Published: February 26, 2013
On January 16, 2013, Kinder Morgan Energy Partners LP (KMP) reported results of operations for 4Q 2012 and 2012. Segment earnings before DD&A and “certain items” are summarized in Table 1 below:
|Natural Gas Pipelines||474||290||1,374||951|
|Kinder Morgan Canada||71||51||229||199|
Table 1: Figures in $ Millions
Products Pipelines’ refined products volumes were down ~1.5% in 2012 compared to 2011, but NGL volumes were up ~22% and ethanol and biofuels volumes were up ~11%. Segment earnings growth in 2012 was only 1.3%, below its 2012 budget of 6%, mainly due contract expiration in the first quarter and to a slower volume ramp-up on the crude and condensate pipeline.
The Natural Gas Pipeline segment exceeded the year’s budgeted growth of 19% mainly due to drop downs by KMI into KMP of 100% interest in Tennessee Gas Pipeline and the 50% interest in El Paso Natural Gas pipeline. These interests were contributed for $6.22 billion, including assumed debt, and generated $344 million of incremental earnings between May 25 and December 31, 2012. Growth from the drop-downs was partly offset by lost income due to FTC-mandated asset sales, by lower volumes on KinderHawk as a result of reduced drilling in the dry gas areas, and by worse-than-expected Texas Intrastate performance, primarily as a result of slower than budgeted growth in Eagle Ford volumes.
The CO2 business contributed most in terms of year-to-year organic growth in segment earnings. This segment produces, transports and markets carbon dioxide for use in enhanced oil recovery projects as a flooding medium for recovering crude oil from mature oil fields. One such field, referred to as the SACROC unit, is comprised of ~56,000 acres in the Permian Basin in Scurry County, Texas. The SACROC unit is one of the largest and oldest oil fields in the United States using carbon dioxide flooding technology. KMP holds a ~97% working interest in this field and has increased production and ultimate oil recovery over the last several years. Management noted it is discovering more and more opportunities to expand the field and to push back the decline curve. The CO2 segment finished the year modestly below the 26% budgeted growth target mainly due to lower NGL prices (oil volumes and NGL volumes were above budget).
Terminals segment earnings growth was driven by the liquids terminals, particularly in Houston and New York Harbor, and by higher demand for export coal. For the full year 2012, coal export volumes were up ~38%. Segment earnings growth in 2012 was 7.3%, slightly below its 2012 budget of 8% growth primarily because of lost business due to the hurricanes, low river water levels that inhibited some volume movements, and lower steel and salt volumes.
Kinder Morgan Canada includes the Trans Mountain pipeline system, a 1/3 ownership interest in the Express pipeline system, and the 25-mile Jet Fuel pipeline system. Segment earnings growth in 2012 is primarily attributable to a $17 million decrease in Trans Mountain income tax expenses. Trans Mountain also benefited from higher non-operating income, related primarily to incremental management incentive fees earned from its operation of the Express pipeline system. Earnings from KMP’s equity investment in the Express pipeline system increased year-over-year mainly due to volumes moving at higher transportation rates on the Express (Canadian) portion of the system, and to higher domestic volumes on the Platte (domestic) portion of the segment.
Contributions to net income provided by each segment are summarized in Table 2 below:
|Natural Gas Pipelines||387||241||1,121||788|
|Kinder Morgan Canada||57||37||173||143|
|Less: Interest, net||-180||-138||-632||-531|
|Net income before certain items||669||491||2,244||1,759|
|Less: certain items||-50||-12||-888||-491|
Table 2: Figures in $ Millions
In an article titled Distributable Cash Flow (“DCF”) I present the definition of DCF used by KMP and provide a comparison to definitions used by other master limited partnerships (“MLPs”). KMP’s definition and method of deriving of DCF (what KMP refers to as “DCF before certain items”) is complex and differs considerably from other MLPs I have covered. Using KMP’s definition, DCF per unit for the trailing 12 months (“TTM”) ending 12/31/12 was $5.07, up from $4.68 for the TTM ending 12/31/11.
