This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Kinder Morgan Energy Partners LP (NYSE:KMP) and looks "under the hood" to properly ascertain sustainability of Distributable Cash Flow ("DCF"). The task is not easy because the definitions of DCF and "Adjusted EBITDA," the primary measures typically used by master limited partnerships ("MLPs") to evaluate their operating results, are complex. In addition, each MLP may define these terms differently, making comparison across MLPs very difficult. Nevertheless, this is an exercise that must be undertaken to ascertain what portions of the distributions being received are really sustainable.
KMP's term for earnings before depreciation and amortization ("EBDA") is "Segment earnings before DD&A and certain items." EBDA and DCF reported by KMP for the periods under review are summarized in Table 1 below:
Table 1: Figures in $ Millions
In a prior article dated April 21, 2013, I discuss what drove the improvements in EBDA shown in Table 1 and how KMP derives the DCF it reports. Using KMP's definition, DCF per unit for the TTM ending 3/31/13 was $5.18, up from $4.85 for the TTM ending 3/31/12. In 1Q13, DCF per unit increased to $1.46 from $1.37 in 1Q12.
As always, I attempt to assess how the reported DCF figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than just the quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.
The generic reasons why DCF as reported by an MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to KMP' results with respect to sustainable cash flowing to the limited partners generates the comparison outlined in Table 2 below:
The principal differences of between sustainable and reported DCF numbers in Table 2 are attributable to a host of items grouped under "Other" as detailed in Table 3 below:
In an article titled Distributable Cash Flow (DCF), I present the definition of DCF used by KMP and provide a comparison to definitions used by other MLPs. KMP's definition and method of deriving of DCF (what KMP refers to as "DCF before certain items") is complex and differs considerably from other MLPs I have covered.
The adjustments in Table 3 illustrate the complexity and subjectivity surrounding DCF calculations and highlight the difficulty of comparing MLPs based on their reported DCF numbers.
The first example is a $225 million gain on sale incorporated into the reported DCF number. This pre-tax gain stems from the March 14, 2013 sale by KMP of its one-third equity ownership interest in the Express pipeline system, as well as the sale of its subordinated debenture investment in Express to Spectra Energy Corp. paid $403 million in cash. I exclude this from my definition of sustainable DCF.
A second example is a $129 million write-down of assets in the TTM ending 3/31/13. This occurred pursuant to an FTC mandate issued in connection with the approval of the El Paso acquisition. Management includes this write-down in its definition of "certain items" and thus does not adjust DCF downwards. I am not comfortable disregarding this as a one-time adjustment (especially when such adjustments repeat themselves). Perhaps I am being too conservative, but I don't like giving management a "free pass' on writing down asset values and am not entirely convinced by the "no cash impact" argument.
The exclusion of net income attributable to Kinder Morgan Inc. (NYSE:KMI), the general partner of KMP, from reported DCF is another example. As can be seen in Table 2, the principal component of DCF is net cash from operations. Net income plus depreciation is, of course, a major contributor to net cash from operations. But Table 2 also shows that KMP deducts the general partner's portion of net income. By doing so, KMP chooses to report a DCF number that covers only that portion attributable to limited partners. I prefer to look at total coverage ratio, one that includes all sustainable cash generated by the partnership vs. the distributions made to all the partners (general and limited). The impact of doing so is shown in Table 4 below:
But this does not conclude the coverage ratio analysis. To understand why, we must look at the capital structure of the Kinder Morgan entities. Kinder Morgan Management, LLC (NYSE:KMR) owns approximately 31% of KMP in the form of i-units that receive distributions in kind. Had these units received cash instead, I estimate total distributions made to KMP's partners in the TTM ended 3/31/13 would have been higher by ~$594 million ($5.08 per share distribution times ~117 million i-units outstanding) and the distribution coverage ratios would have been much lower.
Table 5 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:
Simplified Sources and Uses of Funds
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $310 million in the TTM ended 3/31/13 and by $528 million in corresponding prior year period. These excesses are large relative to the distribution coverage ratios noted in Table 4. The discussion following Table 4 provides an explanation (i.e., KMR holders receive shares instead of cash).
Table 6 below compares KMP's current yield to some of the other MLPs I follow:
As of 05/31/13:
Magellan Midstream Partners (NYSE:MMP)
Plains All American Pipeline (NYSE:PAA)
Enterprise Products Partners (NYSE:EPD)
Targa Resources Partners (NYSE:NGLS)
El Paso Pipeline Partners (NYSE:EPB)
Kinder Morgan Energy Partners
Buckeye Partners (NYSE:BPL)
Williams Partners (NYSE:WPZ)
Regency Energy Partners (NYSE:RGP)
Boardwalk Pipeline Partners (NYSE:BWP)
Energy Transfer Partners (NYSE:ETP)
Suburban Propane Partners (NYSE:SPH)
I am uncomfortable with KMP's distribution coverage. If distributions to KMR had been funded by cash instead of issuing additional capital, I estimate coverage for the TTM ended 3/31/13 would have been 1.03 as reported by KMP, and 0.90 if calculated on the basis of sustainable DCF. These ratios are considerably lower than those shown in Table 4. KMI, which yields ~4.0% but is expected to grow distributions at ~9% per annum (albeit down from the prior guidance of 12.5% per annum), may be a better alternative.
Disclosure: I am long EPB, EPD, ETP, PAA, SPH, WPZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.