Preliminary Review Of Kinder Morgan's Results For 4Q 2015

| About: Kinder Morgan, (KMI)

Summary

Measured in absolute dollar terms, 4Q15 Adjusted EBITDA is roughly unchanged from 4Q14 despite highly unfavorable market conditions, but on a per share basis there was a 34% decline.

Large goodwill impairment charges ($1,150 million) and losses on sale of assets and project delays ($284 million) were the principal drivers of the $609 million loss in 4Q15.

Declines in 4Q15 DCF (-3.5% in absolute dollar terms and -8.3% on a per share) vs. 4Q14 are modest given the headwinds faced.

KMI is now on a much more solid footing; quarter to prior-year quarter EBITDA comparisons should begin to look better in 1Q16; still high leverage level will likely be reduced.

This article focuses on some of the key facts and trends revealed by Kinder Morgan Inc. (NYSE:KMI) results for 4Q 2015. This is KMI's fifth quarterly report after the merger transactions that resulted in payment of a single dividend to all KMI shareholders, in lieu of distributions to the former limited partners in Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB). Data presented below for quarters prior to 4Q14 reflect consolidated results for KMI, while data for 4Q14 and subsequent quarters reflect the merger transactions.

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 shareholders, to evaluate segment performance, and to decide how to allocate resources to KMI's five reportable business segments. Adjusted EBDA over the past 8 calendar quarters is shown in Table 1 below:

Click to enlargeTable 1: Figures in $ Millions (except per share amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.

Adjusted EBDA generated by Natural Gas Pipelines, the largest segment in terms of EBDA contribution, was up 3.9% in 4Q15 vs. 4Q14, while the Products Pipelines segment increased 28.4% and the Terminals segment decreased 7.2% (mostly due to weakness in steel and coal and the bankruptcy of two coal customers). Adjusted EBDA at the CO2 segment declined 20.9% vs. 4Q14 and continues to drag down overall results. This segment's business includes: a) production, transportation and marketing of CO2 for use as a flooding medium enabling increased production in mature oil fields; b) interests in and/or operation of oil fields and gas processing plants in West Texas; and c) ownership and operation of a crude oil pipeline system in West Texas.

Measured in absolute terms, 4Q15 total Adjusted EBITDA is roughly unchanged from 4Q14 despite highly unfavorable market conditions. But, as shown in Table 1, the number of KMI shares outstanding increased significantly after 4Q14 following the previously mentioned 4Q14 merger transaction. The large increase in the denominator is the principal reason for the 34% decline in Adjusted EBDA per share in 4Q15 vs. 4Q14. Quarter to prior-year quarter comparisons should begin to look better in 1Q16.

To derive net income we deduct from Total Adjusted EBDA depreciation, depletion and amortization ("DD&A"), general & administrative ("G&A") expenses, interest expenses, taxes, non-controlling interests' share of net income, and reverse adjustments made by management (referred to as "certain items"):

Click to enlarge Table 2: Figures in $ Millions (except per share amounts). Source: company 10-Q, 10-K, 8-K filings and author estimates.

"Certain items", the largest contributor to the $609 million loss in 4Q15, are an aggregation of various adjustments detailed in Table 3 below:

Click to enlarge

Table 3: Figures in $ Millions (except per share amounts). Source: company 10-Q, 10-K, 8-K filings and author estimates.

KMI adds back to net income the items in Table 3 (i.e., adds the negative values and subtracts the positive values) in deriving Distributable Cash Flow ("DCF"). The $1,434 million of asset impairments in 4Q15 included a non-cash pre-tax charge of $1,150 million triggered by a fair value adjustment of the Natural Gas Pipelines assets and by other charges totaling $284 million for losses on asset sales and for impairments and the indefinite delay of certain projects in the CO2 segment (a $387 million impairment charge taken in 3Q15 was also related to asset impairments in that segment).

"Certain items" also reflect the subtraction of book taxes totaling $156 million (over and above the 4Q15 tax provision of $237 million) and the subtraction of $193 million of other items. The major portion of these other items is $200 million of revenues received due to an early termination of a contract.

Table 4 indicates that, in addition to the "certain items" in Table 3, KMI made further adjustments for purposes of DCF:

Click to enlarge Table 4: Figures in $ Millions (except per unit amounts. Source: company 10-Q, 10-K, 8-K filings and author estimates.

DCF is one of the primary measures typically used by a midstream energy master limited partnership ("MLP") to evaluate its operating results. Though not structured as an MLP, KMI's business and operations make it comparable to MLPs and DCF management believes it is KMI's best indicator of performance (as is the case for most MLPs). Because there is no standard definition of DCF, each MLP (or company in the case of KMI) can derive this metric as it sees fit: and because the definitions used indeed vary considerably, it is exceedingly difficult to compare across entities using this metric. Additionally, because the DCF definitions are usually complex, and because some of the items they typically include are non-sustainable, it is important (albeit quite difficult) to qualitatively assess DCF numbers reported by MLPs. I will attempt such qualitative assessment of KMI's DCF once it provides additional data as part of its Form 10-Q.

