deal is in addition to the earlier $355 million acquisition of Mas CanAm earlier this year. The deals look particularly attractive with expected EBITDA multiples well under 10 times, compared with BP’s recent announcement that it will acquire biogas peer Archaea for an expected 2022 EBTIDA multiple closer to 30 times per PitchBook estimates. Similarly, Kinder sold off a 25.5% stake in its Elba LNG terminals to an undisclosed buyer for $565 million at an attractive 13 times EBITDA multiple, well above its own valuation multiple.

Kinder Morgan's assets span natural gas, natural gas liquids, oil, and liquefied natural gas. The company's U.S. gas pipeline business is particularly impressive. Management claims its daily gas transportation capacity is equivalent to 40% of average U.S. gas consumption and it handles 50% of the LNG market. Kinder serves most major U.S. gas supply and demand regions.

Kinder Morgan's size is both an opportunity and a challenge. Its expansive asset footprint provides numerous investment opportunities if supply or demand bottlenecks develop. Kinder has the financial and commercial heft to execute any project, no matter the size. However, large-scale projects have been fleeting in the past few years, particularly as legal, regulatory, and stakeholder protests have successfully delayed and canceled major U.S. and Canadian pipelines. The shift forced Kinder out of Canada, in what we think was a wise decision, particularly as Trans Mountain pipeline costs have soared since Kinder’s exit. With limited growth prospects, management has slashed investment, strengthened the balance sheet, and focused on returning cash to shareholders through the dividend and stock buybacks. For example, it has bought over $300 million in stock so far in 2022 with some of the cash generated by better-than-expected results.

With ample excess free cash flows, Kinder is pursuing more clean energy investments. It already considers about 70%-75% of its backlog to be low-carbon investments, and it has formed an energy transitions group to pursue investments in renewable natural gas, biofuels, and carbon capture projects. The Kinetrex deal added several renewable natural gas projects at a highly attractive multiple in 2021, and it built on this success with the Mas CanAm and North American Natural Resources and related companies deals in 2022. Given Kinder’s extensive experience with CO2 pipelines and processing facilities, we think it is better positioned than most U.S. peers to evaluate and invest in carbon capture and storage opportunities across its footprint, as well. Methane reduction is another opportunity, and Kinder has been working on this area since 2014 via its ONE Future efforts.

Kinder Morgan has assembled a set of energy infrastructure assets that we believe would be very difficult to replicate. Its pipelines and storage facilities are moaty assets, as the challenges of constructing a competing pipeline confer near-monopoly status on pipeline operators. On the whole, we think its asset portfolio has earned a narrow moat from an efficient scale moat source, as returns excluding goodwill are above its cost of capital. We exclude goodwill because the goodwill was largely incurred during a deal-making spree in 2011-13 where Kinder spent more than $40 billion on largely high-quality natural gas assets, adding $20 billion in goodwill at the time. Since then, with the exception of the one-time corporate consolidation in 2015, which did not materially increase goodwill or intangibles balances, Kinder has refrained from M&A on a similar scale, and we don’t expect it to engage in large-scale M&A going forward. In total, Kinder Morgan’s assets move about 40% of U.S. natural gas consumption and exports, making its infrastructure mission-critical to U.S. stakeholders. Virtually all the business is focused on natural gas or related activities. In that regard, Kinder Morgan looks very similar to narrow-moat peer Williams, which handles 30% of the nation’s natural gas.

New pipelines are typically constructed to allow shippers or producers to take advantage of large price differentials (basis differentials) between two market hubs because supply and demand is out of balance in both markets. Pipeline operators will enter into long-term contracts with shippers to recover the project’s construction and development costs as well as a return on capital, in exchange for a reasonable tariff that allows a shipper to capture a profitable differential, and capacity will be added until it is no longer profitable to do so.

Pipelines are approved by regulators only when there is an economic need, and pipeline development takes about three years, according to the U.S. Energy Information Administration. Regulatory oversight is provided by the Federal Energy Regulatory Commission and at the state and local levels, and new pipelines under consideration have to contend with onerous environmental and other permitting issues. Further, project economics are locked in through long-term contracts with producers before even breaking ground on the project. If contracts cannot be secured, the pipeline will not be built.

