Edited By Kate Boehme
Kinder Morgan Energy Partners (KMP) is a leading energy storage and pipeline transportation company operating in North America. The company distributes diesel fuel, gasoline, natural gas liquids and Jet fuel to a range of markets with the help of its 8,400 miles of refined petroleum products pipelines. The company also possesses 60 associated product terminals and petroleum pipeline transmix processing facilities. For its natural gas segment, Kinder Morgan has a total 16,200 miles of natural gas distribution pipelines. Along with the distribution pipelines, KMP also operates gas treating, storage and processing facilities. KMP also has CO2 segment which produces, transports and markets carbon dioxide to different oilfields through 2,000 miles of pipelines. These oilfields use carbon dioxide to increase production. The CO2 section also operates and owns eight oil fields, and a 450-mile crude oil pipeline system in West Texas. The KMP Terminals division stores and delivers bulk, petrochemical, petroleum, and other liquid products through its 115 liquids and bulk terminal facilities. It also controls around 35 rail transloading and materials handling facilities. The general partner of KMP is Kinder Morgan Inc. (KMI). KMI owns the general partner interest of KMP and El Paso Pipeline Partners, L.P. (EPB), along with limited partner interests in KMP, and Kinder Morgan Management, LLC (KMR). The total combined enterprise value of Kinder Morgan family of companies is about $100 billion.
Kinder Morgan Canada uses its network of 2,500 miles of pipelines to deliver refined petroleum products and crude oil. It transports the products from Alberta, Canada to marketing terminals and refineries in British Columbia, the Rocky Mountains, Washington state, and other locations in the central United States. This subdivision also runs the Jet Fuel aviation turbine fuel pipeline that caters the Vancouver (Canada) International Airport. KMP typically operates fee-based assets, which are central to North American energy transportation. At the start, KMP grew mainly through buying assets like refined petroleum and transportation pipelines, CO2 production fields, and bulk and liquids terminals. More recently, the majority of KMP's growth has originated from expansions and new projects. During the past 15 years, KMP have invested $22 billion in nurturing company growth, in the form of joint ventures, acquisitions, and expansions.
KMP has a strong history of dividends, and the company has been increasing quarterly dividends on a consistent basis. It has a dividend yield of 6.10 percent and annual dividends of $4.92. In this article, I try to assess the stability of the KMP's dividends by looking at its business, revenues, and cash flows. Through these means, this article will assess whether or not KMP will be able to maintain its current dividends.
KMP revenues have experienced negative growth for the last two quarters. In the past ten quarters, KMP has faced such negative revenue growth three times. Total revenues for the second quarter this year were $1,852 million; these revenue figures show a decline of 8.28 percent from the same quarter last year. In addition, the natural gas segment also showed a decline of more than 40 percent from the same period last year. Meanwhile, services and product sales segments both experienced positive revenue growth. However, falling revenues did not affect earnings, and there was a 23.3 percent increase from a year ago.
In addition, a major increase in the EBITDA for gas pipelines business came from the KinderHawk Field Services. KMP acquired the remaining 50 percent ownership of KinderHawk to make it wholly owned by KMP. KinderHawk thus contributed $31 million, which amounts to a 246 percent increase in earnings.
Second quarter earnings include non-cash losses of $327 million from remeasurements of the FTC Natural Gas Pipelines disposal group to fair value. KMP missed analyst estimates due to the losses from discontinued operations and low revenues from the natural gas segment. Natural gas prices are currently down by almost 23 percent, amounting to a large revenue loss for KMP.
KMP increased the cash distribution to the shareholders by seven percent, raising the dividend for the quarter to $1.23 per share. Meanwhile, distributable cash flows for the company stood at $366 million, 13 percent higher than the same period last year amount of $324 million. KMP also has fairly healthy operating cash flows of $2,874 million. For the last three years, KMP cash flows from operations have shown a steady increase. The company consistently invests capital in new ventures and expansions. For the last three years, KMP capital expenditures have actually taken more than $1 billion from its cash flows. These capital expenditures have helped the company to increase its cash flows significantly and guarantee future cash flows. Recent KMP free cash flow amounted to $1,674 million, which also gives an indication of where the company is headed. KMP free cash flows have demonstrated exceptional growth; FCF almost doubled in 2011 and showed an increase of almost 18 percent in the previous year.
KMP has announced the purchase of the Tennessee gas pipeline, as well as 50 percent of El Paso natural gas pipeline, for a total cost of about $6.22 billion, from its parent company, Kinder Morgan, Inc. The company plans to finance this purchase with a mixture of debt and equity. KMP will also issue units of $387 million in favor of KMI, which amounts to the ten percent of the transaction value. These assets will increase the KMP cash flows. KMI decided to reduce these assets in accordance with an agreement with the Federal Trade Commission for the acquisition of the El Paso Pipelines.
KMP has total debt values of just above $14 billion. The company has issued $1.25 billion worth of senior unsecured notes. A new debt offering was made to fund the Tennessee gas pipeline and to purchase 50 percent of the El Paso natural gas pipelines. Even with high debt figures, KMP has a debt-to-EBITDA ratio of less than four. KMP also has an extremely well managed and considered capital-spending program. KMP debt figures appear to be near the top of the higher side, but the company has a strong business profile. Increased cash flows from expansions also ought to help supply sufficient capital to cover interest payments. Furthermore, increased cash flow from the Tennessee gas pipeline and El Paso gas pipeline will help maintain the dividends.
KMR vs. KMP
Kinder Morgan Management LLC is a limited partner of the Kinder Morgan Energy Partners, and holds a 30% interest in the company. Normally, you would expect KMR to support a market cap of $8.52 billion, which is 30% of KMP's market cap as of the last close. However, given that KMP has a market cap of $28.4 billion, KMR's market cap of $7.58 billion shows that KMR is trading at a 15% discount compared to KMP.
Essentially, there should be no difference, as both stocks refer to the same company, where each shareholder is entitled to the same rights and ownership interests. KMR also offers regular distributions, but these distributions come in the form of additional shares. By doing so, it automatically allows for dividend reinvestment. If investors are in need of cash, they can create their own cash dividends by selling some of their shares.
The spread is not unique to the current period. KMP has always been trading at a premium compared to KMR. In the last 2 years, the spread between the two has been as low as $5, but as high as $15. Currently, KMP is priced at a premium of $8.4. I think the premium has something to do with the KMR's dividend not showing on stock screeners. Its yield is actually higher. But the automated information collection robots are not well programmed to capture KMR's dividends -- as it pays in terms of additional units but not cash. Playing this spread could be pretty profitable for the long term, but one needs to have the patience until KMR catches with KMP, which might take several years.
KMP has healthy business profile, which gives it a solid competitive advantage in many of its markets. In particular, it has significantly large-scale operations, a diversified asset mix, a sizable proportion of fee-based revenues, and an active commodity price-hedging program that lessens risk from oil production operations. KMP's natural gas and petroleum products department provides a concrete foundation for stable cash flows. The company benefits from volume and pricing security, as most capacity in these segments is under long-term take-or-pay contracts. Keeping in mind the competitive position of the company and its forward thinking management, I can say with some certainty that KMP will maintain its current dividends level, or even raise it, in the future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.