Why Investors Should Add More Kinder to the Fire

Kinder Morgan Energy Partners is at it again, boosting DCF by strong double digits

Jan 22, 2014 at 10:25AM

Investors can be put off by a 6.7% yield as they question its sustainability, but worries should be laid to rest when they see Kinder Morgan Energy Partners (NYSE:KMP) results backing it up. A 26% increase in distributable cash flow for the full year -- up 28% y-o-y in the latest quarter -- allowed Kinder Morgan Energy Partners to increase its distribution to $5.33 in 2013, which is slightly less than the $5.39 in distributable cash flow (DCF) generated per unit. This gives Kinder Morgan Energy Partners a coverage ratio of just a little over one, but as long as it keeps growing like this that will move upwards starting this year.

Management is guiding for 2014 earnings to come in at $6.4 billion, which is $750 million more than Kinder Morgan made in 2013. With the amount being spent on capex growing to $3.6 billion over $3.5 billion last year, Kinder Morgan Energy Partners should be able to generate plenty of additional DCF this year. Kinder Morgan Energy Partners plans on paying out $5.58 per unit in 2014, which would be an increase of 5% over last year.

It looks as if Kinder Morgan Energy Partners distribution is safely protected if all goes well, but how does it plan to meet its guidance?

Expand, expand and expand some more
The Eagle Ford is a booming shale play that needs infusions of capital to support additional output. In this frenzy, Kinder Morgan Energy Partners has teamed up with Magellan Midstream Partners (NYSE:MMP) to expand the capacity of their 50/50 joint venture Double Eagle Pipeline to 150,000 bpd, a 50% increase from current levels.

This expansion will be supported by the joint venture creating a new pump station and 160,000 barrels of storage capacity that will be linked by building out a 10-mile pipeline system around Gardendale, Texas. On top of this, Kinder Morgan Energy Partners will build 240,000 barrels of storage capacity at its Helena Station.

Money will be rolling in from all angles for both Magellan Midstream Partners and Kinder Morgan Energy Partners starting in the second half of 2014 when the expansion is completed. Kinder Morgan Energy Partners does a great job of leveraging its assets to boost growth, which has allowed the company to raise its distribution 50 times since 1997.

Arrrgh matey!
Kinder Morgan Energy Partners isn't just looking at the ground either, it has set its sights toward the high seas with the purchase of five Jones Act medium-range product tankers, each with the ability to store 330,000 barrels on average.

Why is the Jones Act important? Well its an obscure rule dating back to 1920, dictating that all trade between US ports must be done with ships constructed in the US. This severely limits the supply of tankers able to move gasoline and other petroleum products across America. One example is shipping from the refinery complex in the Gulf of Mexico to Northeastern markets up along the East Coast.

What happens when demand outstrips supply?
ExxonMobil recently set a record when it renewed its contract for a 337,000 barrel Jones Act tanker at $110,000 a day, which was a 50% increase from this summer. As demand for these types of ships keeps increasing due to rising petroleum production, rates will keep going up as supply can't keep up.

Why can't supply keep up with demand? Because there are fewer than 50 ships moving crude oil and petroleum products between US ports, with a quarter of them moving crude back and forth between Alaska and the West Coast.

It takes a long time for these vessels to be built and they are, at times, five times more costly than tankers made in Asia. So unless there is any change in legislation, rates only have once place to go but up as US crude and petroleum output rise towards a record. To get an idea of the economic ramifications of this law, it costs $2 a barrel to ship petroleum products from the Gulf Coast to Canada but $5-6 a barrel to ship to the East Coast.

Foolish conclusion
Even though the coverage ratio is close to one, acquisitions and expansions will shore that up quickly. Adjusted earnings are expected to rise by 13.3% while capex will rise by only 3%, boosting distributable cash flow.

As one of the largest midstream operators in America with a plan to continuously grow, Kinder Morgan Energy Partners is great for anyone looking to balance income with growth in an investment. 

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Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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