A network of pipelines serving multiple end markets and supplied by multiple regions is typically more valuable than a scattered collection of assets. A pipeline network allows the midstream company to optimize the flow of hydrocarbons across the system and capture geographic differentials. Finally, it is typically cheaper for an incumbent pipeline to add capacity via compression, pumps, or a parallel line than it would be for a competitor to build a competing line.

Kinder's portfolio includes 72,000 miles of natural gas pipelines, which provide transportation between most of the country's largest gas supply and demand regions. In addition, Kinder Morgan operates one of the largest products pipeline and terminals networks in the country. Kinder Morgan's extensive natural gas and refined products pipelines and continued investment in major projects look set to extend the company's asset footprint and cash flows.

Historically, Kinder has assembled its assets by aggressively purchasing third-party assets of all sizes, including large transactions (El Paso, Copano, and Hiland, for example) to small bolt-on acquisitions and including pipelines, storage and terminal facilities and Jones Act vessels. The purchase prices for midstream assets had been bid up as competition from many midstream players has been fierce. However, virtually all of these investments took place nearly a decade ago, and M&A activity has been far more restrained and thoughtful over the past decade, as asset sales and pruning have come to the forefront.

Importantly, more than 90% of its contracts are take-or-pay or fee-based. Among its most important business, which are natural gas and terminals, contracts are almost entirely take-or-pay, providing substantial security that Kinder will be paid throughout any oil and gas environment. More than 50% of the business operates under regulators’ pricing, providing additional security for the durability of returns. More than 70% of its customers are end users such as utilities, integrated energy firms, refineries, and other industrial users providing a steady source of demand. This dynamic is in contrast to supply-oriented contacts that would be exposed to concerns over a basin’s economics and drilling activity.

While contract lengths across the business are shorter, on average, between a few years and up to 10 years, we think this reflects the maturity of Kinder’s assets versus a lack of pricing power. For newbuild assets such as Whistler which cost billions of dollars, long-term contracts over 10-20 years are expected to recover the investment outlay. However, on average, with Kinder’s network highly developed, the incremental investments tend to be smaller individually and thus require shorter contracts to recover the lower amounts of investment needed. In fact, we wouldn’t be surprised if some of Kinder’s smaller assets operate without contacts entirely, given their dominance over their local market for a lengthy period of time and the lack of competing assets.

Kinder's carbon dioxide business is directly exposed to commodity price fluctuations. Although we generally do not assign a moat to oil production, we think the CO2 business on its own deserves recognition. By controlling the source and transportation of CO2 and oil production from two fields using CO2 floods, Kinder has created a minimonopoly in the Permian that would be difficult for a competitor to replicate.

Tax benefits have boosted returns following the consolidation of its former master limited partnerships, Kinder Morgan Energy Partners and El Paso Energy Partners. The consolidation of these two led to a large increase in tax depreciation, as the acquired assets were revalued at the purchase price rather than the historical cost for tax purposes. This offsets taxable income and reduces cash taxes. Kinder does not expect to pay meaningful cash taxes until 2024 after factoring in the 2017 federal tax cuts.

Material environmental, social, and governance exposures create additional risk for midstream investors, though it is worth noting that Kinder Morgan is ranked the best oil and gas firm from an ESG perspective by Morningstar Sustainalytics. In this industry, the most significant exposures are greenhouse gas emissions (from upstream extraction, midstream operations, and downstream consumption) and other emissions, effluents, pipeline spills, and opposition and protests. In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as production limits, removal of existing infrastructure, and perhaps even direct taxes on carbon emissions.

Midstream emissions are relatively low in the lifecycle of oil and gas, and midstream firms have relatively lower risk than upstream and downstream firms from carbon taxes. Canadian firms already pay carbon taxes on their carbon emissions, most of which are generally passed to their shippers and other customers. Spills represent a major threat and have created great resistance from environmentalists, Indigenous groups, and other climate-conscious persons. Examples of the opposition are seen in President Joe Biden’s revocation of the Keystone XL presidential permit and the legal challenges with the Dakota Access Pipeline system.

Kinder Morgan has yet to lay out any material ESG-related targets or goals.

After updating our model for third-quarter results, we are maintaining our $17.50 fair value estimate. Our fair value estimate implies a 2022 enterprise value/EBITDA multiple of 9.4 times.

