Much like in our previous article, we remain positive on the performance of Kinder Morgan Partners L.P (NYSE:KMP), which has been characterized by its stable business model, high yield, and commitment to increasing its future cash distributions. For these reasons, we retain our buy rating on the stock.
KMP operates as a master limited partnership (MLP). MLPs offer substantial distribution to shareholders, and offer other advantages such as reduced tax liability, owing to the hefty tax write-offs for depreciation and other expenses. Yield-starved investors will find these investments particularly lucrative, since they offer high yields with the added advantage of reduced taxation. Companies like KMP offer high yields and operate in a favorable environment, where continued demand for fuel will be sustained as the economy looks towards natural gas as a cheaper energy alternative. Also, oil companies employ techniques such as enhanced oil recovery by Co2 to extract the remaining reserves in mature fields, and thereby boost production in the existing discovered fields.
KMP operates in the pipeline transportation and energy storage business - it is the largest midstream and the fourth-largest energy company in North America - with an aggregate enterprise value of over $100b. Its general partner is Kinder Morgan Inc (NYSE:KMI), which operates 29,000 miles of pipeline and 180 terminals. The assets are diversified in terms of product mix and on a geographical basis. The company's pipelines transport refined petroleum products, in addition to crude oil, carbon dioxide and natural gas, amongst other products, whereas its terminals offer storage facilities for chemicals, petroleum products, ethanol and steel. Carbon dioxide provided by the company is also used to enhance oil recovery from oil drilling operations in North America.
KMP operates under five reportable business segments. Natural Gas Pipelines is primarily involved in the business of transporting, storing and selling of natural gas. The Products Pipelines segment is in the business of providing transportation and terminal storage of refined petroleum products. The Terminals segment offers storage of refined petroleum products, coal, petroleum coke, cement, alumina, salt and other bulk chemicals. The Co2 segment is involved in the business of production and sale of crude oil, and furthermore, in the transportation and marketing of carbon dioxide.
The Good and the Bad
Natural Gas Pipelines contain both interstate and intrastate pipelines. Within this segment, KMP owns about 16,300 miles of natural gas pipelines and the storage and supply lines that are located in the North American pipeline grid. It remains the largest business segment for the company, contributing ~50% of total revenues for FY2011.
Consumption of natural gas has been on the rise, as the world looks for cheaper and more efficient fuels. Natural gas offers more energy than coal at a lower cost, and is about one-third of the total cost of crude oil (on an energy equivalent basis). This attractiveness has led to an increase in gas usage in industrials. Total gas consumption is projected at 69.8Bcf/d for 2012. The electric power sector has been particularly interested in the cost effectiveness offered by natural gas, and is extrapolated to account for roughly 36% of total consumption. Natural gas consumption in electric power generation is expected to increase by 3.2Bcf/d in 2012, up by 4.8% from last year. Total gas consumption is set to increase to 69.96Bcf/d, representing an increase of 0.2%. We thereby see continued support for stable shipments for the Natural Gas segment. According to the EIA, U.S. natural gas production will grow to 27.9 trillion cubic feet by 2035, almost entirely because of the projected growth in the shale gas production, which is believed to grow to 13.6 trillion cubic feet in 2035.
The Co2 division contributed ~18% of total revenues in FY2011, and is the only segment that exposes KMP to oil price volatility. Apart from its Co2 business for Enhanced Oil Recovery (EOR), the company has ownership positions in several oil fields, and also owns a crude oil pipeline located in the Permian Basin region of West Texas. Demand for carbon dioxide is expected to remain strong as companies look to boost production of existing maturing fields by extracting two-thirds of the oil that is left in the ground after the primary and secondary phases of extraction. Revenues from this division will increase in tandem with future crude oil price increases. The oil market has always stayed volatile, and a meaningful analysis is difficult to present. However, Saudi Arabia has committed to bring prices down by boosting oil supply. Dampening growth in China and the deteriorating European economic conditions both increase the downside risk to future prices. On the other hand, the Middle East unrest, sanctions on Iran, and recent anti-U.S. protests threaten to disrupt oil supply, and thereby push the prices higher. The EIA expects the WTI to average $93 in the second half of 2012, and maintain this level in 2013 as well.
KMP's partnership agreement dictates that the company must pay out its total available cash to partners every quarter. Consequently, KMP maintains a high yield, which currently stands at 6%. The company has furthermore expressed its commitment to expand its cash disbursements by 7% in future. It has a total debt-to-equity ratio of 176%, and a high (5.24x) interest coverage ratio, which point towards its ability to comfortably service its debt.
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Analysts expect EPS to be $2.3 for the year ending 2012, and $2.54 for the following year. Furthermore, the long-term earnings growth rate is projected to be 13%. The analyst mean price target is $87. In light of the stable business model employed by KMP, and in line with the expected growth potential, we maintain a positive outlook for the stock, and rate it as a buy.