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Kinder Morgan 4Q13 Results: “You Sell, I Buy”

KMP’s earnings and DCF per unit came in better-than-expected, but the beat was driven by higher E&P spending and production, and lower sustaining CapEx.  A low-quality beat, in our view.  KMP's Natural Gas Segment volume growth is anemic – concerning given +$1 billion of “growth” CapEx in that segment last year.  KMI was slightly disappointing with an EPS miss and no dividend increase from 3Q13; interestingly, it was KMI who was in the market buying back stock after the disappointing 2014 guidance in early December.  No KMI warrants were repurchased in the Q.   EPB was weak, as expected.  Poor EPB.

 

The conference call was short on forward guidance given the Analyst Day in two weeks, but long interesting commentary from CEO Rich Kinder, including “You sell, I buy!”

 

We’ll have more to say on the Kinder Complex on the other side of the Analyst Day (1/29/14) and the 2013 10-Ks.  No change in our negative view here.

 

KMP

  • KMP reported EPU (before certain items) of $0.77 in 4Q13 (+2.7% YoY), which was better than the $0.73 consensus estimate, and $2.42 in 2013 (+4.8% YoY).  The headline number – DCF/unit – came in at $1.44 in 4Q13 (+6.7% YoY), also better-than-expected, and $5.39 in 2013 (+6.3% YoY).  The “payout ratio” (distribution-to-earnings per unit) was 177% in 4Q13 and 220% in 2013; payout ratios continue to creep higher, supportive of our bearish view (we are not in the “earnings don’t matter” camp).  KMP’s “coverage ratio” (headline DCF-to-distribution per unit) was 1.06x in 4Q13 and 1.01x in 2013.  KMP’s E&P ops and lower sustaining CapEx drove the “beat.”  SACROC oil production jumped 9% QoQ, and realized oil/NGL prices were strong.  Sustaining CapEx was $117MM in 4Q13 (+5.4% YoY), and $327MM in 2013 (+14.7% YoY).  This growth in sustaining CapEx pales in comparison to the growth in Segment DD&A (in our opinion, a reasonable proxy), which was +29% in 4Q13 and +34% in 2013.  We believe that that’s largely a function of KMP under-reporting Copano and E&P sustaining CapEx.  Sustaining CapEx for 2013 came in $12MM below KMP’s guidance, despite the fact that Copano was not included in that guidance, which seems questionable.
  • KMP’s EOR production surprised to upside, but at what cost?  In 2013, KMP spent ~$475MM in E&P organic CapEx and at least $285MM in E&P acquisitions, for total capital expenditures of ~$760MM.  And how much of that was allocated to sustaining CapEx?  ZERO.  An analyst asked on the call yesterday if Kinder Morgan would consider divesting the E&P assets.  The answer, of course, was ‘no.’  This is the KMI gravy train, it’s not going anywhere.  KMP’s net oil production was +7% in 2013, but E&P costs incurred will be up over 100% YoY, and nearly double the ~$400MM guidance put out at the start of the year.  We look forward to the 2013 F&D results in the 10-K to see just how strong this year was for KMP’s E&P operations.
  • KMP’s CO2 segment continues to disappoint.  SW Colorado CO2 production was flat YoY despite major CapEx (at least $200MM), and the Company took down its CO2 growth guidance from an additional 800 MMcf/d by 2017 last quarter to an additional 700 MMcf/d by 2017 this quarter.  We believe that the McElmo Dome project is letting KMP down.
  • Most concerning to us in this quarter’s results is the anemic volume growth in KMP’s Natural Gas segment.  For 2013 compared to 2012, transport volumes were -2%, sales volumes were +2%, and gathering volumes were -2%.  KMP’s Natural Gas Segment growth CapEx (pro forma) is likely running ~$1.2 - $1.5 billion on an annual basis, and sustaining CapEx at only ~10% of that.  It doesn’t make sense, and it’s a major headwind for KMP.  This is the issue with KMP’s sustaining CapEx definition – KMP faces capital structure dilution as new “growth” or “expansion” projects do not generate pure incremental DCF, but at least in part replace cash flow declines from other assets.  How much capital did KMP spend on new well connections over the last year for ­down gathering volumes?  How much of that CapEx was sustaining CapEx?
  • KMP has similar issues in its Bulk Terminals business, where volumes were down 7% YoY in 2013.  Again, it’s nonsensical to have volume declines and growth CapEx.
  • KMP Products had a solid 4Q13 and 2013.  Volumes were up, even in California, and Segment EBDA increased $106MM YoY in 2013 as pipeline expansions ramped up and more than offset the adverse SFPP rate case. 
  • KMP’s 4Q13 total CapEx was ~$1 billion, about flat with 3Q13.  With KMP’s 2014 growth CapEx guidance at $3.6B, it looks like the CapEx run-rate for KMP is firmly at $1 billion per quarter, before acquisitions. 
  • Did management say on the call that sustaining CapEx would be up $100 million in 2014?  They may have let that slip…  If true, that’s likely higher than most analysts are modeling, though not surprising to us, and still not even close to where it needs to be to prevent dilution at KMP over the long-term.