We broadly expect Kinder's growth to be driven by Mexican natural gas imports, U.S. LNG exports, and its small but growing efforts around renewables and low-carbon energy. Kinder's network of assets is heavily leveraged to Texas, and we expect the Permian and Haynesville to be some of the key growth basins. We assume normalized oil and gas demand to support 3% growth from its existing assets. Based on these core assumptions, we forecast $7.6 billion EBITDA in 2022. We expect 4%-8% EBITDA growth starting in 2024.

We assume Kinder invests $1.5 billion in growth projects in 2022 and include its multiple RNG deals and Elba sale. Beyond 2022, we assume growth investment stays well below Kinder's $3 billion annual growth investment run rate in 2014-18 and averages about $1.5 billion annually. We think large growth projects will be scarce for the foreseeable future.

We assign Kinder Morgan a Morningstar Uncertainty Rating of Medium. Kinder Morgan faces all the standard risks confronting midstream infrastructure owners. This includes the possibility of regulatory changes, interest-rate risk, changes in regulated pipeline tariffs, capital investment risks, and pipeline spills, explosions, or ruptures. Kinder has limited direct exposure to North American energy prices, but it has indirect exposure as changing oil and gas prices impact volumes through its network.

Kinder's growth investment potential primarily depends on increasing gas demand for power generation, liquefied natural gas exports, and Mexican exports. The LNG export growth in particular will be highly sensitive to the spread between U.S. gas prices and gas prices in Europe and Asia.

We expect Kinder to search for growth opportunities in its core gas business and clean energy, supporting its recent deal to acquire Kinetrex. Management cut investment in the CO2 business as oil prices sank, and we don't expect that investment to come back even if the rebound in oil prices holds.

Kinder's decision to publicly offer 30% of its Canadian business in May 2017 came full circle just two and a half years later when it sold the controversial Trans Mountain pipeline to net $1.9 billion of aftertax cash. Kinder ultimately sold its entire Canadian stake to Pembina in late 2019, eliminating all Canadian investment risk.

Kinder Morgan faces environmental, social, and governance exposure primarily related to its handling of fossil fuels throughout the value chain. This creates potential greenhouse gas emissions, effluents, pipeline spills, and opposition and protests that in the long run could push consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as production limits, removal of existing infrastructure, and perhaps even direct taxes on carbon emissions.

We assign Kinder Morgan management a Standard capital allocation rating. Management deserves credit for strengthening the balance sheet and restoring a strong dividend while managing and investing in some of the largest energy projects in the U.S. during the last several years. Chair Rich Kinder built the firm out of Enron's unwanted midstream assets in the late 1990s and then consolidated it in 2014 to create one of the few U.S. C-Corporation midstream firms at the time.

Capital allocation will be management's biggest challenge as organic growth opportunities wane and free cash flow grows. Management has even more capital allocation flexibility after collecting substantial cash during the 2021 winter storm. We think the company can return as much as $3 billion to shareholders annually through dividends and stock buybacks based on its core growth plan. It has met our expectations here with the dividend but has fallen short on recent stock buybacks, so it can do more. The $1.2 billion Stagecoach acquisition and $310 million Kinetrex acquisition suggest Kinder is looking to acquire growth in its core business and expand slowly into clean energy. The early results from these deals look compelling, and Kinder has continued to add more RNG assets via M&A.

Management failed to reach the $1.25 per share dividend in 2021 that it had targeted in its 2017 long-term plan. We think it will instead pursue a more measured 3% growth rate instead of retargeting the initial $1.25 a share, which is appropriate, in our view. However, management has a $2 billion stock-repurchase plan approved in 2017 that it can take advantage of with excess cash flows. It has followed through with about $273 million in buybacks so far in 2022.

The exit from Canada, including the Trans Mountain and Kinder Morgan Canada sales, looks like a great move, given the subsequent energy market crash. Kinder sold its Pembina shares assumed through the Kinder Morgan Canada deal just weeks before the market toppled in spring 2020. The deals brought in substantial cash and remove regulatory concerns but also eliminated substantial growth potential. Similarly, the partial sale of its Elba LNG terminal at a 13 times multiple in 2022 is a very good price.