Series 7-C—Will the Fed take a bite out of Apple? (Part 6 of 6)
Kinder Morgan–Q2 bear food?
The below graph reflects the strong outperformance of Kinder Morgan Energy Partners, KMP. From a long term perspective, Kinder Morgan has left both the S&P 500 and the Morningstar large cap growth total return index in the dust. Given the energy renaissance in the USA, it is no wonder that Kinder Morgan and other energy-related Master Limited Partnerships, or MLP’s have performed so well. However, as the Fed removes the punchbowl, and its bond purchasing program could end by the end of the year, Kinder Morgan and other high flying growth stocks could take a significant near-term hit. This article explores the prospects for Kinder Morgan and MLPs in general in the context of the Fed’s tapering plans and the possibility of higher rates.
For an overview on the four main risk factors for equity portfolio returns, please see the prior series, The end of QE and the Four Most Important Factors for Your Portfolio and Key Strategy: Four Key Risk Factors as the Fed Tapers.
Why MLPs work until they don’t work
Because MLPs distribute most of their income to investors, they require ongoing rounds of financing to grow. MLP’s issue more equity—which could be aggressively price to begin with—then borrow more debt on top of the equity to finance more growth projects. This is fine as long as the debt is not excessive and the ability to issue new equity does not decline. Should equity valuations decline while profit margins become thinner, it becomes harder to finance new growth, and possibly harder to finance debt on the books.
Kinder Morgan looks solid, but…
With a forward PE of 26.02 (Capital IQ, 2015 E) and an EBITDA of $4.68 billion against $21.24 billion of total debt, Kinder Morgan does not seem to be too leveraged and in danger of experiencing debt service issues anytime soon. With Fitch Ratings assigning a BBB rating to Kinder Morgan Energy Partners’ proposed senior notes last month, it would seem that Kinder Morgan’s stable earnings and growth prospects are excellent. As a result, it would seem that long-term investors should not be too concerned about Kinder Morgan’s long-term growth prospects. Investors should be more concerned with near-term issues such as the possibility of a hot money bear attack on MLPs in general.
Bear food: Kinder’s payouts and class action lawsuit
According to a class action lawsuit filed February 5 this year in Delaware Court against the Kinder Morgan Management Company, KMI (which also involves Kinder Morgan Management, KMR, as KMR is an LLC that solely owns KMP units and reinvests dividends), KMI’s accounting may not have been consistent with investor expectations. Apparently, the classification of some of the costs attributed to the upkeep of its 80,000-mile pipeline network were classified as future growth investment rather than current expense—creating a thicker than otherwise bottom line of profits to be paid out. This legal complaint thereby suggests that payout rates to investors (and thereby…cough, cough..management) might have been too high. While investors like the cash payout, they seem to have a greater interest in keeping the cash in the company to finance growth rather than (management) taking out cash today. Apparently, investors feel that KMI’s accounting might have been a bit self serving and not fully consistent with the long-term interests of investors. Since this filing on February 5 th , KMP has fallen nearly 7.0% while the S&P 500 has risen roughly 6.0%.
While long term investors should be reassured of KMP’s long-term growth prospects, they should be aware that KMP’s exceptional momentum and less than flattering recent headlines can set the stage for near-term stock price pressure. Hedge funds and fast money are always looking for attractive tactical shorts, and with the accounting issues and the Fed taper in the mix, the lure of short term profits via tactical short sales could be quite tempting. Additionally, Wells Fargo estimates that 65% of MLP’s are owned by retail investors, which are often contra-indicators of prudent investment timing. MLP’s have been generating lots of fees for the investment banks who provide the ongoing rounds of debt and equity so that both growth and payouts remain robust. Lets hope Main Street fares as well as Wall Street in MLP’s in 2014.
Equity Outlook: constructive macro view
Despite problems in the Ukraine and China, and despite the modest consumption data in the USA, US labor markets appear to be well into recovery—with the exception of the long term unemployed. From this perspective, it would appear that the US is probably the most attractive major investment market at the moment. While the fixed investment environment of the US is still quite poor, corporate profits and household net worth have hit record levels. Hopefully, all of this wealth and liquidity can find their way into a new wave of profitable investment opportunities, and significantly augment the improvement in the current economic recovery. For investors who see a virtuous cycle of employment, consumption and investment in the works, the continued out performance of growth stocks over value stocks could remain the prevailing trend, favoring iShares Russell 1000 Growth Index (IWF), and growth oriented companies such as Google, GOOG, or Apple, AAPL.
Equity Outlook: cautious macro view
Given the China and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index, IWM, State Street Global Advisors S&P 500 SPDR and Dow Jones SPDRs—SPY & DIA, and iShares S&P 500, IVV. Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index, IWD, such as Wallmart, WMT.
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