KMI

  • KMI’s results were a bit soft with 4Q13 EPS of $0.33 coming in below consensus at $0.35.  The quarterly dividend held flat at $0.41, which probably gives the bulls some concern.
  • The interesting thing here is that KMI repurchased 5.2MM shares in the Q for $172MM – an average price of $33.08/share.  That means that KMI came in and aggressively bought stock in early December when the stock dropped after disappointing 2014 guidance.  This was the only time that KMI traded near $33/unit in the Q.  We were wondering what was going on with KMI at the time, now we know.
  • KMI did not repurchase any warrants in 4Q13, which could put a dent in the bull case for that particular security.
  • KMI has no plans on amending the KMP Partnership Agreement with respect to how it defines and calculates sustaining CapEx.

EPB

  • EPB reported EPU (before certain items) of $0.48/unit in 4Q13 (-23% YoY!), and $1.88/unit in 2013 (-14% YoY).  DCF/unit was $0.66/unit in 4Q13 for 1.02x distribution coverage, but the “payout ratio” jumped to 135% in 4Q13 from 98% in 4Q12.  As announced in early December, EPB has halted distribution growth, and it likely won’t be long before coverage slips below 1.00x and KMI takes more cash than it should from this MLP.
  • Sustaining CapEx was $15MM in 4Q13, down 12% YoY, even as the asset base grew in size, as evidenced by DD&A up 17% over the same period.  In 4Q13, EPB’s sustaining CapEx fell to just 28% of DD&A.  Recall that EPB’s sustaining CapEx as a % of DD&A was +60% in the years prior to the Kinder/El Paso deal.
  • Transport volumes were -3.0% YoY in 4Q13 and -4.7% YoY in 2013 – not good.

 

Kevin Kaiser

Managing Director


[video] Keith's Macro Notebook 1/16: UST 10YR GOLD #GROWTHDIVERGENCES


All-Time Is a Long Time

Client Talking Points

UST 10YR

Dollar Up, Rates Up, Stocks Up – that’s the US growth signal I want to see. So, with rates backing off into yesterday’s close (at a lower-high on the 10-year yield with TRADE resistance now 2.92%), it’s a good time to take gross long exposure down and tighten your net some again. Incidentally, the SPX risk range now is 1835-1852.

GOLD

I’d be buying/covering Gold along that line of thinking again too (I’m risk managing Gold both ways using rates as my leading indicator). Gold is signaling higher-lows of support ($1233 then $1215) as the 10-year yield signals lower-highs.

#GrowthDivergences

Current growth divergences (one of our Q1 Macro Themes) is actually pretty obvious from a Global Equity market read-through perspective. In our model, it's all about the rate of change. And its relative too. Take a look around... Greece, Portugal, and Denmark up between 6-11% year-to-date. Now cast your eyes upon China, Japan and Brazil down 3-4% year-to-date. It makes for a great macro tape for country picking equities.

