Kinder Morgan Back in the Bargain Bin

 | Feb 26, 2014 | 11:00 AM EST  | Comments
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Kinder Morgan Energy Partners (KMP) is in the bargain bin again, and for familiar reasons. Barron's penned another negative article on the partnership last week, sending shares down by nearly 4% Monday and adding to what has already been a difficult last couple of months.

Just before the negative article from Barron's, management had to issue 6.9 million additional shares to pay off commercial paper. Barron's article was awfully well-timed as it hit the stock when it was down

But issuance of Kinder Morgan Energy units is indeed nothing new. This has happened at least once a year for the last five years. The transaction amount was for about $560 million -- not too big for a company whose market capitalization is $30 billion to $40 billion.

As for the Barron's article, I could see little difference between the concerns in this article and that of the past ones which Barron's has written on Kinder Morgan. The Barron's article even featured the same market commentator as it did before, Hedgeye's Kevin Kaiser.

Kinder Morgan responded much the same way it did to the previous negative article from Barron's. As its biggest concern, Barron's cited lack of "maintenance capital expenditures" and an abundance of "growth cap expenditures" despite lackluster growth in cash flow. The article implied that Kinder Morgan was understating maintenance capex and overstating growth capital expenditures in order to maximize its reported distributable cash flow, or DCF.

Distributable cash flow is the most meaningful way of measuring a partnership's ability to pay distributions. Management's response to Barron's claims (PDF) was to point out that most pipeline maintenance gets classed as operational expenses and not maintenance-related capital expenditures.

Another one of Barron's' concerns was the impact on Kinder Morgan Energy's future DCF when the partnership's CO2-injection oil fields begin to decline. The article argued that because a good chunk of the partnership's DCF -- about 20% -- comes from the partnership's CO2-aided oil production, it could be forced to cut distributions when production here begins to decline.

But management estimates are that the partnership's oil fields will not see production decline until 2021. To put things into perspective, the decline from these assets will only be $200 million in 2021, vs. an entity which today altogether generates $4.4 billion in DCF. That should generate "substantially greater" DCF by 2020.

Fundamentals and Valuation

 With $14 billion in ongoing projects, management expects 5% DCF growth from Kinder Morgan Energy units and about 8% DCF growth in the lower-yielding Kinder Morgan (KMI) this year. Although KMI has more growth, at just below 14x DCF partnership units trade at a higher yield and a better valuation. I believe that the partnership units are the better deal right now.

There are downsides to owning KMP -- Kinder Morgan Energy -- as opposed to KMI. Because KMI has incentive distribution rights over KMP, and also benefits first from any accretive deals, many regard KMI as the safer bet. KMP's distribution coverage ratio is, in the words of Barron's, "razor thin" at just 1x. KMP also occasionally raises equity, too. (See this PDF presentation, as well, which details metrics for all of the Kinder Morgan businesses.)

A solid 5% cash flow growth rate, coupled with high cash flow visibility from long-lived assets, and finally a distribution yield now at 7.15%, makes it a good time to add units of Kinder Morgan Energy. This company has the most extensive pipeline network across the continent, and is in a market with rather high barriers to entry. Buying here will lock in a very healthy yield, growth well above inflation, and the opportunity for some nice capital gains.

Kinder Morgan Energy units are at a low not seen since summer of 2012. Negativity is swirling around the stock despite its good fundamentals. It is precisely this which makes now a fine time to buy.

Sources:

 http://www.kindermorgan.com/investor/presentations/Credit_Suisse_2014_Energy_Summit.pdf

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