Kinder Morgan Shedding Its Backlog

| About: Kinder Morgan, (KMI)
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Summary

Kinder Morgan's backlog decreased by $4 billion.

Thanks to a customer bankruptcy and a project going sour, DCF estimates brought down by 4%.

However, Kinder Morgan still has a huge backlog that it will be busy with for years.

2016 estimates have changed, unclear whether this will affect long-term targets, but give Kinder Morgan the benefit of the doubt for now.

Earlier this week, Kinder Morgan (NYSE:KMI) gave its first-quarter earnings results. Overall the results were mixed, with the refined products segment doing particularly well and the CO2 segment, predictably, not doing so well.

As often happens with Kinder Morgan and other pipelines, investors were fairly certain about the company's operating results. More important were the state of the company's backlog, the viability of its projects and its running debt-to-EBITDA ratio.

Last December Kinder Morgan slashed its dividend by three quarters. Management did this in order to avoid a possible credit downgrade (right now Kinder Morgan is just one notch from non investment-grade status). By doing so, Kinder Morgan no longer needs to raise debt or capital to fund its growth projects. Therefore, as Kinder Morgan's cash flow grows, the debt-to-EBITDA ratio will drop accordingly.

Mixed results

That plan to deleverage via growth is probably the single most important factor for Kinder Morgan right now, and the results appear to be mixed thus far. For example, in the first quarter, Kinder Morgan completed its expansions and improvements on the Tennessee Gas Pipeline, and also a crude and condensate processing facility on the Houston Ship Channel in 2015.

The completion of TGP improvements and the Hiland acquisition in the Bakken led to a 4% year-over-year segment earnings growth in dry gas, despite transport volumes coming down 2%. Segment earnings in products pipelines jumped 17%, thanks in large part to the Houston Ship Channel processing facility.

But not all went well. Predictably, CO2 segment earnings dropped 20%. This is mostly due to lower commodity prices, although average production volumes dropped 6%. Either way, it makes sense that Kinder Morgan isn't investing much in CO2 or enhanced oil recovery wells, because commodity prices are rather low. Either way, segment earnings from here continue to drag.

In addition to this, Arch Coal, one of Kinder Morgan's coal-producing customers, went bankrupt last quarter. This and a decline in dry gas transport volumes have forced Kinder Morgan to recognize that the company will not meet its EBITDA and DCF targets for 2016. The shortfall is not that much: Only 3% off of EBITDA and 4% off DCF. I expect revised full-year DCF growth to therefore be in the low-to-mid single-digits.

A few backlog projects have been cancelled as well. The Palmetto Pipeline project was cancelled because the Georgia state government became reluctant to enforce eminent domain, and that made the project difficult for Kinder Morgan to finish. The Northeast Energy Direct pipeline was also cancelled, this one due to lack of firm customer commitment.

A lot to choose from

At this point, it is unknown whether this will affect Kinder Morgan's growth rate over the long term. After all, the company has a huge, multi-year backlog of projects, with many different projects to divert capital towards.

Even that backlog is changing, however. Kinder Morgan has high-graded its backlog, selecting the highest-return projects and shedding the lowest-return projects in this low-commodity price environment. The size of the backlog went from $18.2 billion to $14.1 billion.

Some might argue that a smaller backlog is a good thing in this environment. After all, growth capex is going down by $4.2 billion to $2.9 billion in 2016, so that's a savings of $1.3 billion, which doesn't need to be spent out of Kinder Morgan's cash flow.

Also, keep in mind the enormity of Kinder Morgan's backlog. Enterprise Products Partners (NYSE:EPD) has a $6.8 billion project backlog. Energy Transfer Partners (NYSE:ETP) has a backlog of $9 billion. Yet, even after Kinder Morgan's 'high-grading,' its backlog is still $5 billion greater than that of its closest peer.

There're still a lot of projects for Kinder Morgan to do, and management expects an EBITDA multiple of 6.7 times, meaning that the $14 billion backlog could translate to $2.15 billion in EBITDA; a nice addition to the estimated $5 billion per year in EBITDA today. I'm not saying Kinder Morgan's quarter was good, but a little bit of perspective here is in order.

Conclusion

Through both high-grading its backlog and projects being cancelled, Kinder Morgan's backlog is starting to reflect the reality of low-commodity prices. That said, it's a little early to say its backlog is deteriorating, especially since that backlog is still huge. Despite this, I continue to like Enterprise Products Partners better than Kinder Morgan Inc., for reasons I've given in previous articles. Fewer shoes are going to drop on the businesses that weren't aggressive a few years ago.

Disclosure: I am/we are long EPD.

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.