Seeking Alpha

Analyst explains Kinder Morgan "house of cards" in Gasparino interview

  • Hedgeye's Kevin Kaiser explains his "house of cards" view on the Kinder Morgan companies in an interview with Charlie Gasparino (video): "To me, 'house of cards' means something that has an unstable foundation, and when you need to raise more and more capital to continue to pay out higher and higher distributions... that’s a very unstable foundation."
  • Kaiser doesn't see anything illegal but thinks "there are some very misleading statements with some of the non-GAAP financials."
  • "The entire MLP sector is sort of a regulatory nightmare," he says, but the issues around Kinder Morgan "are more egregious than some of the others."
  • In today's trading: KMI -2.8%, KMP -1%, KMR -2%, EPB -0.9%.
Comments (91)
  • crash9010
    , contributor
    Comments (101) | Send Message
     
    Why does everything this guy says come across as fear-mongering?
    11 Sep 2013, 05:58 PM Reply Like
  • jerrywengler
    , contributor
    Comments (402) | Send Message
     
    Because it is fear mongering for the purpose of personal gain.
    11 Sep 2013, 06:07 PM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Purpose of the fear mongering is to support their short sales that they claim they do not do. Does anybody believe this is to sell $29 monthly subscriptions? Does not pass the smell test and Hedgeye stinks really bad.
    12 Sep 2013, 10:10 AM Reply Like
  • Onlinden
    , contributor
    Comments (117) | Send Message
     
    All I can say is I'd trust my life savings to Rich Kinder above just about anyone, certainly above an analyst who was in Elementary School when Kinder started building Kinder Morgan into the 3rd largest energy company in the nation!
    11 Sep 2013, 06:07 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    IMO, there needs to be some standards developed for non-GAAP measures, with more disclosure in the 10-Qs, 10-Ks of what these measures are comprised of, specifically. It looks to me like there is considerable leeway for companies to manage (manipulate) earnings using DCF.

     

    I would like to see more rules established now, rather than an MLP, or several, go belly up, then some standards be established.
    11 Sep 2013, 06:54 PM Reply Like
  • Energysystems
    , contributor
    Comments (944) | Send Message
     
    Problem with that is Bryce, we all know that Washington doesn't act until after the fact. I'm all for transparency, the more, the better. We have a reactionary SEC. Just another thing in DC that needs to be overhauled and reformed.
    11 Sep 2013, 07:02 PM Reply Like
  • fredj
    , contributor
    Comments (128) | Send Message
     
    lol. The reason they are non-GAAP is because they aren't GAAP. If you want GAAP then read the year end financial statements.
    11 Sep 2013, 07:57 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    The non-GAAP is what is relied upon, rather than GAAP. Which means the non-GAAP needs to have standards of some sort so that yahoos don't push the envelope of DCF, like Enron did with GAAP, and investors suffer losses due to idiots who don't know better.

     

    I find no credibility is saying that it's not important. If it is what you rely upon to make your investment decision, then yes, it's important.
    11 Sep 2013, 08:02 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    The reason the Securities Act of 1933 and Securities Exchange Act of 1934 were passed was due to no federal standards for disclosure existing at the time. No accounting standards existed for public companies at this time, either.

     

    So, we have precedent for what happens with no standards - fraud and deceipt, resulting in a nation's economy collapsing. Those who fail to learn from the past are destined to repeat it.

     

    http://bit.ly/15U6ReK

     

    http://bit.ly/15U6O2J

     

    LOL :)
    11 Sep 2013, 08:20 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Hi Bryce,

     

    Do you own any of the Kinder entities?

     

    Bottom line: Do you agree with his call?

     

    I am long KMR
    11 Sep 2013, 10:34 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Don't own any of Kinder, no.

     

    I have not looked at KMP or the other entities, so I don't have an opinion on the overall report.

     

    But, because investors rely upon the non-GAAP measures to make investment decisions, I'd like to see standards developed for the measures so we don't have as much disparity regarding what should or shouldn't be included in the DCF calculation.
    12 Sep 2013, 03:16 AM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Hi Bryce,

     

    Thanks.

     

    So my interpretation of your answer is that you see problems with the standards for non-GAAP measurements, HOWEVER you do not have an opinion on whether or not this makes Kinder Morgan a house of cards.

     

    In other words, there are issues with accounting standards in the MLP sector but you can not determine if Kinder Morgan will suffer down the road because of these issues. Do I have that correct?
    12 Sep 2013, 09:25 AM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Yes, correct. My concern is that since no standards exist for what is maintenance cap ex, or what is to be included in the calculation of DCF, that companies in the MLP sector may exclude certain expenditures that should be included in the calc of DCF, in order to manage earnings.

     

    However, whether such manipulation and risk would ever result in a reduction in distributions and share price is debatable. MLPs borrow and issue equity on a regular basis. There are a lot of moving parts. Even if a company excludes legitimate maintenance cap ex from the DCF calc, I still don't know if it would ever matter. They may be able to borrow or issue equity to cover it. So, I view excluding legitimate maintenance cap ex as a risk, but whether that will ever result in anything significant, I can't answer.

     

    There are situations where not performing regular maintenance on assets, but letting them "go" without proper maintenance results in higher economic depreciation, in the long term, than actual recorded book depreciation. So, maintenance cap ex in this situation would not reflect actual expenditures necessary to maintain assets over the long term, and cash paid out in distributions could potentially be excessive in relation to the internal cash needs of the company. Whether this applies to KMP, I don't know.

     

    See: "Reason #3: EBITDA does not consider the amount of required reinvestment-especially companies with short lived assets", on page 9 and 10 in the link.

     

    http://bit.ly/1668USd
    12 Sep 2013, 01:21 PM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Bryce:

     

    You want more regulation, non-GAAP eliminated or changed to GAAP, greater maintenance spending, etc., etc. All of what you want comes at a cost that probably cuts the yield by 2-3%. That may be fine for you, but maybe other investors accept the judgment of Kinder Morgan and Linn Energy on these issues for the yield they receive.

     

    Why do you want to cut the yield for other investors?

     

    Higher yield equates to higher risk. I believe most informed investors in such companies (Kinder Morgan, Linn Energy) are comfortable with the balance (between yield and risk) that these companies have determined.

     

    For those that do not agree, there are many other investments without these issues that pay 2-3%. You could buy McDonalds or Microsoft.
    12 Sep 2013, 05:35 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "All of what you want comes at a cost that probably cuts the yield by 2-3%."

     

    Blarney. All transactions are recorded in some manner, there are no financial transactions that are not recorded. KMP and LINE keep track of total growth cap ex, as well as maintenance cap ex. Classifying a transaction as either one will take no extra time or effort. They keep track of both. Nice try. Though it's not reported in the SEC reports, I'm sure that the companies accumulate management accounting data on both growth cap ex and maintenance cap ex. I would like to see more disclosure of what comprises maintenance cap ex in the financials.

     

    To rely upon the companies to "tell us" what is growth cap ex or maintenance cap ex makes up dependent upon the company. That way they can feed us whatever they choose. No, we need more info to be able to verify and validate, and to keep the companies transparent. I don't care for another "black box" like Enron.

     

    I said nothing about eliminating non-GAAP or changed to GAAP. Yo are distorting what I have stated.
    12 Sep 2013, 09:11 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Thank you Bryce,

     

    I feel better.

     

    I am asking a few other people whom I respect for their viewpoint on the Kinder entities in the light of the Hedgeye report, although these issues do NOT seem to be NEW ones. They own 3 of the 4 entities.

     

    Thanks again.
    12 Sep 2013, 09:57 PM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Bryce:

     

    Why don't you devote a major part of your life lobbying for all the changes you want.

     

    I will favor your changes as long as they cost me "zero" in yield.

