"I'm The Guy That Does His Job. You Must Be The Other Guy."
For a time, that was the sentence which graced the front of Hedgeye analyst Kevin Kaiser's Twitter account. Hedgeye was a virtually unknown research firm until it very vociferously attacked the largest upstream MLP with the help of a major financial publication. After knocking the price of its shares down, even the SEC began an informal investigation on this partnership.
A big reason for Hedgeye's success in knocking the share price down was that many investors in this partnership were retail investors; people who are easily scared and sometimes don't "do their homework."
With brand new media attention and a social media soapbox, Kaiser and Hedgeye set its sites on Kinder Morgan Partners (NYSE:KMI) (NYSE:KMP). With significant buildup on Twitter, Kaiser finally released his report in which he called Kinder Morgan a "house of cards."
The main thrust of Kaiser's piece is that the partnership starves its pipelines of the maintenance it needs to reduce maintenance expenditure, an important part of the partnership's Distributable Cash Flow numbers. Once the pipeline comes into disrepair, the report alleged, Kinder Morgan just replaces the whole pipeline, thus classifying the expense as "growth capex," which does not subtract from Distributable Cash Flow.
But on September 17th Rich Kinder, CEO and co-founder of Kinder Morgan, called a special session where he went above and beyond necessary disclosure requirements. Kinder went over maintenance spending item-for-item, accounting for and explaining maintenance variances for KMI subsidiary El Paso Pipeline Partners (NYSE:EPB) between 2011 and 2013. This level of granularity was above and beyond what was required. And personally, I was not the least bit surprised.
The purpose of this article is not to bash Kevin Kaiser or refute his report. In fact, I've only read a summary of it. And while I will explain and cover the numbers Rich Kinder went over in the meeting, that isn't the central theme of my article, either.
Although I recognize the spending numbers as important, this exchange between Kinder Morgan and Hedgeye reveal a more important aspect about investing often overlooked; evaluating and placing trust in the people running a company.
No Frills Management
Personally, I decided to invest in Kinder Morgan on December 2008. I was 25, sitting in my '02 Cavalier on lunch break in the Wendy's parking lot with a printout of the 10K in my hand.
No, I didn't fully understand the partnership. I just didn't have the time to. But, I was impressed by a couple things: Kinder gave himself a salary of $1. When on road shows, I would notice management rarely staying at the luxurious hotels where the event would be held. "It's the shareholder's money" Kinder would often say, "not ours." If I ever managed a company, I might do it the same way.
So I partially based my investing decision on little hints like that. And I'm not ashamed to admit it, because I made the right choice then and there.
No Stone Unturned
I wasn't at all surprised that Rich Kinder came on to personally address some of Hedgeye's claims, particularly the claim that the partnership was under-maintaining El Paso Pipeline's assets to maximise Distributable Cash Flow.
In 2011, El Paso Pipelines allocated $499 million to maintenance capital expenditures (capex). In 2013, under Kinder Morgan, El Paso received only $132 million for the same pipeline system.
On this conference call, Kinder got into the nitty gritty of that $367 million "maintenance capex" difference. Here is what it consisted of:
- At the time, El Paso was spending $41 million on launchers and receivers, items which go through the pipeline system for calibration and related things. Kinder Morgan only spends $16 million on that. The difference is $25 million.
- In 2011 El Paso spent $40 million on anomaly repairs compared to $5.3 million in 2013. However, this year Kinder Morgan will spend $96.8 million on "Operations and Maintenance," which is instead an operational expense. This brings El Paso's 2013 total to over $100 million. Considering how much Kinder Morgan is spending on maintenance as an operational expense, Kinder questioned the usefulness of the "maintenance capex" number.
- El Paso's IT spending declined by $36 million in the last two years. The savings come from a smaller, leaner IT shop with Kinder Morgan. This brings the total savings (items 1 and 3) to $61 million.
- Kinder Morgan retired El Paso's "Foresight" project, which provided a means of automated monitoring for all pipelines. KMI already had the technology in place. This resulted in savings of $24 million. Bringing the grand total to $85 million.
- Kinder Morgan saved another $30 million on machines and equipment maintenance. At Kinder Morgan, vehicles run until 160,000 miles. Apparently it was less at El Paso. None of this has anything to do with pipelines. This brings the total cost savings to $115 million.
- Finally, pipeline retirements and reimbursement (due to government eminent domain) expenses were $37 million in 2011 but didn't exist in 2013. This will, of course, vary from year-to-year. That brings the total cost savings to $152 million.
So there you have it. Nearly half of the decrease came from efficiency gains and cost savings. But not only that, $160 million of El Paso's $499 million was spent on a Florida pipeline which Kinder Morgan doesn't even operate anymore. Oops. When we add that $160 million, we can see that most of the $367 million variance will have no impact on how the pipelines are maintained.
Kinder Did His Homework
There were a few other points made on this call, but you get idea. For his part, Kinder stated that it is the partnership's job to minimize costs because of how competitive the landscape is. They've done a good job at that, no doubt.
Yet, at the same time, they have managed their infrastructure just fine. New pipeline being replaced in Arizona, for example, will have significantly more capacity. The big difference between El Paso in 2011 and Kinder Morgan was that Kinder Morgan replaced and performed maintenance as per its diagnostics, not simply hours run. At the end of the day, investors have to trust that Kinder and company, with all their experience and expertise, know better when and how to maintain pipes than does an analyst who has probably never even seen a launcher or recieiver.
Compiling all the above numbers took "hundreds of man-hours," all due to Hedgeye's report. This wasn't a legal necessity on Kinder Morgan's part, either. In fact, I've rarely seen companies "open the books" in such detail and cost.
As investors we like to boil everything down to numbers, but sometimes investing is as much about people and judgment of character as it is raw statistics. This is one of those cases. Yes, it is important to understand the specifics of how Kinder Morgan operates. That way, when moments like these come, the intelligent investor will know better. But for those who don't have the time to "do the job," we simply have to trust management.
While I've gotten more sophisticated since the day I first bought KMP units, there are still times I don't fully understand Kinder Morgan, especially with KMI added to the mix. But I do trust that Rich Kinder is ultimately going to look out for shareholders and do the right thing. Last week, Kinder and company affirmed my judgment yet again.