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Must-know: Kinder Morgan’s MLP assets

Samuel Madden, CFA of Interactive Buyside

Equity research: Is Kinder Morgan an attractive investment? (Part 3 of 5)

(Continued from Part 2)

MLP assets

We will take a step back here, as this is as good a place to try to explain briefly what an MLP is and a little more about the intricacies of a somewhat complex ownership structure of KMI. Most MLPs can be defined as publicly traded partnerships. MLPs consist of a General Partner (“GP”) and Limited Partners (“LPs”). GPs typically hold a 2% ownership and are responsible for managing the operations of the MLP. The GP runs the company’s operations and holds all of the voting power, while the LPs provide the capital and realize the benefits of the distribution package. These benefits primarily lie in favorable tax treatment. We first wrote about this in September of 2011, see our newsletter here for more information on MLP’s and our original discussion of EPB. The partnership is obligated by law to distribute profits to the partners accordingly, making up a majority of KMI’s earnings. The GP is paid via a management fee. The MLP “shares,” called “units,” make up the majority of the partnership and represent the LP’s stake in the partnership. KMP, an MLP, trades just like a common stock. An MLP must earn 90% of its income from activities related to natural resources, commodities or real estate. KMP fits easily into the definition of an MLP. MLPs allow energy companies to structure themselves in a way that attracts conservative, long-term investors rather than speculators; more income investments rather than capital-gains plays leveraged on commodity prices.

The above explanation is helpful for understanding KMI’s investments and assets. The primary cash inflows for KMI are from its general and limited partner stakes in KMP and EPB. KMI directly and indirectly owns approximately 10% of KMP, including ownership of the GP, while also owning 41% LP interest and ownership of the GP interest in EPB. If we fill in the above chart concerning KMI, they are the GP for both KMP and EPB, with Rich Kinder, other management, and original stockholders owning about 28% of the stock, the public owns about 65% of the stock and sponsors own around 7% of KMI stock.

While, for accounting purposes, KMI consolidates KMP into its financial results, creating complex accounting to track cash flows, if you look at what KMI does, it’s easier to understand the company. It collects cash distributions from its ownership stakes in KMP, EPB and NGPL, pays modest general and administrative expenses, pays interest on KMI-level debt, pays income taxes, and distributes the remaining cash to its shareholders as dividends.

Owning shares of KMI gives investors a claim on the general partner stake of Kinder Morgan Energy Partners. The difference between limited and general partner distribution growth comes down to incentive distributions rights (IDRs). IDRs allow the holder to collect incentive payments that increase as the MLP’s per-unit distribution to limited partners increases based on defined distribution levels, which top out in the high splits, where the general partner is entitled to receive fully half of every incremental dollar paid out as distributions. KMP has been in the high splits for a decade, and currently, KMI’s general partner stake collects roughly 45% of total cash distributions paid out by KMP. This is the primary mechanism used throughout the industry to “incentivize” the GP to grow the distribution payments of the LP, and historically it has worked very well. The following table details IDR’s due to KMI from KMP at various distribution levels.

Similarly, the following table details the IDR’s due to KMI from EPB at various distribution levels.

We’re not new to the KMI story. This is a stock that we have owned for a while. A look at their stock chart for 2013 shows us that KMI is actually down a couple of percent in a year when the overall market moved ahead by over 20%. It’s this experience that creates an opportunity worthy of an outsized position in our portfolio, and that’s why we bring it to your attention now.

Even before we owned KMI, we were long-time owners of EPB stock and were forced to do our due diligence on Kinder Morgan when they announced in October of 2011 that they were going to acquire EPB’s parent company, El Paso Corporation. As a research firm, we have known of Richard Kinder and his Kinder Morgan companies over the years. It did not take us a lot of research time to get on board with Kinder Morgan owning El Paso. Also, at CUSH, we host a monthly investors’ club for area executives and other successful investors. Several times over the years, we have talked about this company. We welcome anyone interested in joining our investors’ club to contact CUSH Capital.

The Market Realist Take

In an article last week by Market Realist analyst Ingrid Pan on Why MLPs provide excellent risk-reward for investors, we see the difference in spreads between master limited partnership (MLP) and BBB high yield corporate indices has not been as wide as it now, at ~280 basis points, or 2.8%. It stated MLPs such as the Kinder Morgan MLP (KMI), Atlas Pipeline Partners, L.P. (APL), Buckeye Partners, L.P. (BPL), and Boardwalk Pipeline Partners, LP (BWP) may outperform BBB corporate credit. Moreover, the AMLP ETF may outperform the JNK ETF (high yield bond market) in 2013 because of increased spending on oil infrastructure in the U.S. and the relatively high spread differential between the two asset classes.

Peer Williams Cos.’s (WMB) MLP Williams Partners (WPZ) reported lower operating profits due to decline in olefin and NGL margins. It updated its guidance for cash distributions per limited partner unit, reaffirming an annual growth rate for 2013 of about 9% and revising the expected annual growth rate for 2014 and 2015 to 6%. The increase reflects an expectation of improved NGL margins, lower costs and lower interest expense, and a planned January 2014 drop-down of Williams’ currently in-service Canadian assets to Williams Partners. The increase will be offset by lower volume growth rate projections at Ohio Valley Midstream.

Enterprise Products Partners (EPD) declared an increase in its quarterly cash distribution rate with respect to 3Q 2013 to $0.69 per unit, which represents a 6% increase over the $0.65 per unit rate that was paid in 3Q 2012. It said that for 3Q 2013, the partnership retained $286 million of distributable cash flow, which is available to reinvest in growth capital projects, reduce debt, and decrease the need to issue additional equity.

Plains All American Pipeline LP’s (PAA) quarterly distribution of $0.60 per common unit or $2.40 per unit on an annualized basis in November 2013 represented a 10.6% increase over the quarterly distribution paid in November 2012, exceeding the high end of its 9% to 10% targeted growth range for 2013. Looking beyond 2013, it expects a 20% increase in its fee-based activities for 2014, and established a 10% distribution growth target. It expects recently completed growth projects and its multi-billion dollar portfolio of organic growth capital investments to provide visibility for continued growth beyond 2014.

Distributable Cash Flow attributable to the partners of Energy Transfer Partners, LP (ETP) for 3Q 2013 totaled $527 million, an increase of $149 million over the same period last year. It said the increase was primarily due to strategic acquisitions in 2012, including Sunoco, Inc,  ownership interests in Citrus Corp., Sunoco Logistics Partners L.P., and ETP Holdco Corporation. It increased its quarterly distribution to $0.905 per unit, a total annualized distribution of $3.62.

Continue to Part 4

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