KMI underestimated the impact of commodity price changes on its results. Their negative impact on DCF over the past 4 quarters exceeded the $264 million predicted by KMI's sensitivity model by ~$137 million. But lower interest expenses and cost savings helped offset this. Overall, I view the declines in 4Q15 DCF vs. 4Q14 (-3.5% in absolute dollar terms and -8.3% on a per share) as modest in light of the highly unfavorable market conditions. The 4x increase in DCF coverage in 4Q15 shown in Table 4 is largely due to distributions being cut to approximately a quarter of their prior level. At this reduced level, distribution coverage becomes less meaningful.

As noted, KMI 's business and operations make it comparable to midstream energy MLPs. Table 5 provides selected metrics of KMI and the MLPs I follow based on the latest available TTM results.

As of 1/22/16:

Price

Current Yield

TTM

EBITDA

EV / TTM EBITDA

IDR- Adjusted EV/

EBITDA

LT Debt to TTM

EBITDA

1-Year

Total

Return

Buckeye Partners (NYSE:BPL)

$56.04

8.39%

847

12.8

12.8

4.3

-20.44%

Boardwalk Pipeline Partners (NYSE:BWP)

$10.52

3.80%

692

8.8

8.9

5.0

-29.32%

Enterprise Products Partners (NYSE:EPD)

$21.56

7.14%

5,248

12.5

12.5

4.3

-34.53%

Energy Transfer Partners (NYSE:ETP)

$26.32

16.03%

5,636

7.0

8.6

4.7

-53.43%

Kinder Morgan Inc.

$15.32

3.26%

7,372

10.5

10.5

5.8

-59.94%

Magellan Midstream (NYSE:MMP)

$61.72

4.94%

1,162

15.0

15.0

2.9

-20.05%

Targa Resources Partners (NYSE:NGLS)

$12.59

26.21%

1,124

6.7

8.0

4.7

-66.85%

Plains All American Pipeline (NYSE:PAA)

$20.97

13.35%

2,199

8.6

11.4

4.8

-54.03%

Suburban Propane Partners (NYSE:SPH)

$26.08

13.61%

334

8.0

8.0

3.3

-33.69%

Williams Partners (NYSE:WPZ)

$21.45

15.85%

3,795

7.9

10.1

4.6

-50.13%

Alerian MLP Index (AMZX)

11.96%

-42.66%

Click to enlarge

Table 5: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Note that BPL, EPD, KMI, MMP and SPH are not burdened by general partner incentive IDRs that siphon off a significant portion of cash available for distribution to limited partners (typically 48%). Hence multiples of MLPs without IDRs can be expected to be higher (see column 5). In order to make the multiples somewhat more comparable, I added column 6, a second EV/EBITDA column. I derived this column by subtracting IDR payments from EBITDA for the TTM period. Other approaches can also be used to adjust for the IDRs of the relevant MLPs

The only meaningful conclusion that can, perhaps, be drawn from the limited sample in Table 6 is that the modestly leverages MLPs, and those least reliant on issuance of units to generate funds, were punished to a lesser degree by the tsunami that hit the space in the past year. I include in that list BPL, EPD, MMP and SPH. I exclude BWP because after it slashed its distribution in February 2014, the price declined by 50%. So the 1-year decline for BWP shown in Table 6 follows a huge drop in the prior year.

In a prior article I expressed continued concern about the sustainability of the $0.51 quarterly distribution rate, let alone the 6%-10% increase then being forecasted by management for 2016. I also expressed concern that the combination of high leverage and not generating excess cash flow constrains KMI's ability to reduce reliance on equity at a time of dramatic increases in the cost of equity capital resulting from the steep drop in the price per share. To an extent, KMI followed BWP's footsteps in being forced to drastically reduce distributions.

The dividend cut decimated quarterly cash inflows many investors were counting on and came on top of large capital losses caused by the precipitous drop in the stock price. However, investors who maintained, or recently initiated, their positions have a stake in a company that is now on a much more solid footing. It can self-fund its $3.1 billion 2016 capital expansion program and expects internally generated cash flow will allow it to fund the equity portion of its 2017 and 2018 capital budget without the need to access the equity market. It anticipates meeting all of the rating agencies' requirements to remain investment grade, and expects a net debt/EBITDA ratio of 5.5 for 2016 and anticipates reducing that ratio in subsequent years.

As previously noted, I began reducing my MLP investments the fall of 2014 and eliminated my KMI position in 2Q15. I remain invested in EPD, MMP and to a far lesser extent, ETE/ ETP.

Disclosure: I am/we are long EPD, MMP, ETP, ETE.

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.