Has The Market Priced Too Much Risk Into Kinder Morgan Energy Partners?

| About: Kinder Morgan (KMP)


Bad news and slower growth prospects have pushed KMP's yield up to 7.4%.

Compared to peer MLP yield and growth rates, KMP is 10% to 15% undervalued.

The lower KMP unit price can affect the net cash flow results of new capex products due to a higher number of shares sold to raise capital.

In recent months, the Kinder Morgan Energy Partners LP (NYSE:KMP) unit price has been hard hit by a combination of negative news articles and the fact that the company has issued lower distribution growth guidance compared to recent years. The KMP unit price has fallen 7.5%, year-to-date, 11.% over the last 12 months and is about 20% below the 52-week high of $93.

As a result of the falling unit price, KMP now yields 7.4%, a level not seen since November 2009. The question now is whether this down move is awaiting a catalyst to move higher and the impact of lower unit and higher yield on its distribution growth capabilities.

Lower Distribution Growth Guidance

According to Kinder Morgan presentation information, the distribution growth rate for KMP has been 13% CAGR from 1996 through the expected 2014 payout of $5.58 per unit. However, the 2014 distribution guidance is just 5% higher than what was paid per unit in 2013. The distribution growth guidance of 5% is significantly lower than the 8% and 7% increases investors earned in 2012 and 2013.

For comparison, here are current yields and distribution growth rates for other midstream MLPs, based on the most recent distribution payment as reported on the Distributions pages of MLPdata.com:

Midstream MLP Yields vs. Distribution Growth
Yield Dist. Growth Coverage
BPL 5.9% 4.8% 1.03x
DPM 6.0% 6.2% 1.07x
EEP 7.9% 0.0% 0.71x
EPD 4.4% 6.1% 1.55x
ETP 6.9% 2.9% 1.05x
KMP 7.4% 5.4% 1.09x
MMP 3.6% 17.0% 1.42x
OKS 5.6% 2.8% 0.99x
PAA 5.0% 9.3% 1.28x
SEP 4.7% 10.0% 0.99x
WPZ 7.2% 7.8% 0.90x

While each company has its own growth story and expected future distribution growth rate, the list above shows that - outside of Williams Partners (NYSE:WPZ) - the current 7.4% yield on Kinder Morgan Partners is higher than its peers with comparable growth rates, including Buckeye Partners (NYSE:BPL), DCP Midsteam Partners (DPM), Enterprise Product Partners (NYSE:EPD) and ONEOK Partners (NYSE:OKS).

Cash Flow Valuation Puts KMP in the Middle of the Pack

A recent energy and pipelines report from Barclays Capital lists KMPs debt to (FFO + interest) ratio and (FFO+D&A+interest) to interest ratio both at 4.2. These ratios are right in the middle of the pack for the MLPs listed above. The Barclays data also reported KMP's FFO at 19.8% of outstanding debt, which is above the other slow growth MLPs and only surpassed by the higher distribution growth companies.

These ratios show that the KMP debt to cash flow levels are not out of line for midstream MLPs and the company is not in danger of missing its distribution guidance for 2014.

Higher Cost to Fund Distribution Growth

The lower unit prices for KMP and sister company El Paso Pipeline Partners LP (EPB) affect the ability of these companies to maintain the desired level of distribution growth. As is typical with MLP funding of capital projects and acquisitions, a portion of the cash to pay is raised through the sale of additional units. If KMP needs to sell units into the market at current share prices, it takes 1.2 times as many units to raise the same amount of capital as would have been necessary a year ago. More units sold equals a greater dilution of the DCF generated by the newly funded project and lower distribution growth potential compared to the outcome if the unit price was higher.

This scenario was graphically illustrated by the Linn Energy LLC (LINE) purchase of Berry Petroleum Co. With the initial merger offer of 1.25 LinnCo (LNCO) units for each Berry share, the deal would have been accretive for Linn investors. However, the Linn units were hit by a similar attack of negative news stories and the company ended up paying 1.68 units for each Berry share. With the higher acquisition cost in units, Linn has not been able to increase the distribution rate paid to investors.

Potential for Price Recovery

At the current unit price and yield, KMP is priced near where some no-distribution growth MLPs are yielding. The several negative news reports over the last several months seem to have impacted the unit price more than the actual potential for distribution growth. Overall growth will also continue in 2014, with $3.6 billion of growth capex in the budget.

It may take some above expectations results on the quarterly earnings reports for market sentiment to turn positive on KMP. If that happens the unit price could rise to put the KMP yield into the 6.5% to 7% range, comparable to peers of the same size and growth potential. Using the forecast 2014 distribution, these yields give a unit price range of $80 to $86, compared to the current $73.50.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Oil & Gas Pipelines, Alternative Investing
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