Historically, the Oil and Gas sector of the U.S. economy has been subject to a lot of volatility. After the global meltdown of 2008, oil prices have slowly recovered from a very low point. Consequently, the sector has to adjust itself continuously in the face of changing dynamics. The latest developments in the sector have uncovered newer sources of energy. This has made the United States more energy independent than before.
A significant portion of the oil and gas sector is the oil and gas pipelines industry. Companies in this industry own pipelines and terminals that are used to transport and store petroleum products, natural gas, carbon dioxide etc. The most striking aspect of this sector is that it is largely defensive. This means that with volatility in the markets, this sector continues to show positive trends. This is because the companies in this industry charge upstream companies for the utilization of their pipelines and terminals. They are also least-affected by the changes in the prices of the commodities being transported. Recently, the companies in the oil and gas pipeline industry have seen an increase in their revenues due to the shale gas operation in the United States. Shale gas operations resulted in increasing production of natural gas, which directly increased the utilization of pipelines and terminals.
Kinder Morgan Energy Partners (NYSE:KMP) is the largest midstream and the third-largest energy company in the United States. The company owns 80,000 miles of pipelines and 180 terminals. The company is one of the many beneficiaries of the shale gas boom in the United States. It has five different segments.
Source: Company Financial Statements
KMP saw a year-over-year growth of 44% in its revenues. It is interesting to note that the largest increase was in the revenues from the product pipelines segment. Product pipelines transport refined petroleum products. The natural gas pipeline segment saw an increase in revenue of 72% as well.
Source: Y Charts
The above chart shows the average return of KMP over a 10-year period. Notice how the stock has continued its upward trend because of operating in a defensive industry. The 2008 recession also had minimal effect on its performance.
Source: Company Presentations
KMP is planning to undertake massive acquisitions in the year 2013. The above pie charts show the 2013 growth expenditure forecast for KMP. The company's management realizes the importance of natural gas segment would play in the coming future. Therefore, the largest increase in assets is for the natural gas pipelines segment of the company.
Source: Company Presentations
KMP has spent close to $40 billion to date acquiring midstream assets. This shows that the company wants to maintain its strategy of acquisitions and it will stay as the largest midstream company in the years to come.
With the oil and gas pipeline industry experiencing better revenue figures than before, the recent performance for companies engaged in this industry have been positive.
Source: Yahoo Finance
KMP has two major competitors in the oil and gas pipeline industry that go by the names of Enterprise Products Partners (NYSE:EPD) and Spectra Energy Corp. (NYSE:SE). KMP's P/E ratio is significantly lower than the industrial average signaling possible undervaluation of KMP's shares. The P/S ratio of KMP is also lower than the industrial average signaling a possible undervaluation of KMP's shares. A point of concern is the company's EPS. It is above the industrial average but lower than what its competitors have been reporting. The higher operating margin coupled with the lower EPS points to the higher expenses faced by KMP.
Risk Management - KMP
The companies in the oil and gas pipeline industry manage their risks in a number of ways. KMP uses derivative contracts to hedge or minimize the risks associated with changing prices of commodities. KMP's current forward contracts are valid until December 2016. KMP is able to enter into newer forward contracts that will reduce its risks associated with changing commodity prices. As previously mentioned, diversification into five segments has also helped KMP to mitigate risks associated with focusing on the sales of one or two segments.
The above table depicts some variables that can represent the financial strength of the company. The current ratio of the company is significantly lower than the industrial average and the sector average. This means that the company can run into liquidity problems in the near future. The long-term debt-to-equity ratio for KMP is greater than the industrial average but lower than the sector average. To finance the massive acquisition capital, KMP issued 4.6 Million shares on February 26, 2013. The share issue had to be supplemented with long-term debt undertakings to meet the acquisition budget of the company. This is a possible reason for an increase in the long-term debt-to-equity ratio. With time, we can see a decrease in this figure as the debt is repaid. Incurring massive debt has also lowered the interest coverage for KMP and its recent figure of 4.41 is significantly lower than the industrial and sector average.
Source: Company Presentations
On a bigger picture, KMP has been able to maintain its performance as a result of operating in a defensive industry. KMP has been able to maintain its Return on Investment (ROI) figures in the 12-14% range. The above table also shows that KMP has been able to consistently increase its Return on Equity (ROE) figures over the years. This has resulted in solid dividend yields for the shareholders, averaging 6.6% for the last five years.
The oil and gas pipeline industry has shown steady growth because of its defensive nature. KMP is the largest midstream company that has grown significantly by way of acquisitions and developing new facilities. The shale gas boom has increased the natural gas production in the United States. Companies in the oil and gas sector are eyeing greater exports of natural gas and that would result in greater utilization of assets (pipelines and terminals) of midstream companies. To exploit this opportunity, KMP has recently invested heavily in newer natural gas pipelines. With solid performance in the past, KMP is in a sweet spot to expand its revenues further. I would therefore give the buy stance to investors for a long horizon.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Core Equity Research, Analyst. Core Equity Research is not receiving compensation for it (other than from Seeking Alpha). Core Equity Research has no business relationship with any company whose stock is mentioned in this article.