The financial publication's Feb. 22 cover story, Kinder Morgan: Trouble in the Pipelines?, rehashed Hedgeye Risk Management's bearish case against the stock from late last year.
My colleague Elliott Gue and I addressed Hedgeye Risk Management's criticism of Kinder Morgan Inc. and Kinder Morgan Energy Partners in a series of articles that responded various aspects of the publicity-seeking newsletter publisher's claims that the companies are "a house of cards on the verge of collapse":
- Kinder Morgan Energy Partners LP: Not a House of Cards addressed criticisms of how the master limited partnership defines and accounts for maintenance capital expenditures in its carbon dioxide segment; and
- Kinder Morgan Energy Partners LP: Reality vs Hyperbole examined the relationship between Kinder Morgan Inc. and Kinder Morgan Energy Partners, and highlighted the general partner's long history of supporting the limited partner by waiving its incentive distribution rights.
Nothing has changed since we first responded to Hedgeye Risk Management's argument-except that these views appeared in Barron's, a publication widely read by the retail investors that make up much of Kinder Morgan Energy Partners' investor base.
Before we delve into the article itself, let's first consider the context.
The journalist who penned the hit piece, Andrew Bary, is the same writer who regurgitated Hedgeye Risk Management's slander of Linn Energy LLC (NSDQ: LINE) in a series of articles.
Why would Barron's publish a one-sided attack piece on Kinder Morgan Energy Partners?
Consider the publisher's perspective: It doesn't matter whether Hedgeye Risk Management is right or wrong about the stock; Barron's merely reports the "news" and racks up the page views.
Hedgeye Risk Management's choice of targets speaks volumes about their motivations. Linn Energy is the largest upstream MLP by market capitalization, while Kinder Morgan Energy Partners is the second-largest publicly traded partnership; attacking these names will garner a lot of attention.
One has to ask why Hedgeye Risk Management hasn't focused on marginal MLPs that actually are at risk of cutting their distributions.
Timing is another important element. This week's attack comes on the heels of Boardwalk Pipeline Partners LP (NYSE: BWP) slashing its distribution by 81.2 percent, an announcement that saw the MLP's units lose half their value.
After this news, investors were particularly open to suggestions that there's something rotten in MLP land.
Although Hedgeye Risk Management's bearish arguments against Kinder Morgan Energy Partners failed to gain currency last fall, the Barron's article gave these views a wider platform and shook out weaker hands.
The recent selloff is frustrating for anyone who owns Kinder Morgan Energy Partners, including founder and CEO Richard Kinder. The silver lining is investors again have an opportunity to buy a great company on the cheap.
Barron's ability to move markets demonstrates yet again how many investors reflexively give more credence to bear arguments than to bullish ones. But just as not every long-term investor is a Warren Buffett, only a tiny fraction of short sellers have the acumen of Jim Chanos.
Hedgeye Risk Management followed the same playbook with its coordinated attack on Linn Energy, sending the upstream operator's unit price plummeting lower.
However, the stock rallied significantly after the partnership closed its takeover of Berry Petroleum; many short sellers who piled on at Hedgeye Risk Management's urging had their heads handed to them.
And there could be more pain to come for the shorts. The recent recovery in the price of natural gas liquids (NGL)-the real reason behind Linn Energy's poor quarterly results-should likewise provide a boost to the partnership's fourth- and first-quarter results, though this tailwind will dissipate in subsequent quarters.
Units of Kinder Morgan Energy Partners finished last year roughly flat, reflecting the MLP's reversion to normalized distribution increases of 5 percent to 6 percent after drop-down transactions of the former El Paso Corp's assets had temporarily juiced its growth rate.
Kinder Morgan Energy Partners isn't "a house of cards on the verge of collapse," nor is the widely held partnership another Boardwalk Pipeline Partners.
Loews Corp (NYSE: L), Boardwalk Pipeline Partners' general partner, sat on its hands while the term remaining on contracts covering the MLP's natural-gas storage and long-haul pipeline assets slowly ticked down.
With the exception of last year's proposed joint venture with Williams Companies (NYSE: WMB) to transport NGLs from the Utica Shale to the Gulf Coast, Boardwalk Pipeline Partners and its general partner did little to address the ticking time bomb.
Loews' hands-off approach has also created similar headwinds for Diamond Offshore Drilling (NYSE: DO), a contract driller saddled with an older fleet that will struggle to renew many of its contracts at favorable day-rates.
Kinder Morgan Inc. and Kinder Morgan Energy Partners, however, have created significant value for shareholders by building a diversified portfolio of energy-related assets through acquisitions and organic growth projects.
Natural-gas pipelines last year accounted for about 58 percent of Kinder Morgan Energy Partners' revenue, but the partnership has moved aggressively to limit its exposure to long-haul pipelines that present the greatest re-contracting risk.
To this end, Kinder Morgan Inc.'s acquisition of El Paso Corp proved a master stroke.
To gain regulatory approval for the deal, Kinder Morgan Energy Partners divested its 50 percent interest in the Rockies Express pipeline, which transported natural gas from Wyoming and Colorado to Ohio.
The emergence of the Marcellus Shale had severely curtailed demand for this service, significantly increasing the risk that expiring contracts would be renewed at drastically lower rates-if at all.
