Image source: Kinder Morgan, Inc. 

For the most part, Kinder Morgan (NYSE:KMI) has at least met expectations this year, if not exceeded them. For example, the company said it would spend the year working to improve its balance sheet to push its leverage ratio below 5.5 times debt to EBITDA by the end of this year. However, thanks to several strategic initiatives, the company should end the year with a 5.3 times leverage ratio. That said, the company's financial results have missed expectations, with management forecasting that adjusted EBITDA will be roughly 3% below budget while distributable cash flow should end the year 4% below the projection. One of the main culprits is the disappointing results in the company's products pipeline segment.

Drilling down into the results

As the chart below shows, all but one of Kinder Morgan's segments have delivered earnings growth through the first nine months of the year:

Data source: Kinder Morgan. Dollar figures in millions. Chart by author.

The lone laggard is the carbon dioxide segment, which is down 20% year over year. However, the company expected as much due to this segment's direct exposure to commodity prices. While oil prices have been higher than forecast and costs have come in under budget, production has trailed expectations. That said, the company still expects this segment to produce roughly $916 million in earnings, which is spot on with the budget that results would be down 20% from the prior year.

One of the factors offsetting this decline and keeping earnings relatively flat this year is the company's products pipeline segment, where EBITDA is up 5% year to date. Driving this growth was the start-up of a second condensate processing facility along the Houston Ship Channel last year, and a year-over-year improvement in the performance of the company's Transmix business due to more favorable market pricing. That said, the company initially expected a lot more from this segment.

Whiffing on expectations

Kinder Morgan budgeted that the product pipeline segment would produce $1.232 billion in adjusted EBITDA, which represented an increase of 12% from last year. However, the company warned early on in the year that it would miss that mark by 5%. Driving the decline was lower crude oil and condensate volumes on the company's KMCC, Double H, and Double Eagle pipelines, lower throughput on KMST, lower rates on the SFP pipeline, and the loss of income due to the sale of the Parkway Pipeline to Valero (NYSE:VLO).

To be fair, the products pipeline segment is not the only one that will miss expectations this year. The terminal segment also expects to be 5% below budget, which is also quite disappointing considering the company expected earnings of $1.195 billion, which represented a 13% year-over-year increase. That said, about 4% of this miss is due to a coal customer bankruptcy earlier this year, which was out of the company's control. Aside from that, Kinder Morgan recently warned that it has been experiencing lower throughput on some of its liquids terminals than budgeted. While that is a disappointment, it is not quite as disappointing as the products pipeline segment, where the company seemed to misjudge expected volumes this year, leading to a big miss on expectations.

One of the major factors driving that miss is the location of the company's pipelines. Both the KMCC and Double Eagle systems serve producers in the Eagle Ford while Double H services the Bakken. Those locations are noteworthy because the oil market downturn hit these shale plays the hardest, forcing oil companies to significantly cut investment spending, which caused production in both regions to fall. In fact, According to data from oil-field service company Core Labs (NYSE:CLB), U.S. onshore production will fall by more than 1.1 million barrels per day this year led by the Eagle Ford, Bakken, and Niobrara plays. That decline rate is a bit higher than Core Labs initially expected, which means less crude is flowing through regional pipelines. While Kinder Morgan secures most of its product pipelines with take-or-pay contracts to insulate it from volume fluctuations, there was enough volume exposure on these systems to make a meaningful difference and cause the company's results to trail expectations. That said, given the flexibility of shale production, these regions should be among the first to ramp back up as oil prices rise, which could result in stronger volumes next year

Investor takeaway

Kinder Morgan expected a great year from its products pipeline segment due to recent acquisitions and project completions. Unfortunately, it missed those lofty expectations after sinking shale production caused volumes across several pipelines to come in below expectations. Because the company did not expect these volumes to drop off as much as they did, it made this segment's results appear pretty disappointing.