Equity research: Is Kinder Morgan an attractive investment? (Part 2 of 5)
KMI investment framework
We mention KMI’s complicated ownership structure as one of the factors that creates some confusion around the stock and periodically leads to undervaluation. KMI is basically the parent company to three other publically traded entities. We found this article from Adam Jones did a good job of laying out all the moving pieces.
The predecessor to KMI was Kinder Morgan Energy Partners, L.P. (KMP) which was founded in February of 1997 when a group of investors led by current chairman and CEO Richard D. Kinder and former Vice Chairman William Morgan acquired the general partner of a small, publicly traded pipeline limited partnership. This pipeline partnership came about as part of the Enron collapse. This was a set of pipelines that Richard Kinder knew well since he had been the President at Enron just five years before it went down. It was called Enron Liquids Pipeline, L.P.
Based in Houston, Texas, KMP began with relatively few assets, 175 employees, and an enterprise value of around $325 million. Richard Kinder and Bill Morgan had a vision to build a different type of energy company and they wanted to utilize the master limited partnership (MLP) financial structure as the growth vehicle for their new company. Their purpose was to raise capital from smaller investors by offering them a partnership investment in an affordable and liquid security. This strategy has worked, as KMP has become one of the largest publicly traded pipeline limited partnerships in America. In the early years, KMP grew mostly through acquisitions, purchasing such assets as refined petroleum pipelines, carbon dioxide (CO2) production fields and transportation pipelines, intrastate natural gas pipelines and bulk and liquids terminals. In recent years, most of KMP’s growth has come through expansions and newbuild projects. During the past 15 years, KMP has invested over $20 billion to grow the company through joint ventures, expansions, and acquisitions.
In 1999, Mr. Kinder and his management team took over KN Energy, an integrated natural gas pipeline company based in Lakewood, Colorado. KN’s roots dated back to 1936 when, as a local distribution company, it provided natural gas service to small communities and rural areas in Kansas and Nebraska. One of the main assets that came from this deal was Natural Gas Pipeline Company of America (NGPL), which continues to serve the Chicago market. Following the transaction, KN became Kinder Morgan, Inc. (KMI), Kinder Morgan’s second publicly traded company.
On October16, 2011, KMI announced it would acquire El Paso Corporation (EP) for approximately $38 billion. The transaction, which closed on May 24, 2012, made Kinder Morgan the largest midstream and the fourth largest energy company (based on combined enterprise value) in North America. As part of the transaction, Kinder Morgan added a fourth publicly traded entity to its family of companies—El Paso Pipeline Partners, L.P. (EPB).
Today, Kinder Morgan is a Houston, Texas–based holding company that enables the movement of natural gas in the U.S., as well as oil and petrochemicals. It has ownership interests in over 82,000 miles of pipeline, with over 70,000 miles of that pipe carrying natural gas, the rest oil and CO2. Pipelines are approximately 40% of its revenue; 60% of that is regulated. The company has a terminal storage business that includes 180 storage terminals, which handle 2.5 million barrels of oil per day and 55 billion cubic feet of gas per day.
KMI owns the general partner, incentive distribution rights, and roughly 10% of the outstanding limited partner units of KMP, which together account for more than 95% of KMI’s cash flow. It also owns the general partner, incentive distribution rights, and roughly 41% of the outstanding limited partner units of EPB. It also owns a 20% stake in a major interstate natural gas pipeline system, NGPL, which it operates on behalf of its partners.
The Market Realist Take
KMP expects to declare cash distributions of $5.58 per unit for 2014—an approximate 6% increase over its 2013 budget target of
$5.28 per unit and an approximate 5% increase above its current expectation of $5.33. KMI sees growth opportunities across all of KMP’s business segments, including the need for more midstream infrastructure to move and store oil, gas, and liquids from the prolific shale plays in the U.S. and the oil sands in Alberta, along with increasing demand for CO2.
However, investors were disappointed with the projected cash distribution from EPB, which expects to declare cash distributions of $2.60 per unit for 2014, an approximate 2% increase over its 2013 expected distribution of $2.55 per unit. EPB’s 2014 budget includes the expected purchase from KMI of 50% of Ruby Pipeline, 50% of Gulf LNG, and 47.5% of Young Gas Storage. The positive impact from the expected drop-downs at attractive multiples will be largely offset by the impacts of the Southern Natural Gas and Wyoming Intestate Company (WIC) rate cases and expected lower rates on contract renewals on the WIC system. In 2014, EPB expects its regulated pipeline and storage assets, along with its LNG business, to generate earnings of about $1.3 billion, an increase of almost $90 million compared to 2013. EPB also has over $1 billion of expansion projects under contract with customers, which will benefit EPB unitholders in 2016 and beyond. Although El Paso offers a 7% yield currently, analysts are concerned about the slowing distribution growth at EPB.
Peer Williams Partners has a dividend 6.86% yield, while Enterprise Product Partners has a 4.22% yield, Plains All American Pipeline has a 4.47% yield, and Energy Transfer Partners has a 6.61% yield.
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