- Marked deceleration in growth of Adjusted EBDA per unit for the past 3 quarters and TTM ended 3/31/14.
- Coverage ratios based on sustainable DCF are significantly lower than the coverage ratios reported by KMP.
- KMP will require KMI waivers of IDR payments to meet its 2014 distribution.
- Better performance in 1Q14 especially from the Natural Gas Pipelines, but also from Terminals and CO2 .
- Capital expansion program targeted at taking advantage of surge in demand for natural gas.
Kinder Morgan Energy Partners LP (NYSE:KMP) recently reported its results of operations for Q1 2014. This article focuses on some of the key facts and trends revealed by this and prior KMP reports.
Adjusted earnings before depreciation and amortization ("Adjusted EBDA" or "Segment earnings before DD&A and certain items") is one of the important yardsticks used by management to measure its success in maximizing returns to the partners, to evaluate segment performance, and to decide how to allocate resources to KMP's five reportable business segments. Adjusted EBDA for recent quarters and the trailing twelve months ("TTM") ended 3/31/14 and 3/31/13 is presented in Table 1 below:
(click to enlarge) Table 1: Figures in $ Millions (except per unit amounts and % change); Source: company 10-K, 10-Q, 8-K filings and author estimates
Natural Gas Pipelines, the largest contributor to Adjusted EBDA, benefited from contributions from the midstream assets in North Texas and Oklahoma (the May 1, 2013, Copano acquisition), and El Paso Natural Gas ("EPNG"), 50% of which was dropped down in August 2012 and 50% in March 2013. These account for $164 million of the $226 million increase in this segment's Adjusted EBDA from Q1 '13 to Q1 '14. KMP also recorded better performance in Q1 '14 from the Terminals and CO2 business segments.
When each period is compared to the corresponding prior year period in terms of Adjusted EBDA per unit, we see in Table 1 a marked deceleration in growth for the past 3 quarters and for the TTM ended 3/31/14.
Distributable cash flow ("DCF") per unit reported in Q1 '14 and for the TTM ended 3/31/14 is up ~6% from the corresponding prior year periods, as shown in Table 2:
KMP's method of determining DCF is detailed in an article titled Distributable Cash Flow (DCF) that also provides a comparison to definitions used by other MLPs. Based on this method, KMP derives DCF as shown in Table 3. The adjustments made by management to EBDA are referred to as "certain items".
Table 3 indicates the coverage ratio based on reported DCF remains tight in the latest TTM period and highlights the fact that a large portion of KMP's net income and cash flows are claimed by its general partner, Kinder Morgan Inc. (NYSE:KMI). KMP's ability to generate distribution growth is constrained by its obligation to distribute ~48% of every additional DCF dollar to KMI
The generic reasons why DCF as reported by an MLP may differ from what I call sustainable DCF are reviewed in an article titled "Estimating sustainable DCF-why and how". A comparison between KMP's reported and sustainable DCF is presented in Table 4 below:
The principal differences of between sustainable and reported DCF are attributable to working capital and to a host of items grouped under "Other".
Most of the MLPs I follow exclude working capital changes, whether positive or negative, when deriving their reported DCF numbers. I generally do not include working capital generated in the definition of sustainable DCF, but I do deduct working capital invested. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the master limited partnerships should generate enough capital to cover normal working capital needs. On the other hand, cash generated from working capital is not a sustainable source and I therefore ignore it. Table 4 indicates that liquidation of working capital generated a substantial portion ($334 million) of the DCF reported in the TTM ended 3/31/14.
The "Other" item of difference between reported and sustainable DCF incorporates many management adjustments that I ignore in deriving sustainable DCF. These include depreciation, tax deferrals, impairments, and reserve adjustments. In the case of depreciation, for example, KMP adds back its proportionate share of the joint ventures' depreciation, depletion and amortization expenses and subtracts its proportionate share of the joint ventures' sustaining capital expenditures. Encouragingly, the magnitude of these management adjustments seems to be declining in recent periods. This is encouraging
KMP's method of determining DCF differs from most of the non-Kinder Morgan MLPs I follow. As shown in Table 4, KMP deducts the general partner's portion of net income in deriving DCF. It thus adopts a narrow definition, one that includes only that portion of DCF that is attributable to limited partners. The more common and broader definition of coverage is one whose numerator is total DCF (available to both LPs and GP) and whose denominator is the total of all distributions made to all the stakeholders, including the general partner. DCF coverage as computed by KMP is not consistently lesser or greater than it would have been had the broader definition been used. It is just different. Making an apples-to-apples comparison to other MLPs therefore requires adjusting for this factor.