As always, I attempt to assess how the reported DCF figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than just the quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.
The generic reasons why DCF as reported by an MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to KMP’ results with respect to sustainable cash flowing to the limited partners generates the comparison outlined in Table 3 below:
|Net cash provided by operating activities||3,177||2,874||2,420||2,109|
|Less: Maintenance capital expenditures||-285||-212||-179||-172|
|Less: Working capital (generated)||-17||-7||-37||-|
|Less: net income attributable to GP||-1,412||-1,180||-1,053||-936|
|Less: Net income attributable to noncontrolling interests||-17||-10||-11||-16|
|Add: Net income attributable to noncontrolling interests||17||10||11||16|
|Working capital used||-||-||-||203|
|Risk management activities||-53||-73||-157||-144|
|DCF as reported||1,778||1,525||1,360||1,196|
Table 3: Figures in $ Millions
Table 3 clearly shows the extraordinarily high proportion of cash generated by this partnership that is claimed by Kinder Morgan Inc, (KMI), KMP’s general partner.
The principal differences of between sustainable and reported DCF numbers in Table 1 are, in 2011 and 2012, attributable to risk management activities and a host of other items grouped under “Other”.
Risk management activities present a complex issue. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. In this case, the KMP risk management activities items reflect proceeds from termination of interest rate swap agreements rather than commodity hedging and I therefore exclude them.
Items in the “Other” category include numerous adjustments as detailed in Table 4 below:
|Total non-cash compensation adj. ("certain items" netted)||7||8||0|
|Total impairment and reserve adj. ("certain items" netted)||-129||-74||-206|
|Equity in earnings of unconsolidated investment, net of distributions||-43||-25||-3|
|Interest of non-controlling partners in net income||17||10||11|
|Other (no information provided; with "certain items" netted)||-77||156||3|
Table 4: Figures in $ Millions
These adjustments further illustrate the complexity and subjectivity surrounding DCF calculations and highlight the difficulty of comparing MLPs based on their reported DCF numbers. For example, as indicated by Table 4, depreciation added back for purposes of deriving management’s reported DCF exceeds the amount in the cash flow statement because it includes KMP’s share of depreciation in various joint ventures. I therefore exclude these adjustments from my definition of sustainable DCF.
Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:
|Distributions declared per LP Unit||$1.29||$1.16||$4.98||$4.61|
|DCF per LP unit as reported||$1.35||$1.27||$5.07||$4.68|
|Sustainable DCF per LP unit||$0.78||$1.32||$4.12||$4.49|
|Coverage ratio based on reported DCF||1.04||1.1||1.02||1.01|
|Coverage ratio based on sustainable DCF||0.6||1.14||0.83||0.97|
In 2012 management wrote down by $829 million the value of assets to be disposed by KMP as a result of the FTC mandate in connection with the El Paso acquisition. In 2011 asset write-downs totaled $177 million. Management includes these write-downs in its definition of “certain items” and thus does not adjust DCF downwards. I am not comfortable viewing these as one-time adjustments (and therefore simply disregarding them, as does management), especially when they repeat themselves. Hence the significant differences between reported and sustainable DCF. Perhaps I am being too conservative, but I don’t like giving management a “free pass’ on writing down asset values and am not entirely convinced by the “no cash impact” argument.
Table 6 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:
Simplified Sources and Uses of Funds
|Capital expenditures ex maintenance & net of proceeds from sale of PP&E||370||-962|
|Acquisitions, investments (net of sale proceeds)||-3,573||-1,305|
|Other CF from investing activities, net||-13||-|
|Other CF from financing activities, net||-25||-36|
|Net cash from operations, less maintenance capex, net income from non-controlling interests, & distributions||364||447|
|Cash contributions/distributions related to affiliates & noncontrolling interests||107||29|
|Debt incurred (repaid)||1,243||1,090|
|Partnership units issued (retired)||1,636||955|
|Other CF from investing activities, net||-||62|
|Net change in cash||109||280|
Table 6: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $364 million in the TTM ended 12/31/12 and by $447 million in corresponding prior year period. In light of the low distribution coverage ratios noted in Table 5, how can this excess be explained? I believe the capital structure of the Kinder Morgan partnerships provides an answer. Kinder Morgan Management, LLC (KMR) owns approximately 31% of KMP in the form of i-units that receive distributions in kind. I estimate that had these units received cash instead, the $364 million excess would have been reduced by ~$572 million ($4.98 times an average of ~115 million i-units outstanding) and thus there would have been a shortfall for the TTM ended 12/31/12.
