Kinder Morgan to Benefit from Increasing Natural Gas Consumption

Kinder Morgan (NYSE: KMP) is one of the largest owners and operators of energy-related pipelines and storage facilities in the U.S. KMP operates natural gas, refined products and carbon dioxide pipelines that ship these commodities around the nation.

Competitive Advantages

Pipeline and storage assets offer large barriers to entry for would-be competitors. Such assets require significant planning and regulatory approvals before they're built.

Even better, most pipeline and storage owners negotiate long-term contracts with key customers, guaranteeing a certain minimum revenue. These long-term contracts are essentially unbreakable, so competitors cannot compete for that business.

KMP also benefits from its huge size -- it's one of the largest pipeline owners in North America. This gives it the size and access to capital to fund large pipeline projects that typically require huge up-front capital investments.

Growth Drivers

Kinder Morgan has undertaken a series of major pipeline projects in recent years that will generate growth.

The largest of these new projects is the Rockies Express Pipeline, a $2.2 billion project that will carry natural gas from the Rocky Mountains east to the Pennsylvania/Ohio border. The first stages of that project are already complete; the pipeline should be totally finished by the end of 2009.

The Rockies Express Pipeline will be in high demand. It's estimated that natural gas production from the region will grow from 8.2 billion cubic feet per day in 2006 to more than 10.2 bcf/day by 2010. There is simply not enough pipeline capacity to handle all of that gas -- thus, KMP has already had success booking capacity on this pipe.

Kinder Morgan also has a large pipeline network in the Barnett Shale area of Texas, a network it plans to expand in the coming years to handle increased production from that region.

Valuation and Outlook: KMP is organized as a master limited partnership [MLP], meaning that it pays no corporate tax and offers a high yield for investors.

Typically, MLPs are not valued based on earnings and P/E ratios. For master limited partnerships, we calculate ratios using distributable cash flow [DCF] rather than earnings. The reason is that non-cash charges like depreciation and amortization are included in the earnings measure. These can be significant for MLPs because their assets typically throw off large non-cash depreciation charges.

Distributable cash flow is basically net income with non-cash charges added back. From this adjusted figure we subtract maintenance capital expenditures [CAPEX], which is a measure of how much money it costs annually to keep up, repair and maintain existing infrastructure. The final figure is a close approximation of how much cash an MLP actually has on hand to pay distributions to partners.

Kinder Morgan had distributable cash flows of $3.65 per share for 2007 and paid out a total of $3.48 in distributions. Over the next few years, KMP should be able to generate distributable cash flow growth of more than +10%. Meanwhile, the shares trade at roughly 17 times 2007 DCF, an attractive valuation for an MLP.

Better still, KMP offers a solid 6.4% yield backed up by steady cash flows and long-term contracts with customers. Kinder Morgan is a solid, low-risk way to play the growth in natural gas production from key U.S. reservoirs.

Disclosure: none

Comments

[.crazylegs..]

I'm surprised that more focus isn't placed on MLPs. These have been great investments over the last few years and should continue to as the fundamentals for energy consumption should get stronger and stronger over time. I guess the fact that it is a partnership and you get k1s scares people off? Also, you can't hold this in an IRA but you can buy KMR in a tax deferred/free account which pays a stock dividend. This is one of my favorite income producing investments for clients.

[Elliot Miller]

One issue with KMP is that it is required to pay IDRs to the GP. I prefer LLCs without IDRs being siphoned off to the GP.

[DES]

I've owned KMP since 2002 and enjoy the return. I did own KMI, the GP, until it was acquired by private equity guys, so that IDR payout was captured in part.

[Ames Tiedeman]

The dividend on this one is not that great. Take a look at PGH and HTE.