     

    I will be against you if it costs me.

     

    Go for it. Time is a wasting.
    13 Sep 2013, 04:52 PM Reply Like
  • ATrautmann
    , contributor
    Comments (453) | Send Message
     
    Pipelines are regulated by both State and Federal agencies. FERC has stringent standards. Not to mention the counter parties that INSURE firms like Kinder Morgan against
    Potential liabilities from inadequate maint. Cap Ex. The "short case" thesis attached to Kinder Morgan is a real grasp at the moon ! Linn Energy is a great long term investment ,
    especially now that its been run through the Hedgeye prognostications . The shorts perform an excellent job vetting American business . I thank them every day ... I rarely short a stock for that very reason . Thanks for the insightful analysis
    14 Sep 2013, 09:57 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I am selling LNCO, instead, when I can recoup my cost. A lot easier.
    16 Sep 2013, 07:39 PM Reply Like
  • edexter
    , contributor
    Comments (538) | Send Message
     
    I would not trust my life savings with any one person... please diversify just in case..
    11 Sep 2013, 07:11 PM Reply Like
  • fredj
    , contributor
    Comments (128) | Send Message
     
    What makes you think anyone has their life savings in one stock? If they do, they deserve to lose it all for being that stupid.
    11 Sep 2013, 08:00 PM Reply Like
  • toomuchgas
    , contributor
    Comments (535) | Send Message
     
    Funny thing that this guy is so smart that he is the only one that knows the accounting is bad.
    11 Sep 2013, 07:47 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I believe Kaiser's arguments bear some credibility.
    11 Sep 2013, 08:26 PM Reply Like
  • tangocharlie
    , contributor
    Comments (4) | Send Message
     
    Longtime (since 1998) MLP investor. Kinder Morgan (preferably Richard Kinder himself) should make a strong statement here. This is the kind of thing that can damage a whole sector. As far as I can remember, Kinder Morgan has over 30k miles of pipes and not ONE incident or spill. am I right? If so...Then someone needs to point out that this 26 year old is NOT the arbiter of how much in resources are needed for maintenance!
    11 Sep 2013, 07:57 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "As far as I can remember, Kinder Morgan has over 30k miles of pipes and not ONE incident or spill. am I right? If so...Then someone needs to point out that this 26 year old is NOT the arbiter of how much in resources are needed for maintenance!"

     

    From the Hedgeye Report:
    "In its first major acquisition, KMP acquired Santa Fe Pacific Pipeline Partners (SFPP) for $1.5B in late 1997; the deal closed in March 1998. SFPP is a major refined products pipeline system on the west coast, and remains a key asset at KMP Product Pipelines today.

     

    "n April 2004, an SFPP line ruptured and spilled 124,000 gallons of diesel into a marsh in the San Francisco Bay. SFFP plead guilty to four misdemeanors and paid $5MM in fines. It settled additional charges for a small spill at its Carson terminal in Los Angeles in May 2004.
    In November 2004, a gasoline line in Walnut Creek, CA exploded when a construction crew hit it, killing five. Kinder Morgan was convicted of six felony accounts and ordered to pay $15MM in fines because it "had failed to mark a bend" in the line.
    In February 2005, a Kinder Morgan line spilled 77,000 gallons in the Oakland Inner Harbour. In April 2005, another line spilled 300 gallons into a creek in the Sierra Nevadas.
    In August 2005, the PHMSA5ordered Kinder Morgan to address the “rise in pipeline incidents:”
    “Since January 1, 2003, KMEP has experienced at least 44 accidents with some 14 resulting in the release of more than five barrels of refined petroleum products, some in or near environmentally sensitive areas or major transportation corridors . . . ’Our investigations into these incidents identified inadequacies in Kinder Morgan’s interpretation of in-line inspection information to evaluate and repair their pipeline systems,’ said PHMSA Acting Chief Safety Officer Stacey Gerard.”
    Kinder Morgan later reached an agreement with the PHMSA to spend $90MM on “safety improvements” to its west coast product pipelines.
    Also in 2005, the Department of Transportation “formed a task force to look into Kinder Morgan Inc.’s maintenance and inspection practices on several petroleum product pipelines in the West, the first such task force the agency has ever formed.”6
    In connection with the spills in 2004 and 2005, the Environmental Protection Agency (EPA) issued SFPP a notice of debarment which would have debarred SFPP from “participation in future Federal contracts and assistance activities for a period of three years.”7
    The EPA withdrew the proposed debarment in 2008.
    California Attorney General Bill Lockyer stated that, “Kinder Morgan has repeatedly and unlawfully failed to report spills or breaches in their pipelines.
    Another member of the California District Attorney’s Office said that, “This Kinder Morgan operator has repeatedly failed to respond to civil action. We filed criminal charges in order to demand accountability in the future and to force this company to overhaul its business practices.”9"

     

    http://bit.ly/14MJ7sG

     

    Yeah, right. You haven't even read the report, yet you are making comments about the report.
    11 Sep 2013, 08:12 PM Reply Like
  • Zeus2012
    , contributor
    Comments (695) | Send Message
     
    I think Bryce is right that, as investors, we should take a deeper look into these allegations and get some answers from KMI. It would be a mistake to take a cavalier attitude. Better be safe than sorry. Remember, it was not that long ago that people betting against U.S. housing falling in price were laughed at.
    11 Sep 2013, 10:35 PM Reply Like
  • okfixer
    , contributor
    Comments (7) | Send Message
     
    No mention of the hurdles and permits needed to assess the integrity of the pipeline in a California wetland, which were in limbo prior to the leak. Of course approvals were expedited after the fact.
    12 Sep 2013, 09:49 AM Reply Like
  • fredj
    , contributor
    Comments (128) | Send Message
     
    This guy has to keep the fear going or his short is going to fail. He's so full of BS that I hope he loses big money on this.
    11 Sep 2013, 07:59 PM Reply Like
  • CincinnatiRick
    , contributor
    Comments (354) | Send Message
     
    I am uncomfortable with the wildly varying means by which the MLPs are able, each in their own way, to arrive at critical metrics such as AFFO and DCF. So, while I question the methods and motivations of Hedgeye, I agree that some standardization needs to be provided and enforced. I am not sure where this needs to come from and am leery of the utility and validity of anything the government might offer.
    11 Sep 2013, 08:01 PM Reply Like
  • 21thomas99
    , contributor
    Comments (396) | Send Message
     
    'I am uncomfortable with the wildly varying means by which the MLPs are able, each in their own way, to arrive at critical metrics such as AFFO and DCF.'

     

    Each individual REIT also arrives at AFFO in their own way, usually some variance from one REIT to another REIT (albeit, sometimes minor differences from company to company).

     

    While this could bolster your case for standardized AFFO measurements, MLPs are not the only asset class to have such variances.
    11 Sep 2013, 09:11 PM Reply Like
  • toomuchgas
    , contributor
    Comments (535) | Send Message
     
    The National Association of Real Estate Investment Trusts (NAREIT) has industry definitions for the non GAAP measurements but some may fail to follow them. However, this is apt to be pointed out.
    15 Sep 2013, 07:09 PM Reply Like
  • tangocharlie
    , contributor
    Comments (4) | Send Message
     
    well if he has a big short position on KMI or KMR, KMP, then I think he's in HOT water...as that is over a legal "redline" in my opinion.
    11 Sep 2013, 08:01 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    If you watched the 7 minute video, where Gasparino interviews Kaiser, you would know he has no short position.
    11 Sep 2013, 08:33 PM Reply Like
  • Energysystems
    , contributor
    Comments (944) | Send Message
     
    You think Hedgwho doesn't have a financial position in their shorts? Where else would they make money, the double digit subscribership?
    11 Sep 2013, 09:33 PM Reply Like
  • Zeus2012
    , contributor
    Comments (695) | Send Message
     
    Keith M. is short KMP (or was, not sure if he still is). Looking forward to the next analyst meeting with the company. Would be curious if these points are brought up and what the company's response is.

