Does Kinder Morgan (NYSE:KMI) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kinder Morgan, Inc. (NYSE:KMI) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Kinder Morgan

What Is Kinder Morgan's Net Debt?

As you can see below, Kinder Morgan had US$32.2b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Kinder Morgan's Balance Sheet?

We can see from the most recent balance sheet that Kinder Morgan had liabilities of US$4.73b falling due within a year, and liabilities of US$34.4b due beyond that. On the other hand, it had cash of US$111.0m and US$1.27b worth of receivables due within a year. So it has liabilities totalling US$37.8b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$59.0b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Kinder Morgan's net debt to EBITDA ratio of 4.9, we think its super-low interest cover of 2.3 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Given the debt load, it's hardly ideal that Kinder Morgan's EBIT was pretty flat over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Kinder Morgan can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Kinder Morgan recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Kinder Morgan's net debt to EBITDA makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. But on the brighter side of life, its conversion of EBIT to free cash flow leaves us feeling more frolicsome. Taking the abovementioned factors together we do think Kinder Morgan's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Kinder Morgan is showing 3 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.