Asset Allocation

CASH 27% US EQUITIES 18%
INTL EQUITIES 20% COMMODITIES 8%
FIXED INCOME 0% INTL CURRENCIES 27%

Top Long Ideas

Company Ticker Sector Duration
GHL

Hedgeye's detailed and constructive view on the improving fundamentals in the M&A market with a longer term perspective is a contrarian idea at odds with the rest of the Street which is overly focused on short-term results. From an intermediate term perspective, M&A is poised to break out in 2014. We are witnessing record amounts of cash on corporate balance sheets, continued low borrowing costs and the first positive fund raising round for Private Equity in four years. Moreover, a VIX in secular decline (this has historically benefited M&A), recent incrementally positive data points from leading M&A firms that dialogue has improved, and an improving deal tally from Greenhill & Company (GHL) themselves coming out of the summer all bode favorably for GHL. So is a budding European economic recovery that would assist a global M&A market that has been range bound over the past three years. GHL stands out as a leading beneficiary of these developments.

FXB

We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road

TWEET OF THE DAY

US stocks close at all time highs (again); I’d sell some of what you bought Monday on green @KeithMcCullough

QUOTE OF THE DAY

Courage is not something that you already have…Courage is what you earn when you’ve been through the tough times and you discover they aren’t so tough after all. -Malcolm Gladwell

STAT OF THE DAY

China’s holdings of U.S. Treasuries increased $12.2 billion to a record $1.317 trillion in November. (Bloomberg)


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ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks

Takeaway: Both mutual funds and ETFs flagged fixed income inflows for the first week of the year with outflows across the board in equities

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Total equity mutual funds experienced moderate outflows for the first week of 2014 with $646 million flowing out of stock funds for the week ending January 8th. Within the total equity fund result, domestic equity mutual funds lost $3.3 billion, the biggest outflow in a month, with international equity funds posting a $2.7 billion inflow. This weekly loss of $646 million now serves as the running 2014 average and compares to the solid equity inflows experienced in 2013 which put up a $3.0 billion inflow per week. 

 

Fixed income mutual funds broke their dour stretch of 14 consecutive weeks of outflow with the first net subscription last week in three and a half months. In the week ending January 8th, total fixed income mutual funds produced a $2.6 billion inflow which broke out into a $2.9 billion inflow into taxable bonds and a $347 million outflow in tax-free bonds. This week's $2.6 billion inflow now serves as the 2014 weekly average which is an improvement for now against the 2013 weekly average in fixed income of a $1.5 billion outflow.

 

ETFs experienced mixed trends but essentially followed the direction of mutual funds with an outflow in passive equity funds and an inflow into bond ETFs. Stock ETFs lost $1.3 billion for the 5 day period ending January 8th with bond ETFs experiencing a $778 million inflow. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $5.4 billion spread for the week ($1.9 billion of total equity outflows versus $3.4 billion in fixed income inflows - negative numbers imply inflows for bonds). This result was the best week for total fixed income in 17 weeks and compared to the 52 week average of a $7.3 billion spread (positive spread to equities) but was well off of the 52 week high of $30.9 billion (positive spread to equities) and the smallest equity/debt weekly spread of -$9.2 billion (negative numbers imply a net inflow into bonds for the week).

 

We estimate that the strong return for stocks to end 2013 and the negative return for bonds to end last year may be resulting in an institutional re-balance to start 2014. In a hypothetical 60/40 portfolio of stocks/bonds, the returns in the broader averages of 30% in the S&P 500 and a negative 2% for the Barclay's Aggregate Index would mean an institutional portfolio would need to sell 6% of its stock holdings and buy 6% more in bonds, which may account for the year-to-date start in the asset classes (bonds outperforming stocks to start '14) with then mutual fund and ETF flows chasing this performance.


