Pipelines and midstream energy firms are supposed to be boring investments. And historically, energy logistics giant Kinder Morgan (KMI) has fit into that camp. That is, until analysts at Hedgeye Risk Management began to question the company’s — and its subsidiaries Kinder Morgan Energy Partners’ (KMP) and El Paso Pipeline Partners’ (EPB) — cash flows, CAPEX spending and incentive distribution rights (IDRs).
That initial report by Hedgeye sent the normally sleepy and steady dividend grower spiraling downwards.
Well, as they say “time heals all wounds,” and for KMI stock that seems to be coming true. The pipeline firm’s last earnings report was nothing but stellar, and the key cash flow metrics showed vast improvement. All in all, you have to wonder if Hedgeye’s concerns were a bit blown out of the water.
For KMI stock investors, the latest earnings once again proved it’s one of the best midstream firms and showed why KMI deserves a place in your income portfolio.
Higher Distributable Cash Flows
After Hedgeye issued its report back in September on KMP & KMI stock, the key for investors has been the tale of Kinder Morgan’s cash flows and dividends. Well, KMI stock now has two consecutive quarters of solid cash flows (plus year-end numbers) to counter Hedgeye’s concerns.
KMI has a vast network of pipelines and terminals totaling roughly 82,000 miles, which continues to rack up big transportation fees. The key for those steady and rising fees has been KMI’s focus on natural gas. Seeing the writing on the wall early on, Kinder Morgan made strategic buys of El Paso and Copano and expanded the number of natural gas midstream assets in its network.
Those natural gas pipelines have been a monster source of earnings. For the fourth quarter, KMP’s natural gas segment grew roughly 40% on a year-over-year basis, while EPB saw similar gains along its network of natural gas assets in the west. All of which benefits KMI shareholders in the end.
So, what’s strengthening that relationship?
As the sponsoring firm or general partner, KMI stock has been able to take advantage of the lucrative “drop-down” relationships with its MLP subsidiaries. By placing pipeline, storage and terminal assets into a MLP, KMI has been able to avoid taxes and receive generous distribution payments back from the MLPs.
Those payouts have gotten even juicer over the years as the continued relationship between KMI and its two publicly traded MLP subsidiaries has grown. Both the El Paso and Copano buys were perfect candidates for this, and Kinder Morgan has been able to “drop down” plenty of assets into its MLPs.
Secondly, KMI has been able to gain valuable incentive distribution rights (IDRs) from the two MLPS. Those extra payments are set up to ensure that the general partner is doing right by the MLP and serve as an extra reward for “dropping down” assets. The growth in KMP and EPB has Kinder Morgan now in the top bracket for receiving IDRs.
So with KMP managing to report that its distributable cash flows rose 28% YOY to hit $635 million and EPB reporting a slight bump in its DCF numbers, KMI shareholders should be pleased. Perhaps even more so when they realize that their dividends are going to grow because of the bumps at KMP and EPB.
Cash available to pay dividends at KMI surged around 21% during 2013 to reach $1.7 billion. That number trounced management’s original estimates of just $1.63 billion. Overall, KMI estimates that its dividends will grow about 8% in 2104 to reach a $1.72 per share. At today’s prices, that would put KMI’s yield at a juicy 4.7%.
“You Sell, I’ll Buy”
With the distributable cash flows at both its MLP subsidiaries rising, many of Hedgeye’s original concerns seem to be fading. In fact, Chairman and CEO Richard Kinder during the conference call responded pretty directly to the Hedgeye analysts by saying “My message to those who saw the story less positively was: You sell, I’ll buy, and we’ll see who comes out best in the long run.”
So far, it looks like Hedgeye analysts are eating their words.
With KMI planning on dropping down more assets into El Paso — such as its Ruby Pipeline, Gulf LNG terminal and its 47.5% interest in the Young Gas Storage facility — the longer-term cash flows should continue to grow at the firm. Similar drop downs and asset sales are planned for KMP.
All of these will benefit KMI stock on the back end.
KMI stock currently trades for a forward P/E of 22. While that isn’t exactly dirt cheap, you are paying a slight premium for the leading midstream firm in the nation. The premium is certainly warranted as Kinder Morgan continues to churn out cash flows and dividends back to shareholders. Follow Richard Kinder’s lead and buy when others sell.
As of this writing, Aaron Levitt was long KMI and KMR.