An Earnings Preview For The Natural Gas Sector

Includes: KMI, KMP, KMR
by: Kent Moors

Today, I'm convinced, is the financial media's favorite day of the year. For the next 24 hours, they have something to parrot from one show to the next. That's because Goldman Sachs (NYSE: GS) reported fourth-quarter earnings before the bell this morning, beating the ever-lowering expectations of Wall Street analysts. And we all know how much CNBC loves to talk about these Masters of the Universe and what Goldman's earnings mean for 2012.

An equally important company will report earnings after the bell. But it will receive far less coverage.

Later today, Kinder Morgan (NYSE: KMI), master limited partnership Kinder Morgan Energy Partners (NYSE:KMP), and limited partner Kinder Morgan Management (NYSE: KMR) will all report earnings for the first time since the parent company engaged in the largest energy deal of 2011 – the $37.8 billion KMI-El Paso merger.

And here's the thing: I'm not worried if Kinder Morgan beats earnings estimates or not.

I'm more interested in its general performance. That's because of what Kinder Morgan does and what it represents. This company's recent activities provide a glimpse of the domestic energy picture and the major trends moving forward, particularly in the natural gas markets.

Put simply, we can learn from Kinder Morgan.

The company clearly understands where to put its money in order to profit…

After "the Deal of the Year," What Comes Next?

In October 2011, Kinder Morgan signed a deal to acquire all of the outstanding shares of El Paso. Kinder Morgan agreed to a $38 billion deal, which included the inheritance of about $17 billion of outstanding debt.

Kinder Morgan's financials are now, of course, impacted by a sudden increase in debt. But once this deal closes in 2012, expect the company to make its first move to alleviate this pain. Kinder will keep El Paso's pipeline infrastructure (which is really all they ever wanted from the deal) and sell El Paso's exploration and production (E&P) assets.

The sales proceeds will immediately help reduce the debt.

And what does that suggest?

It means that Kinder Morgan recognizes that the best place to profit in the coming years is in transportation of domestic fuels. By selling the E&P assets and maintaining its focus on its midstream operations, the company is poised to make its best profits… particularly when natural gas prices rise.

Midstream Production Will Remain Hot

Pipeline companies earn revenue by transporting natural gas from the field to the market. These midstream companies have been in huge demand over the past few years as upstream gas drillers develop huge new deposits in Pennsylvania, New York, Utah, and other states.

They make their money by charging transport fees. And over the past few years, these fees have remained almost constant, even though natural gas prices have dropped considerably.

2011 was a record year for merger and acquisition activity in the energy sector. And 2012 will likely be even more lucrative. But the major question is where most of this activity will take place.

As Kent said this month, you have to look to the midstream. As oil prices rise and the diversification of gas usages expands, the position of midstream providers will only become more attractive.

Kinder's acquisition of El Paso was the first of many mega deals that the market expects in the future.

The final reason I am interested in Kinder Morgan's performance today centers on one of the most important leaders in the energy sector today.

Continued Focus on Sound Management

In the mid-1990s, Enron made two critical mistakes that ultimately sparked its demise.

The first was abandoning its bread-and-butter pipeline business in order to focus on short-term alchemy in the energy markets.

The second mistake was denying Richard Kinder the opportunity to become its CEO in 1996, five years before the firm's bankruptcy.

Kinder went on to create a pipeline venture with a college friend named William Morgan (the two bought a natural gas venture from Enron in their first company deal.)

Enron went on to become the greatest corporate scandal in American history.

Today Enron leaders are still in prison, and Kinder Morgan executives are sitting on top of the energy world. I think that says a lot about the importance of sound corporate leadership.

And for investors, I think a company's leadership team is a critical thing to weigh when deciding how best to grow your money.

As Kent said last week, sound management is the most intangible factor that he considers when evaluating potential takeover targets. Kent measures "sound management" in two parts:

  1. The balance between debt and operational coats, and
  2. Revenue generation.

Kinder Morgan is currently sitting on a lot of debt (due to the El Paso deal). But the market and analysts seem confident, and not just because the company is the largest pipeline and storage player out there. There is great confidence in the company's leadership to steer this El Paso deal to profitability.

What's more? Kinder seems confident himself. The CEO receives an annual salary of only $1.

His earnings have come from frequent purchases of his company's stock. Appreciation over the years has made him a billionaire.

And insiders at the company continue to accumulate shares, a welcome sign from many investors.

A Bellwether of Confidence

Today, it's important to understand not just where Kinder Morgan is going, but where the natural gas markets are heading in the future.

Kinder Morgan is a bellwether of investor confidence in the marketplace. The company's activities over the last few years show the growth of the unconventional oil and gas markets, the commitment to the midstream, and the importance of sound management in any sector.

As we've said before, there are big deals on the horizon. All it takes is a little bit of confidence from the markets for the stars to align.

Even if the company is close to expectations and confidence in the company remains even lukewarm, I expect other market leaders to show confidence in boosting their midstream operations.

Disclosure: None