Today, Hedgeye's energy analyst Kevin Kaiser took a hatchet to Kinder Morgan Energy Partners (KMP) and all related entities as nothing more than a "house of cards." Hedgeye has aggressively targeted MLPs so far this year, though it has yet to prove any wrongdoing or other problems inherent in the model. Alongside Barron's, it has slammed Linn Energy (LINE) by attacking its accounting practices related to hedges, though the results of an informal SEC inquiry remain forthcoming. I personally believe Linn will emerge legally unscathed. On KMP, I believe Mr. Kaiser is dead wrong and would use this sell-off as an opportunity to build a position in America's pre-eminent pipeline company.
At the end of the day, there is a simple question that will determine the value of every MLP: can they afford to maintain and grow their distribution? KMP clearly can. Over the past four years, the firm has generated $10.58 billion in operation cash flows while only paying $8.296 billion in dividends. That provides the firm with substantial downside cushion. In other words, dividends accounted for only 78.4% of cash flow, giving the firm a $500 million annual cushion for maintenance capital expenditures while new shares and debt offerings can fund accretive acquisitions.
Equally importantly, the company has cautiously increased its distribution to guarantee its sustainability. Operating cash flow was up 11% year over year, but the firm only increased the distribution by 6%. If the company were growing its dividend by more than its cash flows, I would agree that is a red flag. KMP is not doing that.
At the same time, KMP has been de-risking its balance sheet. At the end of 2011, equity accounted for only 33% of the firm's capitalization, leading to debt to equity ratio of 2.0. At the end of last quarter, equity accounted for 40% of the firm's capitalization, cutting debt to equity to 1.5. This less-leveraged structure will allow the firm to grow its dividend while giving it the flexibility to make acquisitions where they make sense. The idea that KMP is an overly levered firm is simply untrue. It has $16 billion in equity (half of which is tangible) and has been cutting leverage. Thanks to the long-term contracts pipeline users sign, the company has high cash flow visibility, which makes the current leverage ratio more than sustainable.
There are also concerns raised about its CO2 business, which are wildly overblown because the business is becoming less and less important. In 2010, it generated 30% of the firm's EBITDA, but thanks to the growth of its pipeline business, that figure will account for less than 15% by 2015 before falling all the way to 10% by 2020. Gas and oil pipelines are the driver of the distribution.
The most important fact is that KMP is in a wildly growing business. The U.S. is on the precipice of an economic revolution that will parallel the personal computer revolution thanks to fracking and shale gas. The U.S. has the capacity to be energy independent within 5-7 years and could be a major energy exporter within a decade. The massive increase in land-locked production requires pipelines. KMP is a like a major toll road, and car volume is poised to grow dramatically for years. That is a business you want to own. Thanks to the energy revolution, I believe KMP can easily increase its dividend by 7% annually through 2020, bringing its distribution beyond $8.50. At current prices, the stock is a steal with a fantastic (and growing) 6.7% yield. I'm adding to my holding and urge you to as well. This selling is wrongheaded and will be reversed. KMP is a strong company poised for years of growth.