     

    I would not simply brush off these allegations just because they're being made by a 26 year old. Let's deal with what's being said and not the person who said it.
    11 Sep 2013, 10:30 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I have to back up on the short position. My first review of the interview, I understood Kaiser say that he and Hedgeye had no short position, but upon a second review of the interview that's not what he said. My apologies. He did say they receive no banking fees or compensation from KMP et al. If they had a short position it would have been appropriate to state that at that point. Not declaring it in the interview is less than transparent, IMO, if they have a short position. Gasparino didn't ask him if Hedgeye had a short position.
    12 Sep 2013, 03:33 AM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Hi Zeus,

     

    There will be a presentation by KM today at 10:30 am Lets see what the questions and answers are? Not an analyst meeting but some questions about this should come up, most likely, lets see?
    12 Sep 2013, 09:29 AM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Hi Bryce,

     

    I suggest that you review my last several comments with a detailed takedown of Hedgeye's report and an explanation of why they the current method of reporting and treatment of maint capex accurately portrays the economics of the business.
    12 Sep 2013, 01:29 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I did read one long post explaining how Hedgeye had it wrong. However, it seems to me that part of replacing pipe further down the road is maintenance cap ex. A portion of that cash outlay is necessary to replace the capacity of the old pipe which generated cash for the company. Replacing the capacity of the old pipe would seem to me to be spending cash to maintain existing revenues and existing operations.

     

    Granted the new pipe may be larger to carry more commodity and generate more revenue than the old pipe, still part of that appears to be simply replacing existing assets to maintain current revenues. If you simply replace the old pipe with the same size of pipe, that appears to be all maintenance cap ex to me. The fact you are replacing it with a larger capacity pipe doesn't negate that the part of the new pipe that represents the capacity of the old would be maintenance cap ex, as best I understand.

     

    Is that reasoning valid, and if so, on what basis to you declare it ALL growth cap ex?
    12 Sep 2013, 01:59 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    What is maintenance cap ex? From the Wells Fargo MLP Primer:

     

    "G. What Is The Difference Between Maintenance Capex And Growth Capex?
    Maintenance capex is typically defined as expenditure that is made to (1) replace partially or fully depreciated/obsolete assets, (2) maintain the existing operating capacity or operating income of an MLP’s assets, and (3) extend the useful life of assets (e.g., routine equipment and pipeline maintenance).
    On the other hand, growth capex is capital expenditure that is made to increase the partnership’s long-term operating capacity or cash flow. Some examples of growth capex include acquisitions, and the construction and development of additional facilities."

     

    Note where it says "maintain the existing operating capacity or operating income of an MLP’s assets". It seems obvious to me that the portion of the capacity of new pipe that is the same as the old represents a replacement of existing operating capacity which maintains existing operating income, and, therefore, is maintenance cap ex. What is wrong with that logic?

     

    http://bit.ly/nI0Yg9
    12 Sep 2013, 02:33 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    It's correct that the new investment is replacing part of existing capacity as well as adding new capacity. However, the new FERC rates and contracts, etc. are calculated on the entire new investment. Therefore, while only part of an expansion project may be replacing existing capacity, 100% of the project is boosting cashflows. That's why the current financial reporting most accurately reflects the economics of the business.

     

    It's true that KMP and other MLPs are incentivized to classify as much as possible as growth capex. However, it's not done to pull the wool over the eyes of KMP investors; it's done to maximize the economics of the business when FERC sets rates. It's a game in which KMP and other operators have tremendous leverage over FERC and the shippers given that the latter want/need new infrastructure built. Here's a recent article that shows you just how much leverage the big pipeline operators have over shippers and FERC and hints at why FERC policy has gotten more pipeline-friendly over the years.

     

    http://reut.rs/13OPRJi
    12 Sep 2013, 03:32 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Value Doc,

     

    Assets are purchased to generate cash flow. But assets aren't free. A portion of the cash flow generated from assets has to pay for the cost of the assets. Otherwise, the asset cost is paid from debt or equity.

     

    EXAMPLE: MLP "A" issues 10,000 units at $20/unit:
    Debit: Cash $200,000
    Credit: Common Units $200,000

     

    (2) MLP "A" purchases an asset for $100,000. The asset has a useful life of 3 years and no salvage value (for simplification):
    Debit: Asset $100,000
    Credit: Cash __________$100,000

     

    (3) In Year 1, the asset generates $100,000 in cash revenue:
    Debit: Cash $100,000
    Credit: Revenue _______$100,000

     

    (4) There is no Maintenance Cap Ex in Year 1. (To follow KMP's example)

     

    GAAP INCOME STATEMENT
    Revenue:........... $100,000
    Less: Depreciation 33,333
    Net Income.........$ 66,667

     

    DISTRIBUTABLE CASH FLOW
    Net Income ____________$ 66,667
    Plus: Depreciation........... $ 33,333
    Less: Maint. Cap Ex.....................0
    Distributable Cash Flow $100,000

     

    (5) MLP "A" pays out all DCF:
    Debit: Distributions (Equity) $100,000
    Credit: Cash _________________$100,000

     

    (6) Years 2 and 3 generate the same Revenue and Distributable Cash Flow, all of which is paid out in Distributions.

     

    (7) At the end of Year 3, actual profit equals total revenues less the cost of the asset, or $300,000 Less $100,000 = $200,000 in Net Income. Total Distributions paid out equals $300,000.

     

    (8) Net Income of $200,000 Less $300,000 in Distributions equals a $100,000 reduction in Equity.

     

    (9) With the DCF formula, if a company's maintenance cap ex is not equal to its economic asset depreciation (is less than), the difference will be paid out in distributions (assumes a distribution ratio of 1 to 1)

     

    If this is the case, a portion of distributions represents a return of capital, rather than it all coming from earnings/profit.

     

    Whether classifying Maintenance Cap Ex as Maintenance Cap Ex is an academic exercise, as you state in another post, depends on one's perspective. Reducing legitimate maintenance cap ex carries the probability that earnings will be insufficient to fund all the distributions. In that case, a company is forced to keep adding debt or issuing new equity (dilution) to fund its growth and distributions. This, IMO, adds substantial risk. That's why I don't care for the MLP model. That could be why Kaiser questions the sustainability of KMP's distributions.
    13 Sep 2013, 05:48 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I would also submit that in the long run, GAAP is going to be the better gauge of actual company performance, as can be seen from my illustration.
    13 Sep 2013, 06:21 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Hi Bryce,

     

    Thanks for the example. The first flaw in your example is that you are assuming they pay out 100% of up-front cashflow on every new project. Given their WACC (cost of capital in the 8.5 to 9% range), in a project with an amazing 44% annual IRR (your example has a 44% annual IRR--you put down $1 and turn it into $3 over a three-year period), it would not be necessary to pay out 100% of the DCF--the project is highly accretive. It's all about IRR hurdles and accretion.

     

    KM breaks down their IRR by segment, and it's clear that they are meeting and exceeding their cost-of-capital hurdles. For regulated assets, FERC allows an unlevered IRR in the 11-13% range. For depleting oil & gas assets, you're talking 25% to 30%.

     

    The second flaw in your analysis is that you assume the cash flows do not grow over time (though in your example, the IRR is so sky-high that they don't need to--a three-year self-liquidating asset would be plenty profitable). They do grow--PPI + 2.65% per year plus any volume growth over time. Thus, a related issue is your embedded assumptions about depreciation and replacement cost of assets.

