In an article titled Distributable Cash Flow ("DCF)" I present the definition of DCF used by Kinder Morgan Energy Partners LP (KMP) and provide a comparison to definitions used by other master limited partnerships ("MLPs"). KMP's definition and method of deriving its DCF (what KMP refers to as "DCF before certain items") is complex and differs considerably from other MLPs I have covered. Using KMP's definition, DCF per unit for 2011 was $4.68, up from $4.43 in 2010. How do these figures compare with what I call sustainable DCF for these periods?
The generic reasons why DCF as reported by an MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to KMP' results with respect to sustainable cash flowing to the LPs generates the comparison outlined in the table below:
| 12 months ending: | 12/31/11 | 12/31/10 |
| Net cash provided by operating activities | 2,874 | 2,417 |
| Less: Maintenance capital expenditures | (212) | (179) |
| Less: Working capital (generated) | (8) | (34) |
| Less: net income attributable to GP | (1,180) | (1,053) |
| Less: Net income attributable to non-controlling interests | (11) | (11) |
| Sustainable DCF | 1,464 | 1,140 |
| Add: Net income attributable to non-controlling interests | 11 | 11 |
| Risk management activities | (73) | (158) |
| Other | 124 | 367 |
| DCF as reported | 1,525 | 1,360 |
Table1, Figures in $ Millions
The principal differences of between sustainable and reported DCF numbers in 2011 and 2010 are attributable to risk management activities and a host of other items grouped under "Other". Risk management activities present a complex issue. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. In this case, the KMP risk management activities items reflect proceeds from termination of interest rate swap agreements rather than commodity hedging and I therefore exclude them.
Items in the "Other" category include numerous adjustments as detailed below:
| 12 months ending: | 12/31/11 | 12/31/10 |
| Depreciation | (171) | (146) |
| Tax deferred | (27) | (26) |
| Loss (Gain) on sale of assets | - | (9) |
| Total non-cash compensation adjustment (with "certain items" netted) | 8 | (5) |
| Total impairment and reserve adjustment (with "certain items" netted) | (74) | (206) |
| Equity in earnings of unconsolidated investment, net of distributions | (25) | (3) |
| Interest of non-controlling partners in net income | 11 | 11 |
| Other (no information provided; with "certain items" netted) | 155 | 17 |
| Total "Other" | (124) | (367) |
Table 2, Figures in $ Millions
These adjustments further illustrate the complexity and subjectivity surrounding DCF calculations. They also highlight the difficulty of comparing MLPs based on their reported DCF numbers, which is another reason why I exclude them from my definition of sustainable DCF.
Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:
| 12 months ending: | 12/31/11 | 12/31/10 |
| Distributions excluding GP incentive distributions ($ millions) | 1,069 | 955 |
| DCF as reported ($ millions) | 1,525 | 1,360 |
| Sustainable DCF ($ millions) | 1,464 | 1,140 |
| Coverage ratio based on reported DCF | 1.42 | 1.42 |
| Coverage ratio based on sustainable DCF | 1.37 | 1.19 |
Table 3
These are solid coverage ratios. However, Table 1 clearly demonstrates the extraordinarily high proportion of cash generated by this partnership that is claimed by Kinder Morgan Inc, (KMI), KMP's general partner. I would therefore also like to evaluate the sustainability of cash flows from the perspective of all partners (limited and general). This requires a closer look at net cash provided by operating activities:
| 12 months ending: | 12/31/11 | 12/31/10 |
| Net income | 1,268 | 1,327 |
| Depreciation & amortization | 961 | 911 |
| Decrease (increase) in working capital | 8 | 34 |
| "Other" | 637 | 145 |
| Net cash from operating activities | 2,874 | 2,417 |
| Less non-sustainable cash items within "Other:: | ||
| Termination of interest rate swap agreements | (73) | (158) |
| Non-cash compensation | (90) | |
| Write downs and reserve adjustments | (338) | 34 |
| Earnings in excess of distributions from equity investments | 25 | 3 |
| Other (no explanation provided) | (161) | (24) |
| Sustainable net cash from operating activities | 2,237 | 2,272 |
| Distributions to LPs, GP & and non-controlling interests | 2,244 | 1,827 |
Table 4, Figures in $ Millions
Table 4 shows that in 2011, sustainable net cash from operating activities only just covered distributions to partners and to non-controlling interests. The bulk of these distributions were made to LPs and KMI (distributions made to KMI reflect its incentive distribution rights as well as the units it holds). Amounts distributed to non-controlling interests are not significant (~$28 million in 2011 and $24 million in 2010).
As always, I also generate 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 in the last two years.
Here is what I see for KMP:
Simplified Sources and Uses of Funds
| 12 months ending: | 12/31/11 | 12/31/10 |
| Capital expenditures ex maintenance, net of proceeds from sale of PP&E | (962) | (787) |
| Acquisitions, investments (net of sale proceeds) | (1,304) | (1,320) |
| Other CF from investing activities, net | - | (25) |
| Other CF from financing activities, net | (36) | (21) |
| (2,302) | (2,154) | |
| Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions | 446 | 434 |
| Cash contributions/distributions related to affiliates & non-controlling interests | 29 | 13 |
| Debt incurred (repaid) | 1,091 | 931 |
| Partnership units issued | 955 | 759 |
| Other CF from investing activities, net | 61 | - |
| 2,582 | 2,136 | |
| Net change in cash | 280 | (18) |
Table 5, Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $446 million in 2011 and by $434 million in 2010. The good news is that KMP is not using cash raised from issuance of debt and equity to fund distributions. The bad news, as I see it, is that most of the excess over this two year period was generated by non-sustainable cash items.
Following KMI's acquisition of El Paso Corp. (EP), I think it is a question of time before KMI attempts to simplify its structure in order to avoid the complication, expense and potential conflict of interest inherent in being the general partner of three distinct MLPs (KMP, KMR, EPB) in which incentive distribution rights are eliminated and a single EPD-like entity remains. In any event (i.e., whether or not a structure simplification takes place), the EP acquisition will significantly impact the underlying Kinder Morgan MLPs. The numbers will change significantly once the drop-downs commence.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
