3 Key Points From Kinder Morgan’s Q3 Earnings

Editor's note: A previous version of this article incorrectly attributed a share buyback strategy to Kinder Morgan Partners when the buyback strategy was for Kinder Morgan. The Fool regrets this error. 

Kinder Morgan (NYSE: KMI  ) and Kinder Morgan Energy Partners (NYSE: KMP  ) released their respective third-quarter earnings Wednesday afternoon and, outside of the headline distribution increase, some investors were a little underwhelmed by the results. Today I'm looking at three points that may have raised some eyebrows. As always, feel free to participate in the discussion via the comments section at the end of the article.

1. Distributable cash flow per unit
Distributions were up, and distributable cash flow was up on an absolute basis. But because of massive unit dilution, DCF per unit was actually down on a year-over-year basis: In 2012 it came in at $1.28 per unit, while this year it sits at $1.27 per unit.

Kinder Morgan Energy Partners has 79 million more units to pay distributions on compared to the same period last year, so despite also generating more DCF, the per-unit results are disappointing.

2. Distribution coverage ratio miss
This is the second straight quarter that Kinder Morgan missed on its distribution coverage ratio. The goal is to have distributable cash flow generated cover distributions paid. Kinder Morgan generated $554 million in distributable cash flow and paid out roughly $587 million in distributions, which means its coverage ratio was 0.94 times distributions, falling short of the 1.0 times payouts that is standard for pipeline master limited partnerships.

Management expected this, and made us all aware that there would be misses in the second and third quarters, insisting that for the full year the partnership would manage 1.0 times coverage, and everything would be OK.

Regardless, many investors are asking, if you can't make the payments, why is the distribution climbing 7%? It's certainly a fair point, and acceptance of management's two-quarter dismissal comes down to how much investors trust said management.

Kinder Morgan does not have the distribution increase history of an MLP like Enterprise Products Partners; it has held its payouts flat in the past, including four straight quarters in 2009 and 2010, and one quarter in 2012.

If management did not think that it could cover its distributions for the full year, there is reason to believe, based on recent history, it would not have increased them this time around.

That said, you can bet if Kinder Morgan doesn't hit that full year coverage ratio, it will sell off in January. For reference, the partnership's distribution coverage ratio through the first nine months of the year is sitting at 0.99 times payouts, so it's quite close.

3. Growth picture
It was easy to ignore the canned response on future growth, but there may not be a more important statement in the partnership's press release than this one:

We continue to see robust growth opportunities across all of our business segments and currently have identified approximately $13.3 billion in expansion and joint venture investments at KMP that we are confident will come to fruition.

Let's not kid ourselves: $13.3 billion is an awfully large sum of money (remember that the big Copano acquisition came in at $5 billion). There has been so much talk of M&A activity ramping up in this space that I find it hard to believe that Kinder Morgan is going to spend $13.3 billion without some part of that going toward another acquisition. Ideally, management will get that share count down before another buy, but we'll just have to wait and see.

Final word
Beyond that, it's an exciting time to be in the natural gas transportation business, and it's important to remember the macro story in the midst of all the hooting and hollering over quarterly earnings. Kinder Morgan's main business is natural gas pipelines, and that is going to be a crucial asset in the American energy story for years to come.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2013, at 11:36 AM, wehart55 wrote:

    I am always suspect when I see sentences beginning with "Obviously". (as in "Obviously, a share buyback would help the DCF/unit situation.")

    When I listened to the earnings call this week, I heard the management team talk specifically about buying back shares and warrants for KMI. I did not hear any discussion of buying back units of KMP. Given the IDR structure, the massive increase in units outstanding for KMP will trigger significant growth in cash to KMI and a buyback of KMI shares and warrants will accelerate the growth in cash available for dividends per share of KMI.

  • Report this Comment On October 20, 2013, at 1:11 PM, toomuchgas wrote:

    Where will they get the free cash to buy back units if they are paying 100% for distributions.

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