     

    Even leaving aside the question of whether the straight-line depreciation life matches the useful life of the pipe, the key issue here is that the easements never depreciate, they only appreciate because it's usually extremely difficult (often impossible) to replicate them. Keystone pipeline debate and Enbridge's Northern Gateway problems give you some idea of how difficult it is to build a green-field inter-state pipeline.

     

    Imagine that we were talking about a crumbling old little apartment building located in downtown Manhattan that I bought 50 years ago. Hedgeye would be yapping that I'm not spending enough maintenance capex to maintain it, that I'm self-liquidating the asset, etc. while completely overlooking the fact that most of the value of the building is in the real estate rather than the bricks, and that I can build a new state-of-the-art 60-story office building on the site. Why has the real estate gotten more valuable? Because the cashflows that it can generate (rents) have grown and compounded over time. Kaiser clearly does not grasp this--I tweeted him on this, and his response was "well, that's OK if you're selling easements". He simply doesn't grasp the economics.

     

    I would also note that there are plenty of examples in the pipelines space outside of KMP where GAAP earnings are starting to catch-up and approach (or even exceed) DCF, thereby validating the economics of the pipeline MLP model. Check out MMP, EPD, SXL, PAA, etc. If Hedgeye's maint cap accounting criticisms, which are levied on the entire pipeline MLP space, not just KMP, were valid, then you would not be seeing this.

     

    Comcast is another great example--10-15 years ago, all EBITDA and capital raises, no GAAP earnings, so what happened? GAAP earnings caught up over time, and Comcast has been an excellent investment all of these years. 10 years ago, Hedgeye would have claimed it was a similar Ponzi.

     

    Stepping back for a second, based on the static analysis you use, if you had looked at EPD 10 years ago, when it was trading at 3x book like it is now, constantly issuing units and debt, and paying out big dividends, would you have come to the same conclusion? If so, then there is something demonstrably wrong with your analysis. EPD has a total return CAGR of 18% over that time, with all relevant financial metrics (EPS growth, DCF/share growth, revenue growth, etc.) validating that share price performance.
    14 Sep 2013, 07:05 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Value Doc,

     

    I'm impressed. :)

     

    "Thanks for the example. The first flaw in your example is that you are assuming they pay out 100% of up-front cashflow on every new project. Given their WACC (cost of capital in the 8.5 to 9% range), in a project with an amazing 44% annual IRR (your example has a 44% annual IRR--you put down $1 and turn it into $3 over a three-year period), it would not be necessary to pay out 100% of the DCF-"

     

    Yet don't MLPs pay out close to 1 to 1 each year? Say, 1.1 or 1.2? If so, the example looks legitimate to me.

     

    "The second flaw in your analysis is that you assume the cash flows do not grow over time (though in your example, the IRR is so sky-high that they don't need to--a three-year self-liquidating asset would be plenty profitable). They do grow--PPI + 2.65% per year plus any volume growth over time"

     

    I was trying to keep it simple, with few moving parts. My point is, even with growing cash flow, whatever that may be, if the MLP pays out close to a 1 to 1 ratio, it's still going to be paying out more in distributions than its actual earnings, provided the Maintenance Cap Ex is less than economic depreciation. Increase in cash flow won't change that. it's built into the DCF forumula. If revenue increases, so do the amount of distributions, assuming they stay close to a 1 to 1 or 1.1 or 1.2 ratio. The goal of LINE is to pay out as much in distributions as possible, as I understand it based upon what I have read in their SEC reports.

     

    The Easements are another issue and, yes, I would agree that some of the property is going to increase in value over time. However, in order to tap into that increase in value, to have cash on hand from it, you have to sell it or borrow against it. Also, is it sufficient to make up for the distributions paid out in excess of earnings on a yearly basis? I'm hoping that GAAP accounting will incorporate FMV accounting on assets like this in the near future. International standards already allow it as an option.

     

    What I tried to show, in a simplified form, is that there is potential for distributions to exceed earnings due to the DCF formula, in which case the excess would have to be made up through asset sales, debt, or equity. I don't see that your first two arguments invalidate what I have presented. The increase in value is another issue, but, again, you have to sell the assets or borrow against them to turn them into cash. Seems counter productive to me.
    14 Sep 2013, 08:31 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Let's say the revenues increase by $25,000 each year. So in year one you have $100K, year 2 $125K, and year 3 $150K. Total revenue of $375K. Year one amounts remain the same.

     

    For year two, Net Income is $125K - $33,333 = $91,667.

     

    DCF = $91,667 + $33,333 = $125,000. Paying it all out, a 1 to 1 ratio equals $125,000.

     

    Year 3 will be similar, $150,000 paid out, using a 1 to 1 ratio.

     

    So, total Net for all 3 years would be $275,000. Total distributions paid out = $375,000. Equity is still reduced by the amount that depreciation exceeds Maintenance Cap Ex.

     

    I'm not familiar with the ratio of DCF to distributions that KMP pays out annually. Maybe they are more conservative than LINE, I don't know. I had in mind someone like LINE, who pays out as much as possible on an annual basis. As long as the ratio is close to 1 to 1 and economic (real, not book) depreciation exceeds maintenance cap ex, there is the probability that distributions will exceed actual earnings.

     

    Even if the payout ratio is smaller, say a 1.1 ratio of DCF to 1 dollar in distributions, you still end up with a similar result, just not as much excess paid out. With a 20% maintenance cap ex ratio to revenue (LINE's ratio for 2012), you have to make the ratio 1.2 to 1 or greater in order for distributions not to exceed earnings.

     

    The IRR is very good, great. The point is you are still paying out more in distributions than actual earnings, whatever the IRR is.
    14 Sep 2013, 08:48 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Please note that I'm focusing on pipelines here so would prefer to reference KMP, EPD, etc. rather than LINE.

     

    1:1 Payout: Yes, but on an aggregate basis (i.e. all assets and projects). If an investment meets or exceeds the IRR hurdle (stream of cashflows including terminal value), and the IRR hurdle satisfies the WACC, then there are no issues.

     

    What is "economic depreciation"? I think you mean book value depreciation (i.e. historical cost). Maint cap does not have to equal book value depreciation--it has to equal the amount necessary to preserve the cashflows (or pipeline capacity--depends on what approach you favor).

     

    Easements: No, you don't have to sell assets to tap into increase in value. The whole point is that the "rents" increase over time. If you own an apartment building, you don't have to sell it to benefit from the increase in value--you just raise the rents, and perhaps at some point even build a bigger building. Actually, the ability to raise the rents and/or house additional tenants IS the increase in value.

     

    GAAP/DCF Abuses: Yes, there is plenty of scope for manipulation. I wouldn't say the issue is necessarily distributions exceeding GAAP earnings (if depreciation doesn't fully reflect economic reality), but rather, distributions exceeding sustainable cashflow. Check out http://bit.ly/L7tNRz for some detailed work on this subject.

     

    Please consider EPD in 2003 and explain to me where the analysis/concerns of Hedgeye and yourself went wrong (i.e. why didn't the accounting bear thesis, which I'm sure would have been levied in 2003), play out? How did earnings and cashflow both grow so dramatically? EPD is even getting close to the point where it does not have to issue new units even to fund massive growth capex. MMP is already past that point--they haven't issued new units in two years. This should be impossible, if your concerns are correct.

     

    What are you missing? I think what all of these criticisms are missing is the simple concept of IRR hurdles and WACC plus the fact that book value has no reference to economic reality--that's why it's not a useful valuation metric for most industries (outside of financial businesses).
    14 Sep 2013, 09:59 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Yes, so they've paid it all out and reduced equity. For theoretical purposes, let's assume this was the only project/asset the MLP had. Basically, the MLP self-liquidated. Did the MLP investors get screwed? No, they put down $100K and three years later had $375K.

