It's not much of a challenge for an investor to rattle off positive attributes inherent in the Kinder Morgan entities these days. It seems like every article I read boasts dividend history and new projects coming online. Admittedly I myself recently reccommended Kinder Morgan Inc (KMI) as a great way to play Kinder Morgan Energy Partners LP (KMP) and El Paso Pipeline Partners LP (EPB) simultaneously. In case you're new to MLPs or instead have been living in a cave for the past several years and are unaware of Kinder Morgan Inc., here is a quick refresher of the positives of owning KMI you should be aware of:
- 3rd largest energy company in N. America with EV of $105 B.
- Largest Nat. Gas Network in U.S. with 70 K miles of pipeline.
- Largest independent transporter of petroleum products in U.S., with ~1.9 MMBbl/d estimated for 2013.
- Largest transporter of CO2 in U.S. estimated for 2013.
- Largest independent terminal operator in U.S., with interest in or operator of ~180 terminals. These assets have ~112 MMBbls of liquids capacity and can handle ~106 MMtons of dry bulk products.
- Chairman and CEO Richard Kinder receives a salary of $1/year, no bonuses, and no stock options. Instead, he owns 24% of KMI. (this is one reason why I prefer this Kinder entity).
- GP IDR ownership of both KMP and EPB.
- Fastest increasing dividend in the complex.
Now that we've covered the obvious yet again, maybe we should examine some of the possible headwinds each Kinder Morgan entity could be faced with in the near future. After all, that's what due diligence is all about; weighing the negatives against the positives to conclude if the downside is more likely and/or worse than the upside. Also, researching a company's weaknesses can help you make better investment decisions, namely when to sell or when to add to a position.
Risks to EPB:
EPB is overwhelmingly comprised of natural gas pipelines. 89% of these pipes are interstate lines and have an average contract life of ~7 years. EPB has minimal commodity price risk since 100% of cash flow is fee-based, which could leave investors disappointed if the price of natural gas price increases radically in the future. However, this immunity is also a simultaneous strength, as the company has a highly stable income stream. Overall EPB is the least diversified of the Kinder entities and the most exposed to natural gas volumes, while being the least exposed to commodity prices. EPB's debt is 100% fixed rate, which is a huge strength considering the looming interest rate increases. This strength probably counteracts a less diversified asset base.
Risks to KMP/KMR:
75% of KMP's 2013 cash flow is fee-based, while another 15% is hedged. This leaves the remaining 10% of cash flow exposed to commodity pricing and therefore higher risk. According to KMP's recent presentation, KMP's 2013 DCF sensitivity is ~$5.9 M per $1Bbl change in crude price. This means oil would have to fall significantly for a long period of time to have profound effect on DCF.
Kinder Morgan calculated each $1Bbl = .1% of KMP EBDA, but DCF doesn't really stem from earnings, so let's do another calculation. KMP's DCF for Q2 2013 was $505 M. This means that for every $1 change in oil price, DCF is either improved or hurt by roughly 1% by this metric. This makes commodity price exposure seem much more significant to DCF than first impressions of KMP's "EBDA" calculation. Obviously, this possible weakness could be viewed as a simultaneous positive considering oil has hovered over $100/barrel for quite some time.
Perhaps the most profound risk to KMP is its debt load. KMP's 70% fixed rate debt seems less than stellar after EPB's 100% fixed rate status, but overall it shouldn't be alarming. As of 6/30/13, $5.4 B of KMP's total $18.6 B in net debt had a floating rate. By Kinder Morgan's calculation, the impact of a 100-bp increase in interest rates for 1 year would equate to a $54 M increase in interest expenses. By some measures this is not a drop in the bucket, especially when considering KMP's net interest expense for the first 6 months of 2013 was $413 M. Assuming a full year expense cost would be $826 M, an increase in interest rates by a full 1 percentage point would cause a 6.5% increase in interest expenses.
However, considering KMP's interest expense was ~7% of revenues for Q2 2013, KMP would not be meaningfully harmed by such an increase. Nonetheless, KMP is certainly not as immune to interest rate increase going forward. What if rates increased 200 bp? 300 bp? Also, a less attractive debt market means KMP would have a less appealing source of capital; a necessary source of expansions and large acquisitions for an MLP like KMP, as I explained in a past article.
For those still not familiar with KMR or who are wondering why I lumped KMR with KMP, I did so because KMR is essentially KMP. KMP's distribution is essentially equal to KMR's, since KMR owns units of KMP.
Risks to KMI:
KMI has many of the same risks of KMP, since it owns directly and indirectly approximately 13% of KMP, including the general partner. From KMP's 2012 10-k, KMI received approximately 51% of KMP's quarterly distributions of available cash. Some of the KMP risk is partially offset by KMI's 41% limited partner interest and 2% general partner interest in EPB, which in my view is the most stable Kinder entity assuming natural gas volumes stay steady in EPB's relatively un-diversified asset base.
KMI has the most debt of all the entities. At 5.0x 2013 debt/EBITDA, KMI has 30% more debt than KMP's 2013 debt/EBITDA of 3.8x, and EPB's 3.9x. In addition, 60% of KMI's net debt is fixed rate, which is lower than KMP. Perhaps to counteract this difference, KMI's cash flow for 2013 is 80% fee-based, versus KMP's 75%, a boost mostly attributable to KMI's ownership in EPB, as well as some of KMI's retained assets it plans on dropping down in the near future.
Overall, the Kinder Morgan entities have some weaknesses, but compared to the strengths, they should be of little concern to investors. Even if interest rates quickly rise while commodity prices fall, KMI should weather this "perfect storm" better than most MLPs, if not all of them. However, I would not expect these companies to excel if interest rates radically elevate quickly. Then again, I can't think of many energy related companies that would!
To this day I still find Kinder Morgan the most appealing MLP network due do its size and diversification in both region and commodity type, as well as resiliency to risk due to fixed rate debt and limited commodity price exposure.
KMI: The Glass is Still Half-Full:
It's still my opinion KMI is the most attractive Kinder Morgan entity, and not just because KMI owns the GP IDRs of both KMP and EPB. Rather, I believe KMI's very intention of existence is to capitalize on the success of the KMP and EPB entities at a faster rate than these entities themselves. It's tough to sell this to some investors given KMI's higher risk profile than KMP and EPB as well since KMI has the lowest yield of the three.
Perhaps the most meaningful "tell" of which entity is the most advantageous is upon realizing Richard Kinder owns 24% of KMI as a whole, or roughly $8 B worth, which is 160x more than his ~$50 M combined stake in KMP/KMR/EPB. Because of this, some view KMI as KMP's/EPB's leeching GP, but in some ways KMI deserves the IDRs it receives. KMI does have the highest debt load, and the highest exposure by proportion to interest rate increases. Thus, I would view KMI as the riskiest of the three entities. However, the rewards definitely outweigh the risks. I still view KMI as the best Kinder name to own for my portfolio. I am long KMI via stock and January $35 strike calls.
Additional disclosure: I am long KMI via shares & Jan '14 calls