 

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart11

 

 

For the week ending January 8th, the Investment Company Institute reported moderate equity outflows from mutual funds with $646 million flowing out of total stock funds. The breakout between domestic and world stock funds separated to a $3.3 billion outflow from domestic stock funds and a $2.7 billion inflow into international or world stock funds. These results for the most recent 5 day period now serve as the year-to-date average for 2014 being they are the first week of the New Year and compare to the 2013 results of a $451 million average weekly inflow into domestic funds and a $2.6 weekly subscription into international or world funds for a total of a $3.0 billion weekly inflow average for last year.

 

On the fixed income side, bond funds broke their streak of 14 consecutive weeks of outflow for the 5 day period ended January 8th, with inflows into bond products for the first time in over 3 months. The aggregate of taxable and tax-free bond funds booked a $2.6 billion inflow, the first net weekly inflow since the $1.7 billion that came into bond fund the week ending September 25th. Taxable bonds carried the load with a $2.9 billion inflow, which was net against another outflow in municipal or tax-free bonds of $347 million. Intermediate term trends in fixed income are still negative with taxable bonds having had outflows in 27 of the past 33 weeks and municipal bonds having had 33 consecutive weeks of outflow. 

 

Hybrid mutual funds, products which combine both equity and fixed income allocations, continue to be the most stable category within the ICI survey with another $880 million inflow in the most recent 5 day period, although the past 6 weeks have been below the recent 52 week average for 2013 of $1.5 billion per week. Hybrid funds have had inflow in 31 of the past 33 weeks.

 

 

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart2

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart3

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart4

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart5

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart6

 

 

Passive Products:

 

 

Exchange traded funds had mixed trends within the same 5 day period ending January 8th but essentially followed the asset allocation flows within mutual funds last week. Equity ETFs posted a weak $1.3 billion outflow in the most recent 5 day period, breaking a streak of 7 consecutive weeks of positive equity ETF flow. The 2014 weekly average for stock ETFs is now this recent $1.5 billion outflow, which compares to last year's $3.4 billion weekly average inflow.

 

Bond ETFs experienced moderate inflows for the 5 day period ending January 8th with a $778 million subscription, an improvement from the week prior which lost $224 million and now also an improvement from the new annual comparison of a $234 million weekly inflow for 2013. Bond ETF trends have been perfectly mixed over the past 10 weeks, with 5 weeks of inflow and 5 weeks of outflow.

 

 

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart7

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart8

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $5.4 billion spread for the week which favors fixed income ($1.9 billion of total equity outflows versus $3.4 billion in fixed income inflows - negative numbers imply inflows for bonds). This result was the best week for fixed income in 17 weeks and compared to the 52 week moving average of a $7.3 billion spread (positive spread to equities) but was well off of the 52 week high of $30.9 billion (positive spread to equities) and the smallest equity/debt weekly spread of -$9.2 billion (negative numbers imply a net inflow into bonds for the week).

 

We estimate that the strong return for stocks to end 2013 and the negative return for bonds to end last year may be resulting in an institutional re-balance to start 2014. In a hypothetical 60/40 portfolio of stocks/bonds, the returns of the broader averages of 30% in the S&P 500 and a negative 2% for the Barclay's Aggregate Index would mean an institutional portfolio would need to sell 6% of its stock holdings and buy 6% more in bonds which may account for the year-to-date start in the asset classes (bonds outperforming stocks to start '14) with then mutual fund and ETF flows chasing this performance. 

 

 

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart9

 

ICI Fund Flow Survey - First Inflow Into Bonds in 14 Weeks - ICI chart10

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA

 



Where We Are

“The task of the leader is to get his people from where they are to where they have not been.”

-Henry Kissinger

 

Where we are from a US stock market perspective is not that complicated. With the SP500 and Russell 2000 closing at 1848 and 1171, respectively yesterday, we are at all-time highs.

 

Yes, all-time is a long time. And, yes, when I say “we”, I’m not talking about them. While my views might rub them the wrong way sometimes (them being the other team, or the other side of the trade), that means I’m just doing my job. I don’t play for them.