     

    What if they had paid 3x book for the equity ($300K)? Did they get screwed? No, they put in $300K and got back $375K in three years.

     

    You will also note that GAAP earnings rose each year--exactly what we've seen in some of the more mature MLPs such as EPD, SXL, MMP with accretive growth models. KMP is distorted right now by all of the M&A accounting and their mid-2000s foray into EP activities, but eventually, you'll see it there too.

     

    I should also note that many of the best MLPs (KMP is an exception due to a provision in their original partnership agreement) in fact do not pay out all of their DCF and are retaining substantial amounts to help fund growth capex (see EPD, MMP, PAA) given that cash has a very low cost of capital compared to equity. They've also expressly noted that this will be better for the LPs in the long run (I agree). For KMP, it's best to split your investment between KMP and KMI for this reason.
    14 Sep 2013, 10:14 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Addendum: " . . . (if depreciation doesn't fully reflect economic reality and we're dealing with long-lived assets where it takes a long time for GAAP earnings to catch up to cashflows)."
    14 Sep 2013, 10:20 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    I think much of confusion and mistrust with mid-stream MLP reporting relates to people focusing on book value and depreciation as measures of economic reality.

     

    I would acknowledge that there's a lot of potential for abuse, but you can say the same thing about GAAP accounting. Huge C-corps manipulate things all the time to "make the number" and prettify their accounting. Manipulating the timing of various things, one-off charges, etc.

     

    I've also noticed that a lot of commenters here, even those with an accounting background, seem clueless about IRR, project hurdles, etc., i.e. basic financial modeling. Is your background pure accounting, or have you also done financial modeling? What is your opinion on REIT accounting--does it similarly bother you that REITs pay out more than GAAP earnings?
    14 Sep 2013, 10:30 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Hi Value Doc,

     

    After reading your comments it is apparent that you are much more knowledgeable then I about MLP's.

     

    It is also apparent you do not believe the Hedgeye claim that KM is a house of cards has any merit.

     

    I would appreciate your answers to two questions I have.

     

    1) I assume you own KMP and KMI from reading your comments.

     

    How do you feel about KMR?

     

    I own KMR because as you know they do not issue a K-1( not an MLP), they trade at a discount to KMP and Kinder management states they are pari passu with KMP.

     

    I also like the fact that they do not issue a 1099 on the share dividends unless one sells KMR shares. No dividend taxes, only capital gains tax (in a taxable account) if one has a capital gain. Since I have lots of carryover capital losses from my internet trading days, I figured I can use them to offset my KMR gains when I sell the KMR shares.

     

    2) How many MPL's do you own? Which do you feel are the cream of the crop?

     

    Thanks in advance.
    14 Sep 2013, 10:46 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    I like your Buffett quote on EBITDA and the employees. Of course, we're not using EBITDA here, we're using DCF which accounts for maintenance capex. Hedgeye would quibble (without substantiation) that they are understating maint capex. I certainly don't see it in the env/safety incident trajectory (for either KMP or the industry). Hedgeye's case is circumstantial based on cherry-picking one or two incidents from 10 years ago and not supported by the data or by real analysis. In fact, it's so poorly laid out that it would amount to a journalistic ethics violation, IMHO.

     

    Also, the reality is that as the physical pipes depreciate, the easements (in KMP's case, a unique continent-spanning integrated footprint with synergistic network effects) do not--they appreciate! That's the big thing that everyone misses focusing on cost depreciation and book accounting.

     

    Actually, I would say that KMP's definition of maint capex (maintaining throughput rather than maintaining cashflow) is the more conservative one--they're not letting tariff raises and inflation bail them out.
    14 Sep 2013, 10:53 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    #1, Yes. I like KMR when it trades at a significant discount to KMP. My initial investment (near the bottom of the June 2012 correction) was all in KMR. At that point, the spread was 10 points. In January of this year, I swapped half of my KMR for KMI to address potential IDR conflicts of interest and benefit from likely higher growth at KMI. More recently, when the spread closed, I swapped the rest of my KMR for KMP. If I were buying fresh today, I would buy KMR rather than KMP as there's a 6-pt. discount.

     

    I recently wrote an article that covers this subject and lists my holdings in the disclosure. I'm only in very conservative large-cap names as my sense is that there's something of a feeding frenzy for the smaller, growthier names, and investors may be underestimating the risks of smaller MLPs (vulnerable to inter-regional shifts in oil and gas production; access to capital in a down-turn, lack of a track record, inability to benefit from synergistic network effects and scale, etc.). Also, I think we're late in the bull market cycle, and this isn't the time to be chasing riskier securities. Even the boring large caps aren't particularly cheap though the recent correction has taken a lot of the froth off the top. Various MLP managements have also noted in conf calls that the capital markets are a bit hot (i.e. valuations of potential targets are not low, and they would prefer to do acquisitions when the little guys are getting squeezed / struggling as capital dries up).

     

    EPD is the cream of the crop and probably the safest MLP. Interestingly, with all of the hoopla over MLP accounting, I noticed that an independent financial analysis firm listed EPD as one of the top five of ALL publicly-traded businesses in terms of governance and financial reporting clarity. Note also that the Duncan family owns a big chunk, and there's separation of insider owners and management.
    14 Sep 2013, 11:49 PM Reply Like
  • Dividends#1
    , contributor
    Comments (2211) | Send Message
     
    Value Doc,

     

    Thank you very much for your explanation to how you manage your KM positions. It makes a lot of sense. I will read your articles.
    15 Sep 2013, 12:12 AM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Value Doc:

     

    I really appreciate your comments. I think much of this including discussions by Bryce is much a do about nothing- arguing over the eye of a gnat. I believe he does not own any Kinder Morgan. He is just trying to show off claiming to be the smartest guy in the room. I wish that SA could put posters on ignore. In my opinion, Bryce adds nothing to investor knowledge and his comments validate lowlife manipulating shorts like Hedgeye, which in my opinion should not be legitimized. Hedgeye just looks for issues they can use to sow seeds of doubt to support short selling- nothing more legitimate than that.

     

    If Bryce is so convinced about how right he is, he should lobby Congress and the SEC for the accounting rule changes that he wants. I would like to see him cease and desist from his arguments on SA against Kinder Morgan and Line Energy and just take his case to the regulatory authorities.
    16 Sep 2013, 12:23 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    First, let me correct myself. I see a problem with the example I have used. The useful life is not reflective of that of the assets of an MLP. What I have used is much shorter, because I was trying to make it simple and short. I don't think I can do that.

     

    "What is "economic depreciation"? I think you mean book value depreciation (i.e. historical cost). Maint cap does not have to equal book value depreciation--it has to equal the amount necessary to preserve the cashflows (or pipeline capacity--depends on what approach you favor)."

     

    Economic is actual depreciation, not book, how quickly an asset deteriorates over time in real economic terms. How do you determine that? I don't know, so this is a problem as well. I don't have all figured out.

     

    "Easements: No, you don't have to sell assets to tap into increase in value. The whole point is that the "rents" increase over time. If you own an apartment building, you don't have to sell it to benefit from the increase in value--you just raise the rents, and perhaps at some point even build a bigger building. Actually, the ability to raise the rents and/or house additional tenants IS the increase in value."

     

    IMO, if maintenance cap ex is materially less than true economic depreciation, the net income is materially overstated in those years. IF a company pays out close to a 1 to 1 ratio of DCF to distributions and the payout ratio is close to 1 to 1, then the result will be what I have presented in my example, IMO. It depends on the size of chasm between maintenance cap ex versus economic depreciation and how close the ratio payout ratio gets to 1 to1. A large or significant chasm and a 1 to 1 ratio will result in more cash being paid out than actual earnings, IMO.