Another adjustment required for sustainable DCF coverage analysis relates to the capital structure of the Kinder Morgan entities. Kinder Morgan Management, LLC (NYSE:KMR) owns approximately 28.1% of KMP in the form of i-units that receive distributions in kind, not in cash (i.e., i-unit holders receive additional KMP units in lieu of cash). In my opinion, in order to make KMP's coverage ratios comparable to other MLPs that do not have the equivalent of i-units, an adjustment is required so that i-units are deemed to have received the same distributions as common units.
Using the broad definition, and adjusting for the i-units, I calculate KMP's DCF coverage ratio as follows:
Table 5 shows that the broadly defined coverage ratios based on sustainable DCF are significantly lower than the coverage ratios reported by KMP (Table 3).
A factor not incorporated into the coverage ratios shown in Tables 3 and 5, but one that must still be borne in mind, is the waiver of KMI's Incentive Distribution Rights ("IDRs"). But for these temporary waivers, less cash would have been available for distribution to limited partners. So far in 2014, KMI waived $30 million of IDR payments related to units issued to finance the May 2013 Copano acquisition and $3 million related to units issued to finance a portion of the January 2014 APT acquisition.
The method used by an MLP to determine into which bucket (expansion vs. sustaining) a capital investment should be placed can have a material impact on DCF and on coverage ratios. There does not appear to be a reliable, consistent, standard and transparent method of making this determination and MLP investors cannot really know whether management inappropriately allocated more than it should have to the expansion bucket, and thus overstated an MLP's DCF and coverage ratio. This note of caution is applicable to all MLPs, not just KMP.
Table 6 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:
Simplified Sources and Uses of Funds
Net cash from operations less maintenance capital expenditures exceeded distributions by $519 million in the TTM ending 3/31/14, and by $412 million in the TTM ending 3/31/13. However, Table 5 and the discussion preceding it explain how, despite these excesses, sustainable CDF coverage is below 1x. While in the periods reviewed KMP did not fund distributions by issuing units or debt, this would not have been achieved but for the impact of the i-units.
Table 7 below provides selected metrics comparing KMP to some of the other MLPs I follow based on the latest TTM results.
As of 05/05/14:
EV / TTM EBITDA
Buckeye Partners (NYSE:BPL)
Boardwalk Pipeline Partners (NYSE:BWP)
El Paso Pipeline Partners (NYSE:EPB)
Enterprise Products Partners (NYSE:EPD)
Energy Transfer Partners (NYSE:ETP)
Kinder Morgan Energy
Magellan Midstream Partners (NYSE:MMP)
Targa Resources Partners (NYSE:NGLS)
Plains All American Pipeline (NYSE:PAA)
Regency Energy Partners (NYSE:RGP)
Suburban Propane Partners (NYSE:SPH)
Williams Partners (NYSE:WPZ)
Table 7: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; EPB and KMP TTM numbers are as of 3/31/14; others as of 12/31/13. Source: company 10-K, 10-Q, 8-K filings and author estimates
It would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table.
KMP's Adjusted EBDA per unit grew ~5% in the TTM ending 3/31/14 and it is investing substantial amounts in capital expansion programs. The 2014 budget of ~$3.9 billion includes small acquisitions and investment contributions, but excludes asset acquisitions from KMI. A significant portion of this amount is allocated to the Natural Gas Pipelines and will position this segment to take advantage of a surge in demand for natural gas such as that seen in Q1 '14. KMP increased its quarterly distribution to $1.38 per unit (from $1.36 in 4Q13 and from $1.30 in Q1 '13). Management's guidance for 2014 is for distributions totaling $5.58 per unit, up 5% from $5.33 in 2013. Long-term debt to LTM EBITDA as of 3/31/14 was a manageable 3.8x.
But the pace of growth of Adjusted EBDA per unit has slowed considerably in the most recent three quarters. Also, KMP's reported distribution coverage is based on cash flows that include items I do not consider sustainable and excludes outflows that would have been required but for KMR holders receiving units in lieu of cash distributions. Finally, KMP will require assistance to meet its 2014 distribution objective in the form of $133 million IDR payments that KMI will waive. KMI will also waive $139 million of IDR payments in 2015 and $116 million in 2016, thereafter decreasing by $5 million per year (the bulk of these amounts are in support of the $5.2 billion Copano acquisition that closed on May 1, 2013).
Investors seeking more rapid distribution growth and/or concerned with KMP's distribution coverage for reasons detailed in this report should look at KMI which, at ~5.1%, yields less than KMP's 7.2% but projects 8% distribution growth in 2014 over 2013 and provides a better alignment of interests with Kinder Morgan's management.