The 2 Biggest Concerns With Kinder Morgan

A pipeline in Panama. Source: Gunvorgroup.

For retail investors, Kinder Morgan is perhaps the best-known midstream pipeline partnership. Despite this, the Kinder Morgan family trades at a substantial discount to other midstream partnership names. The two biggest concerns about Kinder Morgan are that its ownership structure is a bit complicated, with four ticker symbols in all, and also that growth will be difficult for a business that is already so big. 

While it is true that Kinder Morgan may not be growing be growing as fast as many smaller midstream partnerships, such as Williams Partners or Spectra Energy, it is still chugging along and on course to grow distributable cash flow, or DCF, at a mid single-digit clip. 

In a good spot
While the natural gas renaissance rightfully gets the lion's share of attention these days, Kinder Morgan's very strong CO2-injection oilfields operations were actually the brightest of all Kinder Morgan's business segments last quarter: Oil volumes from Kinder Morgan's fields, all of which are in West Texas, grew 7% year over year, with the SACROC field leading the way. 

When considering all three of the Kinder Morgan businesses, which are Kinder Morgan Energy Partners, Kinder Morgan Inc, and El Paso Pipeline Partners, the company's net project backlog increased by $600 million in the second quarter, despite putting $700 million into service. In all, Kinder Morgan added an impressive $1.3 billion to its project backlog. 

Of the $700 million of projects put into service, $500 million was in natural gas, so we can expect DCF from natural gas to pick up the pace in the coming few quarters. One other operational anecdote I believe is worth highlighting is that most new storage and transportation agreements that were signed during this quarter were for existing systems, meaning Kinder Morgan will not have to build out much new capacity for these deals. 

 

A pipeline in Cortez, NM. Source: Kinder Morgan.

How it affects the bottom line
Financially, the first and most important item Richard Kinder mentioned in the most recent conference call is that all businesses are on target to meet and exceed DCF guidance for 2014. Kinder Morgan Inc should grow DCF by 8%, and Kinder Morgan Energy Partners should grow DCF by between 5%-6%.

At a more granular level, per share DCF for Kinder Morgan Energy Partners was up only 1% versus the same quarter of last year, but the partnership usually performs better in the third and fourth quarters. Kinder Morgan Energy Partners' balance sheet remains solid: The debt to earnings before taxes, interest, depreciation, and amortization ratio, or debt to EBITDA, was actually down from 3.8 times at the same time last year to 3.7 times today. 

For Kinder Morgan Inc, cash to pay dividends increased by an impressive 13% versus the same quarter last year. Much like KMP, KMI saw debt levels tick down, in this case, from 5 times EBITDA to 4.9 times. 

Trans Alaska Pipeline. Source: Wikipedia.

Looking at all options 
One theme on the mind of analysts is a simplification of Kinder Morgan's ownership structure. Because Kinder Morgan is more cheaply valued than most other large midstream names, Kinder Morgan cannot access equity markets as well as most other large midstream partnerships can. As a result, Kinder Morgan is at a disadvantage when it comes to acquisitions. While Richard Kinder did not commit to anything specifically, one gets the impression that management is seriously considering reorganization. 

Foolish takeaway
While Kinder Morgan trades at a discount to many other large midstream MLPs, it is doing so in part because of a lower growth rate. However, KMP's 5% growth rate with a yield of 6.8% is certainly not bad. If management does indeed reorganize its ownership structure and is successful at bringing Kinder Morgan up to the valuation of other midstream MLPs, there will be substantial capital gains to be had. Even without a simplification of ownership strucuture, however, both KMP and KMI should deliver solid growth in 2014.

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