     

    I'm not familiar with any MLP, but LINE. I can approach LINE from an adjusted GAAP perspective, taking out all depreciation and depletion, adjusting for the unrealized gains/losses on derivatives, and adjusting for the impairments, and it appears obvious to me that LINE has paid out more in distributions than they have earned over the years. The reason they have, IMO, is because maintenance cap ex was lower than it should have been.
    16 Sep 2013, 08:00 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "Yes, so they've paid it all out and reduced equity. For theoretical purposes, let's assume this was the only project/asset the MLP had. Basically, the MLP self-liquidated. Did the MLP investors get screwed? No, they put down $100K and three years later had $375K."

     

    For a net of $275K, not $375K. Still not a bad deal, true.

     

    I am not suggesting investors are getting "screwed". I am saying that the structure and the way that DCF is calculated is complex, subject to manipulation, without insufficient information to help investors validate what is being reported to them as non-GAAP measures. The only wall of protection currently appears to me to be the auditors. Past abuses show this isn't sufficient.
    16 Sep 2013, 08:09 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "I think much of confusion and mistrust with mid-stream MLP reporting relates to people focusing on book value and depreciation as measures of economic reality. "

     

    I can take depreciation, depletion, and amortization out of the equation for LINE. I don't like what I see.

     

    "I would acknowledge that there's a lot of potential for abuse, but you can say the same thing about GAAP accounting. Huge C-corps manipulate things all the time to "make the number" and prettify their accounting. Manipulating the timing of various things, one-off charges, etc."

     

    True, but a trained eye can understand much of the manipulation, from the SEC info, and can make allowances to get a better, more realistic picture. I don't know that you can do that with DCF, due to the lack of detailed info in the SEC reports as to what comprises maintenance cap ex. But, I would agree that no measure exists which can not be manipulated in some way.

     

    "I've also noticed that a lot of commenters here, even those with an accounting background, seem clueless about IRR, project hurdles, etc., i.e. basic financial modeling. Is your background pure accounting, or have you also done financial modeling? What is your opinion on REIT accounting--does it similarly bother you that REITs pay out more than GAAP earnings?"

     

    My background is strictly accounting. With LINE in particular, I see too much risk for my comfort level. For LINE, I have been able to use GAAP measures to gauge if distributions exceed earnings.

     

    I haven't seen the dividends paid out by AGNC and NLY, the only two mREITs I am familiar with, exceeding GAAP earnings over the last year or so, which is the only time frame I am familiar with.

     

    For the equity REITs, I haven't really delved into their financials at all. I am using someone on the forum to do my analysis for me. In regards to these companies paying out dividends in excess of GAAP earnings, I assume the increase in value of the real estate and increase in rents are the reasons they can. Whether they always pay out close to a 1 to1 ratio and whether the maintenance cap ex is below economic depreciation, I have no idea.
    16 Sep 2013, 08:21 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "Also, the reality is that as the physical pipes depreciate, the easements (in KMP's case, a unique continent-spanning integrated footprint with synergistic network effects) do not--they appreciate! That's the big thing that everyone misses focusing on cost depreciation and book accounting."

     

    Understood. The only MLP I have done extensive research on is LINE. Not familiar at all with KMP or its affiliated companies. For LINE, I"ve been able to take the GAAP distortions largely out of the equation.
    16 Sep 2013, 08:26 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    Chancer,

     

    I am not convinced about how right I am. I may not be. For KMP and affiliations, I really don't have an opinion. As I've stated above, I am not familiar with KMP, only with LINE.

     

    As for as ceasing my arguments against LINE, I suppose any dictator has similar thoughts against their adversaries. In regards to KMP, I don't think I've made much of a credible argument. Too much I don't know about the company, as well as DCF.

     

    For LINE, I can approach it from a GAAP perspective and make reasonable adjustments for the GAAP distortions in order to get what I consider to be a fair picture of how the distributions have exceeded earnings over the years. I can present that again, if you like, but I don't think you want to see it.

     

    As for going to the authorities, I am selling my remaining position in LINE as soon as I can recover my cost. I don't plan on staying in the MLP sector. Too much I don't understand or like. I get it that you don't care for me. I could care less. I make presentations based on my understanding, in good faith to learn and grow. To be afraid to do so, and not post so that I don't offend anyone, would not allow me to learn and grow. I choose to risk being made a fool of in order to learn. You don't have to read my posts. I would agree with you that I wish SA had an ignore poster/author button as well.
    16 Sep 2013, 08:33 PM Reply Like
  • Zeus2012
    , contributor
    Comments (695) | Send Message
     
    Bryce - think both you and Value Doc have made good points. I do think upstream MLPs or downstream MLPs are a different animal versus the traditional midstream plays. This is also why I've avoided upstream MLPs as I think they became popular over the past few years due to the Fed's policy.
    16 Sep 2013, 08:55 PM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Thanks.

     

    Chancer
    16 Sep 2013, 10:53 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Hi Bryce,

     

    You're back! Quick hits:

     

    - Yes, I meant equity REITs, not mortgage REITs, and yes, the accounting and cashflows issues are similar to pipeline MLPs.

     

    - On LINE and other upstream MLPs--I see their biz model as similar to m-REITs--a levered play on oil and gas prices. At the end of the day, they need higher energy prices to do well. My entire discussion is about the pipeline space, not upstream MLPs. I own no upstream MLPs aside from the modest portion of KMI/KMP's biz that is upstream.

     

    - At the end of the day, Hedgeye has not demonstrated that KMP or other MLPs is understating pipeline maintenance capex, or that if they are, the economics of simply replacing ancient pipelines doesn't render such issue moot. I'm not saying it's theoretically impossible, and if we start having massive pipeline explosions and leaks all over the place on an unprecedented scale in the next few years, I would re-evaluate this claim. Seems unlikely though. Over the past 10 years, the accident/spill rate has been improving, not deteriorating.

     

    I don't think we're going to get any further with these theoretical discussions. I go back to one of my original questions: how is it that MLPs like EPD, MMP, PAA, SXL, etc. were paying out much more than their GAAP earnings 10 years ago, but GAAP EPS growth has since steadily outpaced dividend growth, and GAAP EPS now exceeds the dividends? Doesn't this settle it? Go to http://bit.ly/tbObny, and pick the "key ratios" tab for each of these--it will show you 10 years of data, and you can see the trend.
    17 Sep 2013, 03:57 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    BTW, if you want a high-yielder (7.3%) with a call option on oil prices, instead of LINE or other upstream MLPs, consider COSWF. Low valuation, out-of-favor, simple business model, no exploration risk, multiple catalysts in the next couple of years for an upward re-rating even without higher oil prices (de-risking of capex, new pipeline projects completion). March 2009 bottom only 20% below current quote. Closely tracks Suncor, which Buffett just bought into. Syncrude project operated by ExxonMobil.

     

    Best of all for you, it has a single-digit GAAP PE!

     

    Less risk, IMHO. I used to have small positions in LINE and VNR, then dumped them, luckily avoiding most of the carnage in LINE (took a small loss on LINE and a small gain on VNR), as I became uncomfortable with the risks and moving parts in their biz models.
    17 Sep 2013, 04:40 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "I don't think we're going to get any further with these theoretical discussions. I go back to one of my original questions: how is it that MLPs like EPD, MMP, PAA, SXL, etc. were paying out much more than their GAAP earnings 10 years ago, but GAAP EPS growth has since steadily outpaced dividend growth, and GAAP EPS now exceeds the dividends? Doesn't this settle it?"

     

    Settle what? What is "it"? What are you going for with the distributions being more than GAAP earnings 10 years ago, but they being less than GAAP earnings now?

