Edited by Adam Isaac
Kinder Morgan Energy Partners (KMP) is one of the most popular master limited partnerships [MLPs] in the U.S. The company is the largest holder and operator of petroleum product pipelines in the U.S., carrying over two million barrels per day of jet fuel, Gasoline, natural gas liquids and diesel fuel. In addition, the partnership has the capability to carry 9 billion cubic feet/day of natural gas. As I explained in a previous article, KMP has three classes of Units: Class B units, common units and i-units. The difference between class B and common units is that class B units are not traded on the stock exchange, while Common units trade on the stock exchange and represent a limited liability. However, i-units are held by the general partner of the partnership, which is Kinder Morgan Inc. (KMI), though it has delegated its authority to Kinder Morgan Management LLC (KMR). On the other hand, all of the class B units are held by a subsidiary of KMI.
Due to the high percentage of income being distributed; it is imperative for the partnership to have a strong balance sheet and impressive statement of operations. Here, I have analyzed the profitability trends, cash flow trends and leverage indicators of the partnership.
Operating Profit Margin
Net Profit Margin
Source: Annual reports
During the past three years, KMP operating profit margin has been showing fluctuations. KMP operating profit margin fell to 19.87% in the year 2010. The main reason for the fall in operating profit margin was the increase in costs of sales. Natural gas sales amounted to almost 40% of the revenues of the partnership, and during 2010, natural gas sales experienced an increase of 15.2% while the costs to procure natural gas went up by 17.5%. Overall, revenue figures for KMP has shown a positive trend, and recovering natural gas prices will further enhance the revenue figures for year 2012.
However, net profit margin has been declining over the last three years for KMP; interest expense is a major portion which has been increasing over the past three years, and net income as a percentage of revenues has been declining. Return on assets and return on equity also face the same issues of total assets and total equity increasing at a faster pace than the net income.
Debt to Equity
Cash Flow to Debt
Source: Annual reports
Being a master limited partnership, KMP has to generate funds through debt markets to pay for its distribution. Most of the cash generated by master limited partnerships is distributed to the unit holders. However, KMP follows a conservative capital structure; the partnership does not pay cash to the general partners, instead new units of i-units are issued to the general partner. Over the last three years, debt levels for the company as a ratio has not changed significantly; in fact, the change in the ratio has been negligible.
However, debt to equity ratio of the firm has had a jump from .90 to 1.61 in the previous three years. Furthermore, capitalization ratio has also increased significantly during the past three years and currently stands at 61.68%. Nevertheless, both interest coverage ratio and cash flow to debt ratio show positive trends. The current interest coverage ratio indicates the firm should not have any problem meeting its interest expenses in the near future.
Cash Flow Measures:
Operating Cash Flow to Sales
Free Cash Flow to Operating Cash Flow
Capital Expenditure Coverage
CAPEX + Dividends Coverage
Source: Annual Reports
For any business, cash flows component is extremely important. For a master limited partnership, significance of cash flows is magnified. Fortunately for KMP, all of the cash flow ratios show an improving trend. Operating cash flows to sales ratio shows that the firm is converting its sales into cash at an impressive rate, while FCF to operating cash flows ratio has shown a massive improvement from the figures of 2009. Moreover, dividend coverage ratio indicates that the firm should not have any trouble with its cash distributions in the near future.
As a master limited partnership, KMP must distribute about 90% of its income from eligible sources such as interest, natural resources activities, real estate rents, and dividends, income generated from the sale of property, and income and gain from commodities or commodity futures. Much of the distribution is usually treated as "return of capital", which causes a downward adjustment to U.S. taxable investor's cost basis. It is not taxable in the year it is received, but increases capital gains taxes in the year the MLP units are sold. As it is indicated by my ratio analysis, the firm is in a healthy financial position especially the cash flow ratios are incredibly encouraging.
I expect the partnership to improve revenues and cash flows once the El Paso (EPB) acquisition is integrated properly. I think, the premium price paid for El Paso, is well justified given the potential cost savings in the future. The acquisition is likely to change the balance sheet and accruals analysis for future, but the current analysis suggests that Kinder Morgan provides one of the safest dividends in the market.