Cash cow businesses are great, but often don't have much growth potential. While companies hate to part with a segment that generates predictable cash flows, Wall Street can get finicky if overall results are dragged lower because of such holdings. The energy industry can do something about it that most others can't. Kraft (UNKNOWN:KRFT.DL) and Mondelez (NASDAQ:MDLZ) are a perfect example of why you might like the plans taking shape at Dominion Resources (NYSE:D) and CONSOL Energy (NYSE:CNX).
The new Kraft is basically made up of the "old Kraft's" U.S. products, including Oscar Mayer and Jello. While these are well known brands, growth opportunities in the economically mature United States are minimal. Most efforts are focused on market share fights.
Mondelez, meanwhile, took on the "old Kraft's" international brands, like Cadbury and Oreo, with a particular focus on snacks and developing markets. Although management has had some troubles executing on the post-split promises laid out, emerging markets hold more growth potential than the United States. As these nations' economies mature, more will be spend more on brand-name goods.
No way to do it
"Old Kraft" was a cash cow business helping to finance a growing international one. But to appease investors seeking more growth, the company split apart—it was, basically, the only choice. That's an issue facing most companies with cash cow businesses, but energy companies can actually "sell" their cash cow businesses and still retain control of them.
While that sounds like a neat trick, it isn't and giant midstream player Kinder Morgan (NYSE:KMI) is a good example. The company controls 80,000 miles of pipelines and 180 terminals. However, it doesn't actually own all of the assets it controls. Kinder Morgan Energy Partners (UNKNOWN:KMP.DL) and El Paso Pipeline Partners (UNKNOWN:EPB.DL) own many of them.
What Kinder Morgan owns, in addition to shares of each limited partnership, is their respective general partner interests. The general partner runs a limited partnership on behalf of the limited partners (often individual investors). It gets paid a fee and, usually, incentives based on the distributions paid to limited partners. This means that the general partner controls, but does not own, the assets and benefits from any growth at these businesses via incentive distributions. That's a neat trick.
Two worth watching
Dominion Resources is a large and diversified energy company, with over 23,000 megawatts of power generation, 11,000 miles of natural gas pipelines, 6,400 miles of electric transmission lines, and, "one of the nation's largest natural gas storage systems with 947 billion cubic feet of storage capacity..."
The company is also among the first to receive permission to build a liquified natural gas export facility. Dominion's Cove Point facility already has two customers lined up with 20-year service agreements for all of the port's capacity. This is a perfect example of a cash cow business, and Dominion is looking to set up a limited partnership to own it and some of its pipeline assets. In this instance, selling those LP units could help pay for the project, keeping Dominion's costs low while allowing it to retain control of the port and benefit from it's growth.
CONSOL Energy (NYSE:CNX) is considering an LP for its natural gas gathering assets. The company recently sold about half of its coal business so it could refocus around gas drilling. Pipelines are a key part of that effort, but they are expensive to build and aren't growth oriented. For a company focusing on drilling, pipelines can be a burden.
However, if CONSOL sets up an LP, it could sell ("drop down") the pipeline assets and still control them. That would give it more capital to put toward drilling and ensure that its gas will get to market. Of course incentive distributions will also ensure it gets a piece of the LP's growth, too.
CONSOL and Dominion aren't unique in their desires to set up LPs. The energy industry is making increasing use of this beneficial structure. However, both are large and financially stable companies where an LP would support key growth initiatives. Income investors should watch the progress of these potential LPs. Growth investors, meanwhile, might like CONSOL and Dominion more after the assets are "sold."
Warren Buffett is all over energy companies these days. What else can we learn?