     

    For GAAP, I know that it accounts for every financial transaction the company enters into. For DCF, cash flow, and non-GAAP measures, I don't see that. And this is where I get lost with DCF. Looks to me like certain financial transactions, which are real cash costs to the company, are never considered or enter into the equation, such as the cost of assets and early extinguishment of long term debt, etc. If KMP waits and replaces pipeline and considers it growth cap ex., where or when does DCF account for the cost of the pipeline?
    17 Sep 2013, 05:13 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    It's DCF and what it doesn't appear to me to account for which has me befuddled. If you don't account for all material costs, how can you consider it legitimate? I don't get it. That's why I'm staying away from the MLP sector.
    17 Sep 2013, 05:21 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "- Yes, I meant equity REITs, not mortgage REITs, and yes, the accounting and cashflows issues are similar to pipeline MLPs."

     

    Similar? Don't the equity REITs use AFFO? Doesn't that count ALL capital expenditures, not just maintenance cap ex? How is that similar? In accounting for ALL cap ex, you account for the cost of your assets. I don't see DCF doing that.
    17 Sep 2013, 05:26 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I'm a nuts and bolts kind of guy. I like to understand each item and how it impacts the financials, if that is possible, not just look at overall company ratios.
    17 Sep 2013, 05:35 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "Best of all for you, it has a single-digit GAAP PE"

     

    LOL. Not sure what the implication is here. You implying I'm a little slow? LOL You may be right, sir. But I'm not dumb. They don't teach DCF in college, as far as I am aware. Financial Statement Analysis, and how companies distort GAAP standards, they teach, but DCF, maintenance cap ex, etc., I'm not aware that they do.

     

    So, I am getting an education in it currently. By perhaps appearing "slow".
    17 Sep 2013, 05:38 PM Reply Like
  • CincinnatiRick
    , contributor
    Comments (354) | Send Message
     
    Chancer: "I wish that SA could put posters on ignore. In my opinion, Bryce adds nothing to investor knowledge and his comments validate lowlife manipulating shorts like Hedgeye, which in my opinion should not be legitimized."
    ------------------
    Arguments should be evaluated on their own merits and not based on the person making them and their (assumed) motivations. Playing the ostrich regarding that which you do not wish to hear is a mark of intellectual weakness.

     

    Long KMI....but always willing to listen.
    17 Sep 2013, 05:50 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    "plus the fact that book value has no reference to economic reality--that's why it's not a useful valuation metric for most industries (outside of financial businesses)."

     

    I understand what you are saying here, that the FMV of assets may be materially different from book value. On the other hand, book value reflects the value after all financial transactions have been accounted for. So this gives us a firm place to make adjustments, if necessary. To say it has no value, I don't agree with.

     

    If book value has no economic usefulness as a metric, then why is the SEC and the accounting industry using it and not cash flow or DCF? I don't agree with totally disregarding it as invalid. It is what I use and understand. If there are GAAP distortions, provided I understand those distortions, I can make adjustments in order to obtain what I consider a solid number for earnings, such as with LINE.

     

    No one outside the company knows what the increase in value of company assets are, if any. So, how is just knowing that the assets increased in value, by how much we have no clue, going to help me evaluate a company's performance? I need solid numbers to evaluate performance. We don't have that for an assets increase in value. How do you incorporate the unknown increase in value into the performance equation? How can you?

     

    Do you back out all depreciation? Really? How do you know how much to back out, or if backing out everything is going to reflect economic reality?

     

    Do you see, it appears to me that non-GAAP measures appear to me to have as many, if not more, problems as GAAP distortions?

     

    As a junior accountant first, then later with more experience, I saw the VP of Finance and the controller set budgets for every drilling rig (28 total) of a small Texas public oil/gas drilling company. I was amazed at the accuracy of the budgets and how each months actual numbers came very close to the budgeted numbers. All they used that I am aware of was GAAP. For me, I learned that GAAP was reliable to gauge company performance, and my experience after that job only confirmed that. I have a difficult time letting that go. I haven't seen anything else that compares to it, even with its weaknesses. Even DCF is built upon GAAP, with some additions and modifications. I remain cautious of anyone suggesting to completely disregard it, no matter what their education and business experience.
    17 Sep 2013, 06:06 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Hi Bryce,

     

    Relax, I wasn't trying to yank your chain--my apologies if it came across that way.

     

    The point on EPD and the others is that for companies in a growth phase that are building out long-lived assets (Comcast is another example), GAAP earnings can understate the value of the business even if they correctly record what happened in the past. To assess valuation, you need to analyze the business model and consider the trajectory going forward (both future recurring costs and revenues). Lasering in on historical costs (and the depreciation thereof) and assuming the future costs-to-revenues ratio will recur in the same way for a growing pipeline biz is misleading, in my opinion.

     

    I'm also not suggesting that GAAP be completely disregarded--my argument is that DCF can be a useful guide to the valuation and economics on the assumption that GAAP earnings will eventually catch up (and exceed) DCF. We've seen exactly that with many of these other MLPs such as EPD. If you don't like DCF, what would you have used to evaluate EPD, MMP, etc. back in 2003? If you had focused on GAAP, it would have led you to make poor investment decisions (i.e. avoiding and/or shorting these names). I'm focused on securities valuation, not historical cost accounting.

     

    If you're uncomfortable focusing on DCF, then why not ignore DCF and buy EPD based on its GAAP PE (currently 18x forward earnings). Reasonable price, in my opinion, for something with superior growth prospects and low risk. 12x would be better, but hey, who's going to give it away for that unless we get another financial crisis?

     

    For book value, I don't care what the SEC thinks--all I know is that book value would not have suggested buying stuff near the bottom of bear markets. Being a practical guy, from my perch, that makes it useless. Price-to-sales and price-to-cashflow have a pretty good record of marking low valuation periods and telling you when stocks are cheap (or dear). They are currently on the dear side, though I believe that good MLPs will do well even from these levels given the superior growth prospects. Performance to-date from 2007 indicates that was certainly the case in 2007.

     

    On COSWF, it's an honest recommendation. I assume that you bought LINE for a high current yield and some exposure to energy prices. COSWF offers the same thing without the uncertainty of the upstream MLP model and without the accounting complexities. I'm also uncomfortable with LINE and other upstream MLPs, much like yourself.
    17 Sep 2013, 08:40 PM Reply Like
  • Value Doc
    , contributor
    Comments (732) | Send Message
     
    Let's run another example. Let's say they buy a 50-yr old pipeline for $100M, then fully depreciate that cost over 10 years (and let's assume that 10-year straight-line accurately reflects the useful life of the pipe).

     

    After 10 years, is the value of that asset really its book value of zero? No, the easement alone is probably worth even more than the original $100M cost. Net-net, there was no cost--they spent $100M (easement and old pipe) and 10 yrs later still have an asset that's worth at least $100M (the easement).

     

    They can exploit that asset by making new investment (growth capex) in a bigger, brand new pipeline using that easement.
    17 Sep 2013, 09:08 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (2567) | Send Message
     
    I understand what you are saying, that the FMV is greater than book. To me there are two elements to this. The cost of the purchase, which should be depreciated, IMO, then the gain in FMV of the asset. I'd like to see, I think, GAAP address the FMV issue. But, on what basis do you gauge the increase in FMV, without a professional evaluation? I don't see how the average investor can.

     

    I don't honestly think many know what they are invested in with MLPs. I think they, like myself with equity REITs, rely upon someone else they consider an expert in the field.

     

    I got into LINE, without knowing a thing about MLPs, how they were financed, knew nothing of DCF, just saw only positive recommendations on SA about LINE. DCF is still something of a mystery to me. Again, where does it account for the cost of the assets, or for other costs, such as early retirement of debt costs? I am not seeing it. Looks to me like REITs account for all CAP EX, not just maintenance. If MLPs did the same I might feel better.