Kinder Morgan Energy Partners' subsequent acquisition of pipelines formerly owned by El Paso drove distribution growth and effectively replaced this liability with pipelines that afford the partnership ample opportunity for organic growth.
The Tennessee Gas Pipeline (TGP), which boasts an average weighted contract life of six years and seven months, delivers natural gas to customers in the Northeast and to the Gulf Coast.
The pipeline gives Kinder Morgan Energy Partners a number of expansion opportunities to ship inexpensive natural gas from the Marcellus Shale to customers in the Northeast.
Meanwhile, TGP also provides producers in the Marcellus Shale with access to the Gulf Coast, a service that will become increasingly important as export projects in the region ramp up over the next five years.
Kinder Morgan Energy Partners' El Paso Natural Gas system averaged throughput of 7,082 million British thermal units per day in 2013 and stands to benefit from population growth in the southwest and a push to replace crude oil with inexpensive US natural gas in northern Mexico. Management estimates this opportunity set at 2.1 billion cubic feet per day.
Limited Re-contracting Risk
Whereas Boardwalk Pipeline Partners generated almost all of its cash flow from natural-gas pipelines and storage capacity, these assets accounted for 58 percent of Kinder Morgan Energy Partners' total revenue.
More important, Kinder Morgan Energy Partners in 2015 and 2016 faces contract renewals equivalent to 1.6 percent or less of the annual cash flow generated by its natural-gas pipeline segment.
And Kinder Morgan Energy Partners' natural-gas pipelines that have an average weighted contract life of four years or less represent only 1.7 percent of system throughput.
Although Boardwalk Pipeline Partners didn't provide this level of disclosure in its filings, management estimated that the partnership last year had about $40 million at risk on $125 million worth of expiring contracts. More recently, the MLP forecast that distributable cash flow would decline by $158.6 million this year to about $400 million.
Boardwalk Pipeline Partners last year managed to post a better distribution coverage ratio than Kinder Morgan Energy Partners, providing a cautionary tale about relying too much on this metric.
Understanding bigger-picture trends and the risk embedded in the underlying business provides much more insight into an MLP's prospects.
Looking for chinks in Kinder Morgan Energy Partners' armor, the MLP's carbon dioxide division (about 35 percent of 2013 distributable cash flow) entails some risk because of its exposure to commodity prices through 1,313 net producing wells in the Permian Basin.
In this business line, the MLP and its partners inject carbon dioxide into mature fields to increase reservoir pressure and enhance oil production.
The MLP has hedged about 71 percent of its anticipated crude-oil production in 2014; however, this proportion drops to 50 percent in 2015, 34 percent in 2015 and 17 percent in 2016.
Moreover, with the crude-oil futures curve in backwardation-where future deliveries trade at lower prices than the current market-new hedges likely will be at lower prices.
Although these trends represent a headwind for Kinder Morgan Energy Partners, these developments shouldn't jeopardize the MLP's distribution.
Anticipated production growth will help to offset some of this weakness, while the MLP's diversified portfolio and organic growth opportunities should offset this headwind.
And investors shouldn't discount the value of a supportive general partner. Kinder Morgan Inc. repeatedly has waived a portion of its incentive distribution rights (IDR) to support acquisitions and organic growth projects at Kinder Morgan Energy Partners.
For example, to help pay for Kinder Morgan Energy Partners' $5 billion acquisition of Copano Energy LLC, Kinder Morgan Inc agreed to forego more than $60 million worth of IDR fees in 2013, $120 million in 2014 and $2015, and $110 million in 2016. Thereafter, these waivers decline by $5 million each year. Likewise, the general partner voluntarily relinquished $11 million worth of incentive distributions in 2010, $28 million in 2011 and $27 million in 2012 to support the acquisition of KinderHawk Field Services.
And in 2010 the general partner refused about $170 million in IDR payments that stemmed from capital transactions rather than cash flow from operations.
This long history of waiving IDR obligations to support Kinder Morgan Energy Partners' growth suggests that Kinder Morgan Inc would move aggressively if the limited partner's distribution coverage were called into question or threatened.
One potential step would be to reset the target levels on the MLP's IDR schedule. Such a move wouldn't be unprecedented in the MLP universe: Enterprise Products Partners LP's (NYSE: EPD) former general partner in 2002 reduced the top-tier split to 25 percent from 50 percent. The MLP didn't pay anything to its general partner for this relief.
Even a relatively modest reduction in Kinder Morgan Inc's IDR take would save Kinder Morgan Energy Partners significant sums. Consider that the $120 million worth of IDR obligations that the general partner waived for 2014 amounts to $0.39 per LP unit outstanding.
Such a move would quickly alleviate concerns about the Kinder Morgan Energy Partners' ability to grow its distribution and kick the legs out from underneath any short sellers who have followed Hedgeye's advice.
Barring a major acquisition that accelerates distribution growth and energizes the investor base, price appreciation may be hard to come by this year. However, Kinder Morgan Energy Partners' distribution appears safe, and, contrary to certain sensationalist claims, the partnership isn't on the verge of collapse.
Learn more about our favorite energy-related MLPs in Two Under-the-Radar Master Limited Partnerships.