Kinder Morgan Energy Partners LP (KMP) reported its results of operations for 3Q 2013 on October 16, 2013. This article focuses on some of the key facts and trends revealed by this report. Given the significant quarterly fluctuations in important business parameters, trailing 12 months ("TTM") figures are also reviewed, in addition to the quarterly numbers.
The Tennessee Gas Pipeline ("TGP") and El Paso Natural Gas ("EPNG") dropdowns from Kinder Morgan, Inc. (KMI), KMP's general partner, enhanced revenue growth. These dropdowns are associated with KMI's acquisition of El Paso Corporation completed on May 24, 2012. The midstream assets acquired via Copano Enegy (acquisition completed May 1, 2013) also enhanced growth, as did increased oil production in KMP's CO2 segment and the good results produced by the Products Pipelines and Terminals businesses.
Revenue growth is shown in Table 1 below:
KMP's term for earnings before depreciation and amortization ("EBDA") is "Segment earnings before DD&A and certain items". EBDA is one of the important yardsticks used by management to measure its success in maximizing returns to the partners. It is also regarded as an important internal management tool for the purposes of for evaluating segment performance and deciding how to allocate resources to KMP's five reportable business segments. Segment EBDA is summarized in Table 2 below and shows solid growth in EBDA per unit in the TTM ended 9/30/13:
Table 2: Figures in $ Millions (except per unit amounts and % change)
The above-mentioned dropdowns, acquisitions and performance improvements more than offset the year-over-year negative EBDA impact of having had to divest certain KMP assets in the Rockies in order to obtain regulatory approval of the acquisition of El Paso Corporation.
Natural Gas Pipelines, the largest segment in terms of EBDA contribution, benefited from strong results generated by the Eagle Ford assets, contributions from the midstream assets in North Texas and Oklahoma (the Copano acquisition), and contributions from TPG (dropped down in August 2012) and EPNG (50% dropped down in August 2012 and 50% in March 2013).
General & administrative expenses and interest expenses are deducted from the earnings contributed by all five operating segments. "Certain items" are then added or deducted to derive net income, as shown in Table 3 below:
Table 3: Figures in $ Millions (except per unit amounts and % change)
The principal component of the $503 million gain from "certain items" appearing in Table 3 for the TTM ended 9/30/13 is a $558 million re-measurement of KMP's original 50% interest in the Eagle Ford joint venture to fair market value as a result of the Copano acquisition. Added to that is a $225 million pre-tax gain stemming 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. These are offset by a $177 million addition to legal reserves attributable to an adverse Court of Appeal decision denying an income tax allowance on the Product Pipeline segment's intrastate operations in California. A further offset is due to a $129 million write-down of assets that occurred pursuant to an FTC mandate issued in connection with the approval of El Paso acquisition. Numerous other items account for the balance.
Distributable cash flow ("DCF") per unit in 2Q13 and 3Q13 decreased vs. 1Q13, but that is not surprising as the first and fourth calendar quarters typically produce the strongest results. DCF per unit in 3Q13 is unchanged from the prior year period, but up 6% on a TTM basis, as shown in Table 4 below:
Table 4: Figures in $ Millions (except per unit amounts and % change)
KMP increased its 3Q13 distribution to $1.35 per unit from $1.32 in 2Q13. DCF per unit for these two periods was $1.22 and $1.27, respectively. Therefore, coverage in 2Q13 and 3Q13 is negative.It is typically offset by excess coverage in the stronger first and fourth quarters.
Note that the Kinder Morgan entities calculate DCF (and consequently DCF coverage) differently than some of the other MLPs I cover with respect to the general partner's share of DCF (see article dated June 2, 2013). Specifically, KMP reports 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).
Another notable caveat to KMP's reported DCF coverage ratio is discussed in a prior article dated August 5, 2013 in which I explain why I believe the KMP's capital structure, specifically the large position (~28%) held by Kinder Morgan Management, LLC (KMR) in the form of i-units that receive distributions in-kind distributions, causes the coverage ratio to be overstated.
After KMP files its third quarter report on Form 10-Q I will provide a comparison of the ratios produced by these two methods, as well as an assessment of the impact of KMR's i-units and of the sustainability of DCF for 3Q13 and the TTM ended 9/30/13.
In the meantime, I look at another cash flow indicator, one that is less susceptible than DCF to subjective interpretations, to help assess KMP's cash generation capability. Operating income, plus depreciation, less interest expense, less maintenance capital expenditures is shown in Table 5 below:
Table 5: Figures in $ Millions (except per unit amounts and % change)
The 6% increase in DCF per unit for the TTM ended 9/30/13 over the prior year period is accompanied by a 10% increase in a cash flow indicator that is less susceptible to subjective interpretations. This gives me some reason for optimism regarding the DCF sustainability.
Table 6 below adds TTM numbers to KMP's October 16 press release that provides a reconciliation of net income to reported DCF for 3Q13 and 3Q12:
Table 6: Figures in $ Millions, except per unit amounts
Table 6 reflects KMP's method of determining DCF. This method is detailed in an article titled Distributable Cash Flow (DCF). This article also provides a comparison to definitions used by other MLPs. I find this method of deriving DCF (referred to as "DCF before certain items") complex. It also differs considerably from the method used by other MLPs I cover.
The issue of the adequacy of maintenance capital expenditures came up yet again at the conference call discussing 3Q13 results. Management provided a detailed analysis of GAAP operations & maintenance expenses for the major El Paso pipelines (TGP, EPNG, CIG and SNG) in further response to the allegation that they were underfunded following their acquisition by KMI. Indeed, the level of these expenditures in 2013 is ~$191 million less than it was in 2011. Management reviewed virtually all the line items comprising this drop. A line item of particular note was expenditures on pipeline integrity. These actually increased by $63 million in 2013 vs. 2011. As noted in a prior article, I realize pipeline safety is a significant risk factor but don't know of any metric available to the public that would reliably indicate the sufficiency or insufficiency of these maintenance capital expenditures. I see no indication of a reason to distrust management on its commitment to safe operations.
Table 7 below compares KMP's current yield to some of the other MLPs I follow:
As of 10/20/13:
Magellan Midstream Partners (MMP)
Enterprise Products Partners (EPD)
Plains All American Pipeline (PAA)
Targa Resources Partners (NGLS)
El Paso Pipeline Partners (EPB)
Buckeye Partners (BPL)
Kinder Morgan Energy Partners
Williams Partners (WPZ)
Energy Transfer Partners (ETP)
Boardwalk Pipeline Partners (BWP)
Regency Energy Partners (RGP)
Suburban Propane Partners (SPH)
KMP increased its quarterly distribution to $1.35 per unit (from $1.32 in 2Q13 and up 7% from $1.26 in 3Q12). Distributions for the TTM ending 9/30/13 are up ~8.4%. Management projects distributions in 2013 will total $5.33 per unit, up 7% from the $4.98 per unit in 2012. The long-term debt to LTM EBITDA as of 9/30/13, as calculated by management, was a manageable 3.9x. Investors seeking more rapid distribution growth and/or concerned with KMP's distribution coverage for reasons detailed in a prior report should look at KMI which yields ~4.6% but has increased its 2013 projection of distribution growth to 14% over 2012.