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Why Investors Shouldn't Worry About Kinder Morgan's Distribution Coverage

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Income plays are all the rage these days, and it's not hard to see why. Interest rates remain near historic lows, which means high payouts are hard to come by. That's why a large-cap energy conglomerate providing a huge yield in such a low-rate environment seems like a great bet. Indeed, Kinder Morgan Energy Partners (UNKNOWN: KMP.DL  ) is one of the most well-known midstream master limited partnerships out there. Even better, Kinder Morgan Energy Partners just gave its investors a distribution increase and now yields 6.5%.

At the same time, investors likely noticed the narrowing distribution coverage ratios across the Kinder Morgan family of securities this quarter. For those who keep a close eye on sustainability, this may have thrown up some red flags. However, in times like these investors would be well-served to focus on broader trends, as well as what management itself has to say about full-year trends, and not get too worked up over one quarter's worth of information. Here's why.

Should investors doubt Kinder Morgan's distribution sustainability?
Kinder Morgan Partners increased its distribution 2.5% on a quarter-over-quarter basis and 7% from a year-over-year perspective. Meanwhile, pipeline subsidiary El Paso Pipeline Partners (UNKNOWN: EPB.DL  ) , which was acquired by Kinder Morgan for $21 billion two years ago, bumped up its own payout by 3% over the previous quarter and 12% from the same quarter last year. Likewise, Kinder Morgan, (NYSE: KMI  ) , which owns the general partner and limited partner interests in both KMP and El Paso, raised its payout by 2.5% sequentially, and 14% over the same payout this time last year.

At the same time, investors may have gotten nervous after recent quarterly results from the various Kinder Morgan entities. Distribution coverage ratios got very tight across the Kinder Morgan family of securities, and in particular, KMP's distribution coverage ratio fell to under 1.0 this quarter, which may raise some concerns.

As a result, it's tempting to worry about whether Kinder Morgan can keep funding such generous payouts in light of the fact that, at least for this quarter, its distribution coverage dropped to dangerous levels.

Don't get bogged down in short-term results
At first glance, investors may be tempted to panic that Kinder Morgan's various entities fell short of covering distributions this quarter. However, to take that view would be short-sighted, in light of the fact that management has long cautioned investors that this would happen. Moreover, it's well-advised to focus on longer-term patterns, and in the case of Kinder Morgan, full-year coverage remains intact.

In fairness, Kinder Morgan Energy Partners has paid $3.97 per unit in distributions and has generated $3.94 in per-unit distributable cash flow over the first nine months of the fiscal year. But there's a big caveat here, which is that management knew this would happen and insists that fourth-quarter coverage will be sufficient enough to cover its distribution for the full year.

El Paso, for its part, has paid $1.90 in per-unit distributions through its first three quarter, and generated $1.96 per unit through the first nine months of the year, so there's no real cause for concern.

Take the long view
As previously mentioned, Kinder Morgan has known for some time that certain quarters this year would see narrowing distribution coverage, and management deserves credit for getting ahead of the issue and providing fair notice to investors. As Kinder Morgan Energy Partners Chief Financial Officer Kim Dang told analysts on the third quarter conference call, "As we've told you all year, we expect coverage to be negative in the second and third quarter, positive in the first and fourth and positive for the full year."

Should management projections prove accurate, investors will have little to worry about. That being said, investors would be wise to monitor Kinder Morgan's progress in the quarters ahead, but for now, I'm inclined to believe Kinder Morgan management. I'm not concerned about Kinder Morgan covering its distributions this year, and I'd advise my fellow investors not to panic either.

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  • Report this Comment On November 07, 2013, at 11:04 PM, alsowrongagain wrote:

    As long as Rich Kinder takes only $1 a year salary and he owns millions of shares and makes over one billion a year on his dividends, he will not lower dividends, but will increase them, wouldn't you?

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