Smart Money Eyes Kinder Morgan

02/24/2016 7:00 am EST

Focus: STOCKS

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

With energy and gas prices not this oversold since at least 2002, calling a bottom in the energy market is tough to predict, asserts Nicholas Vardy, editor of Bull Market Alert.

Yet some of the smart money investors are doing just that. Warren Buffett’s Berkshire Hathaway (BRK.B) has taken a position in energy giant Kinder Morgan (KMI).

In addition, David Tepper of Appaloosa Management, one of the savviest and most successful traders in the hedge fund business, has placed big bets on Kinder Morgan.

Here’s why I agree and expect that Kinder Morgan will rally sharply during the next three months.

First, despite a continued plunging in energy prices, Kinder Morgan was able to generate $4.7 billion in distributable cash flow in 2015. That comes to $2.14 per share, a 7% increase over 2014.

How did it manage such robust results? Kinder Morgan has more than 90% of its cash flow secured by fixed-fee long-term contracts.

Second, Kinder just cut its dividend by 75%. Why is that good news? The cut will generate $3.6 billion in cash flow in excess of its dividend for 2016.

This extra cash is more than enough to cover management's expected $3.3 billion in capital spending.

When combined with a new dose of $2 billion in unsecured loans to refinance existing debt, the extra cash ensures that the company won't need to access additional debt or equity markets beyond 2016.

Finally, from a technical standpoint, Kinder Morgan has shown impressive relative strength. It is up slightly for 2016, a remarkable feat for an energy stock.

What’s the risk here? Despite its robust business model, a bet on Kinder Morgan is ultimately still on a bet on the oil price.

Kinder's projected $4.7 billion in 2016 distributable cash flow is based on projections that the price of WTI crude and natural gas prices will average $38 per barrel and $2.5 per MMBTU this year.

While a 30% rise in oil and gas price in 2016 from current levels may seem like a stretch, remember that the last time oil traded this low, it rebounded 150% within the next 12 months. Extremes simply don’t last that long.

Here’s a word of warning. With volatile energy prices, this is a high-risk bet. If you act on this recommendation, you might want to start with a smaller than usual position and strap yourself in for a volatile ride.

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