Table 7 below compares KMP’s current yield to some of the other MLPs I follow:
|As of 2/26/13:||Price||Quarterly Distribution||Yield|
|Magellan Midstream Partners (MMP)||$49.28||$0.50||4.06%|
|Plains All American Pipeline (PAA)||$54.30||$0.56||4.14%|
|Enterprise Products Partners (EPD)||$55.79||$0.66||4.73%|
|El Paso Pipeline Partners (EPB)||$41.00||$0.61||5.95%|
|Kinder Morgan Energy Partners (KMP)||$86.09||$1.29||5.99%|
|Targa Resources Partners (NGLS)||$40.97||$0.68||6.64%|
|Williams Partners (WPZ)||$49.37||$0.83||6.70%|
|Energy Transfer Partners (ETP)||$46.98||$0.89||7.61%|
|Buckeye Partners (BPL)||$53.72||$1.04||7.73%|
|Regency Energy Partners (RGP)||$23.52||$0.46||7.82%|
|Boardwalk Pipeline Partners (BWP)||$25.74||$0.53||8.28%|
|Suburban Propane Partners (SPH)||$41.87||$0.88||8.36%|
KMP has achieved compound annual growth rates in cash distributions to its limited partners of 8.0%, 5.8% and 7.4%, respectively, for the one-year, three-year and five-year periods ended December 31, 2012. Management expects to declare distributions of $5.28 per unit for 2013, up 6% from 2012. The management team is strong, there are good organic growth opportunities, and KMP has a history of impressive performance for its limited partners.
However, despite including earnings from dropped-down assets for periods prior to their acquisition, sustainable DCF for the trailing 12 months ended 12/31/12 did not improve compared to the prior year period and, in fact, declined on a per unit basis. Coverage ratio based on sustainable DCF is below for 2012. Another factor to consider is the high cost of capital resulting from the need to allocate ~50% of available cash flow to KMI. At the 2012 distribution level, KMI received ~ 51% of all quarterly distributions of available cash (~45% attributable to KMI’s general partner and ~6% attributable to KMI’s limited partner interests). Also, KMP has undertaken significant acquisitions to fuel growth, most recently acquiring Copano Energy LLC (CPNO) before having fully digested the drop-downs from KMI’s acquisition of El Paso Corporation. In the 9 months ended September 30, 2012, CPNO generated $4 million of EBITDA and $182 million of Adjusted EBITDA. The ~$5 billion price tag (including debt assumed) is therefore very expensive and could only be made accretive for KMP unitholders by having KMI forgo some of its incentive distribution rights (an amount yet to be determined in 2013, $120 million in 2014, $120 million in 2015, $110 million in 2016 and annual amounts thereafter decreasing by $5 million per year from this level). In addition to issuing ~36 million units to CPNO shareholders, KMP will also need to issue units to pay KMI for the remaining 50% ownership interest in EPNG (owner of the El Paso and Mojave natural gas pipeline systems); and EPMIC (the joint venture that owns both the Altamont natural gas gathering system, processing plant and fractionation facilities located in the Uinta basin of Utah, and the Camino Real natural gas and oil gathering system located in the Eagle Ford shale formation in South Texas).
I therefore remain on the sidelines with respect to KMP. KMI which yields ~4.1% but is expected to grow distributions at ~9% per annum (albeit down from the prior guidance of 12.5% per annum) may be a better alternative.