     

    I don't rely on historical costs or GAAP, solely. But, I do use it as a beginning point of reference because it does account for every transaction a company executes and because it has been reliable for me in my own business experience. Obviously, when the market tanked in 2008, it was a time to buy in, which I did. With any good market correction I'll do the same again. Maybe In time I'll get comfortable with DCF, but it will take some time, if I ever do.

     

    I am leery of companies pushing the envelope too far when standards are gray, unclear, or undefined as with DCF. I have good reason to be from past idiots giving the bird to ethics and common sense in favor of greed and short term wealth. Lose the trust of the investor, and it's gone for at least a generation, as we see with the 2008 financial crisis.

     

    Thanks for the discussion.
    18 Sep 2013, 04:03 AM Reply Like
  • tangocharlie
    , contributor
    Comments (4) | Send Message
     
    If you noticed...the market had a pretty good day, whilst KMI, KMP, EPB and KMR were down ..... and most MLP names were down too.....they wer having trouble getting a bid...even the quality names, like PAA, EPD, and even TRGP which as been very strong recently. obviously the "tapering" question and rising rates in the bond market have been presenting headwinds for MLPs, but I just have a gut feeling that this guy from Hedgeye caused some damage over most of the sector today...just my opinion.
    11 Sep 2013, 08:07 PM Reply Like
  • 21thomas99
    , contributor
    Comments (396) | Send Message
     
    You're giving too much credibility where none exists.
    11 Sep 2013, 09:12 PM Reply Like
  • sarichter
    , contributor
    Comments (273) | Send Message
     
    All the better... keep the prices low for a little bit so the rest of us can buy more! KMI isn't going anywhere regardless of the report, tapering questions, and bond market. Mr Kinder knows what he is doing (as I am sure many of the other MLP heads do).
    11 Sep 2013, 09:42 PM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    Yeah. I used that as an opportunity to add to LNCO.
    What was I thinking?
    I guess I did not get enough Hedgeye.
    Note to self:
    "Self, call Kevin Kaiser. Ask his opinion. Do the opposite."
    16 Sep 2013, 02:56 PM Reply Like
  • Workinhard
    , contributor
    Comments (166) | Send Message
     
    Whether he is right or wrong, this will certainly make mlp's look at their business finances in a more conservative fashion, and if they tighten things up that is a good thing.
    11 Sep 2013, 10:31 PM Reply Like
  • DanHJ
    , contributor
    Comment (1) | Send Message
     
    Hedgeye's Kevin Kaiser ...just a foolish fear monger. KMP investors can see this is a good company to buy into. I work for a KMP competetor, but have great admiration for the recent EP purchase. I would love to work for KMI/KMP. I'm a damn good control technology specialist Mr Rich Kinder.
    11 Sep 2013, 10:42 PM Reply Like
  • Groundhog666
    , contributor
    Comments (7) | Send Message
     
    Is Hedgeye's Kevin Kaiser short Kinder Morgan?
    11 Sep 2013, 10:42 PM Reply Like
  • rab9909
    , contributor
    Comment (1) | Send Message
     
    Oh, sure KMI is a big mess -- that is why Kinder just spent $18million to add to his stock of this great company!!! I'm keeping my investment in KMI.
    11 Sep 2013, 10:44 PM Reply Like
  • snoopy44
    , contributor
    Comments (641) | Send Message
     
    I don't understand the comment, "the entire MLP sector is sort of a regulatory nightmare".
    In what way? How? Is it because there are tax implications by investing in them? How is that any different from investing in REITs? In that sector you have issues like qualified vs non-qualified dividends. There is just no substance to the allegations being made. Most traders are well aware that MLPs require the raising of capital in order to make distributions. So what? The underlying concern seems to be that rising interest rates will crush their business model. That remains to be seen in light of Bernanke's comments that rate hikes may not begin until 2015-16.

     

    S.
    11 Sep 2013, 10:46 PM Reply Like
  • Maryellen41
    , contributor
    Comments (3) | Send Message
     
    Mr Kaiser is a publicity hound at any cost.
    11 Sep 2013, 11:03 PM Reply Like
  • connecticutyankee
    , contributor
    Comments (6) | Send Message
     
    Bryce_in_tx Is the only person in this thread who has any idea of what they are talking about. You should listen to what he is saying.
    12 Sep 2013, 02:02 AM Reply Like
  • huey35
    , contributor
    Comments (77) | Send Message
     
    I watched the video from Fox news with Charlie G interviewing the "kid". Charlie threw him softballs and made it sound like it was a young man against a corporate evil giant. The troubling item is that he called him an analyst and both he and the "kid" acted like he was just stating the facts as a hero for "the people" . Is Hedgeye a short house or a well respected analytical house?? I am confused?? I checked out their website and everything is negative about every company. Iwonder why so many "journalists" are promoting this guy. I just do not get it? I guess bad news makes good press? Long MLP ETNs, KMP, KMR.
    12 Sep 2013, 02:52 AM Reply Like
  • Chancer
    , contributor
    Comments (2520) | Send Message
     
    I have the same confusion over Obama.
    All media promoting him.
    Nobel Peace Prize for a couple of speeches.
    Where is the beef?
    Beef must be hiding in ObamaCare.
    It is all just so confusing?
    This would all make sense, if only I was a socialist, who worshipped narcissists.
    16 Sep 2013, 03:01 PM Reply Like
  • waltd80
    , contributor
    Comments (15) | Send Message
     
    I love this guy Kaiser, he's given me two great opportunities to get into Line and KMI at phenomenal prices. These are exactly the market inefficiencies that allow investors who are seeking alpha to actually get it. Listening to him on tv made me feel even better to be on Rich Kinder and Lee Coopermans side. Totally unconvincing appearance. What's next Kevin?
    12 Sep 2013, 06:42 AM Reply Like
  • SamSpade01
    , contributor
    Comment (1) | Send Message
     
    This has nothing to do with reporting. It has to do with business operations and expenditures. If your wanting the government to regulate how much money a company allocates to maintenance that's different than a SEC regulation on reporting.
    12 Sep 2013, 08:52 AM Reply Like
  • coyote flaco
    , contributor
    Comments (40) | Send Message
     
    Let's not forget that Richard Kinder learned his craft as an employee and heir apparent and perfidious issue of Ken (Kenny boy) Lay and EOG (Enron Oil & Gas).
    12 Sep 2013, 02:36 PM Reply Like
  • 21thomas99
    , contributor
    Comments (396) | Send Message
     
    'Let's not forget that Richard Kinder learned his craft as an employee and heir apparent and perfidious issue of Ken (Kenny boy) Lay and EOG (Enron Oil & Gas). '

     

    You know not what you speak of.

     

    When Kinder was President of Enron and Ken Lay was their CEO, Kinder was given to believe he was to succeed Lay as CEO.

     

    After Ken and Kinder discussed this, Ken went to the BoD of Enron and started badmouthing Kinder. This badmouthing, coupled with Enron's BoD viewing Kinder as expendable (Kinder wanted to move Enron in the direction of using pipelines; the BoD wanted to move into energy trading) resulted in Kinder leaving Enron.

     

    The Wednesday before Thanksgiving, 1996, Kinder left Enron, but not until he told Ken Lay what he could do with his badmouthing.

     

    When Richard Kinder left Enron, Jeffrey Skilling took over as President of Enron. This was when the illegalities started to happen.

     

    In fact, when Kinder left Enron, his old college friend (William Morgan) called Kinder and asked if he wanted to start a pipeline business. Kinder said yeas. $40 million later, what is now the Kinder Morgan entities was born.
    12 Sep 2013, 04:13 PM Reply Like
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