Units of Kinder Morgan Energy Partners (NYSE:KMP) are up over 1.5% after the company reported a strong quarterly report (press release here). While units have struggled over the past 12 months, this quarter reaffirmed the bull thesis that KMP is significantly undervalued with a fantastic and growing distribution. I would remind all readers that this analysis applies to Kinder Morgan Management (NYSE:KMR), which is an LLC that holds units of KMP and automatically reinvests distributions.
To begin with the basics, KMP reported distributable cash flow of $635 million, which was up 28% from last year. Now, KMP has been investing heavily in growth projects. In fact, its 2013 growth cap-ex spend was higher than originally budgeted at $3.5 billion vs. $2.9 billion. To fund these investments, KMP issues both equity and debt, so KMP now has 440 million units outstanding up from 368 million last year. Even with this increase, KMP has proven its growth efforts to be accretive as DCF/unit was up to $1.44 vs. $1.35 last year.
Thanks to strong DCF, KMP has increased its quarterly distribution by a penny to $1.36, a figure the company comfortably covered. Investors should note that KMP tends to more than fully cover its distribution in the 1st and 4th quarters when natural gas volumes are stronger and pay out slightly more than it generates in the 2nd and 3rd quarters. Still for all of 2013, the company paid out $5.33 while it generated $5.39 for a coverage ratio of 1.01x.
Management has also built an expansion project backlog of $13.5 billion, which will drive continued distribution growth through the decade and cumulatively increase the distribution by well over 20% over five years. Given 7% distribution growth in 2013 on the back of expansion projects, investors can feel comfortable that these growth projects will be done in an accretive fashion. In 2014, I expect KMP to spend another $3.5-$4 billion on growth projects with a focus on Canada pipelines and U.S. shale formations.
KMP also confirmed its previously announced 2014 guidance. Management anticipates paying out $5.58 in 2014. I would note that in 2013 KMP was able to distribute $0.05 more than was originally forecasted. I am currently looking for KMP to pay $5.59 in 2014, or $0.01 more than is currently forecasted. At management's forecast, KMP boasts a forward yield of 6.84% based on where units were trading after-hours.
Thanks to drop downs and expansion activities, natural gas pipelines were KMP's leading segment as earnings before DD&A rose $101 million to $662 million and now account for over 40% of the company's earnings. CEO Richard Kinder continues to believes that natural gas will be a leading fuel of the future, and we are already seeing near universal adoption of the fuel for electricity generation (mainly at the expense of coal). Nat gas has gained some share in the auto sector, mostly in California and fleet purchases. I expected continued fleet adoption in 2014 while retail adoption will remain slow. Further, with the U.S. starting nat gas exports, production volume should continue to grow dramatically. KMP is perfectly positioned to profit from wider nat gas usage and has been expanding in growth areas like the Marcellus Shale.
Importantly, investors should be aware that nat gas results could be even better. Pro forma for acquired assets, natural gas volumes were down 5% to 1,414 Tbtu. Cold weather in December helped to slow production, which is a major reason for this decline. Moreover, we are starting to see a recovery in natural gas prices, which will lead to expanded drilling activities. Most international markets price natural gas significantly higher than the United States (often by 100%). As such, exporting nat gas could be extremely lucrative, which will lead to increased volumes on KMP's network. I am looking for a year over year increase in nat gas volumes pro forma for acquisitions of 5% in 2014, which will be a major driver of the company's distribution growth. There are few companies as levered to the natural gas revolution as KMP, which is great for unitholders.
Even though the company is rapidly expanding, KMP is maintaining balance sheet strength. While total debt is up $2.9 billion, total equity is up $4.5 billion. As a consequence, KMP's debt to equity ratio actually fell from 1.34x last year to 1.16x today. In 2014, KMP has the flexibility to issue more debt than equity to avoid diluting existing holders by selling units when the price is too low. Often when a company expands, there is risk it overspends and "invests itself into bankruptcy" by taking on too much debt. Clearly, KMP is not doing this as its balance sheet is stronger than it was one year ago.
Now, some bears like Hedgeye's Kevin Kaiser continue to be unimpressed by the company's results. He notes that sustaining capital expenditures were only up 5% year over year in the quarter to $117 million. For comparison, the company's PP&E was up 23%. From this simplistic comparison, there may be a concern KMP is under-spending on its network. However, maintenance is lumpy one quarter to the next, so a full year comparison is more appropriate. For all of 2013, maintenance cap-ex was $325 million, which is up 15% year over year.
This figure is far closer to the growth in the size of KMP's network, though it is admittedly lower by 8 percentage points. There is a reason for that. KMP is vastly expanding its network, and new pipelines obviously require less maintenance spending than older pipelines, which accounts for the discrepancy. Further, KMP maintains a very strong safety record, which is strong evidence that it properly maintains its network.
Kinder Morgan Energy Partners continues to execute and grow DCF/unit, which will allow the company to continue to grow its distributions. With a current backlog of $13.5 billion and growing natural gas production in the shale formations, KMP will continue to grow its distribution in the 5-7% through the decade. With a strong 6.75% current yield and growing payouts, KMP is my favorite MLP. In the low $80's, I would continue to buy units.
Disclosure: I am long KMP, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.