 

The aforementioned quote comes from page 59 of Unusually Excellent. The chapter is called “Being Compelling – The Commitment To Winning.” In spite of my many human flaws and countless mistakes, that is my commitment to both you and my team.

 

Back to the Global Macro Grind

 

Winning in this game (or in life for that matter) doesn’t start and end with feeling like we’re winning an argument. I personally have too many silent arguments in my head throughout a week to count – and if I’m not losing some of those, I’m not growing.

 

Arguing with the score of the game is harder to do than simply dismissing the other side of what you think. I just read an article about a hedge fund in Greenwich, CT that got smoked last year (and closed the fund). The head of the firm blamed a macro market that was “dislocated from fundamentals.” I guess that was easier than blaming himself.

 

This, of course, has been one of the best 13-14 month periods to be invested in “growth”, as an investment style factor, ever. Particularly if you are a macro guy (or gal) who was net long growth equities and short slow-growth yielding bonds (or stocks like Kinder Morgan (KMI), which missed last night, that look like bonds). #Fundamental, it was. Indeed.

 

But that is yesterday’s news…

 

Where we go today, tomorrow and the next day are places we have never been.  My job is to help both you and my firm get there without having to make excuses for wrong turns along the way

 

So let’s start with what matters most about where we are – our position:

  1. CASH = 27%
  2. Foreign Currencies = 27% (we still like the Euro, Pound, Kiwi, etc.)
  3. International Equities = 20% (we still like most of Europe, especially Germany and the UK)
  4. US Equities = 18% (Tech, Healthcare, Financials, Industrials, and Materials)
  5. Commodities = 8% (Coffee, Cattle, Copper – and maybe some Gold)
  6. Fixed Income = 0%

Explaining 1-6 in reverse is pretty straightforward:

  1. Fixed Income 0% allocation for 184 days (73% of the time in last 12 months - net short via sovereigns, long corporates)
  2. CRB Commodities Index signaled don’t short last month – still a Bernanke Bubble that popped, but one we can risk manage
  3. US Equities is where we made a Sector Style Shift away from Consumption and Into Inflation (see Q1 Macro Themes deck)
  4. International Equities is the easiest to stick with because the slope of European #GrowthAccelerating is the most obvious
  5. Foreign Currencies will only be easy to stick with if EUR/USD and GBP/USD hold $1.35 and $1.63 TREND supports
  6. Cash, when you are knowingly buying-the-damn-bubble #BTDB in US Equities, is still King at my house

In order to expand on how we think about asset allocation, country and sector/style picking, etc. we do our Global Macro Themes deep dives. If you’d like to review that slide deck, ping us at and you’ll see us refresh our risk management themes on our disruptor (to consensus TV) video platform @HedgeyeTV.

 

One of the videos our all-star offensive line analyst, Darius Dale, and I did this week walks through why we A) like Yen Down, Nikkei Up’s intermediate-term TREND, but B) wouldn’t be aggressive in allocating capital to Japanese Equities on pullbacks until we see some of our key lines of support (for the Nikkei) and resistance (for the Yen vs USD) confirm.

 

Here’s the video link.

 

Where we are from an immediate-term TRADE perspective sometimes deviates from our intermediate-term TREND views. That’s just the way markets (and life) work. Why else would I subject myself to getting up at this un-godly hour to hand bomb immediate-term TRADE lines in my notebook?

 

The alternative to being committed to winning is accepting mediocrity. The Manifestation of Mediocrity in America is something I think I could write a book about. So I’ll end that prickly point with a period. Because, to get a certain kind of person from where they are to somewhere better, sometimes feels like just that. Capitalizing on their frustration wins too.

 

Our immediate-term Global Macro Risk Ranges are now (TREND in brackets):

 

UST 10yr Yield 2.79-2.92% (bullish)

SPX 1 (bullish)

VIX 11.84-13.35 (bearish)

USD 80.74-81.31 (neutral)

Brent 106.12-108.66 (bearish)

Gold 1 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Where We Are - Chart of the Day

 

Where We Are - Virtual Portfolio


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