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KMP: A Close Look at the K

Kinder Morgan Energy Partners (KMP) - one of our Best Ideas on the short side (since September 2013) - released its 2013 10-K on 2/18.  As part of our process, we closely review the SEC filings of our Best Ideas.  In our experience, companies press release what they want to disclose and file what they have to disclose.  We discuss six key topics from KMP's 2013 10-K in this note:


1.  KinderHawk may lose ~$120MM in annual EBDA over the next two years

2.  E&P results were weak in 2013 

3.  KMP's Goldsmith PV-10 begs further questions

4.  New maintenance CapEx definition and added disclosure

5.  On KMP’s rate cases and potential refunds

6.  Miscellaneous quotes, comments, and questions from the 10-K




1.  KinderHawk may lose ~$120MM in annual EBDA over next two years......The table on page 13 of KMP's 2013 10-K has new disclosure related to throughput of KMP's Natural Gas segment pipeline assets.  Some interesting trends there, but the two that jumped out at us were Texas/Tejas throughput down 14% and KinderHawk throughput down 30% in 2013.  This is particularly interesting given that Texas/Tejas EBDA was up 5% (+$16MM) and KinderHawk up 8% (+$13MM) in 2013 (2013 10-K, pg. 59).  Significant volume declines coupled with increased profitability is likely a function of automatic volume/price step-ups in contracts and/or cost cuts - and likely means that EBDA will drop hard when contracts start to roll off.  We believe that this will happen in a big way at KinderHawk, KMP's Haynesville Shale gathering asset, with BHP Billiton as the anchor producer.


BHP Billiton's minimum volume commitment to KinderHawk expires at the end of May 2015 (2013 10-K, pg. 15), at which time EBDA will likely fall hard.  In 2013 KinderHawk throughput was only 668 MMcf/d, 34% below the 2014 minimum volume commitment of 1,010 MMcf/d.  BHP Billiton is directing the majority of its US oil and gas CapEx to its Eagle Ford and Permian assets, so we expect that its Haynesville production will continue to decline.


BHP Billiton discloses enough information regarding the KinderHawk agreement for us to confidently forecast KinderHawks's future EBDA (from BHP's 2/18/14 6-K): 


KMP: A Close Look at the K - bhp disclose


Assuming that KinderHawk throughput continues to decline ~5-10% per year through 2016 (versus down 30% in 2013!), and that the gathering + treating rate ($/Mcf) stays flat (this is likely optimistic given the excess capacity), we estimate that KinderHawk's EBDA will decline $74MM YoY in 2015 and another $45MM YoY in 2016.  Said another way, this asset will generate $211MM of EBDA in 2014 and $92MM of EBDA in 2016, a $119MM hit to DCF.


KMP: A Close Look at the K - kinderhawk


Organic cash flow declines like this are particularly negative for KMP because it has razor-thin distribution coverage, and its maintenance CapEx definition has nothing to do with keeping cash flows that, such that it will take ~$1B of externally-financed "expansion" CapEx (which is 27% of the 2014 budget) just to replace these cash flows.  In other words, more dilution at KMP.


2.  E&P Results Were Weak in 2013......KMP management says that its E&P segment had a strong year in 2013, while the data in the back of the 10-K tells a different story.  The marginal production "beat" is not impressive considering that E&P capital costs incurred came in at $767MM (including the $285MM Goldsmith acquisition), more than double the 2013 guidance of $367MM.  


Further, open EBITDA (i.e. EBITDA before the impact of commodity derivatives) increased only $10MM YoY in 2013 despite open revenues up $144MM.  Production costs (excluding expensed CO2) jumped to $22.48/boe, up 41% from $15.93/boe in 2012.  As a result, KMP's E&P open EBITDA margin fell to 69% ($63.26/boe) in 2013 from 76% ($66.93/boe) in 2012.


KMP: A Close Look at the K - kmp11


On the capital side, the key metric is the Organic Proved Developed Finding and Development (F&D) Cost.  This is where the rubber meets the road - turning capital into production (not PUD reserves).  In 2013, KMP had organic costs incurred of $482MM and added 13.8MMboe of PD reserves including revisions, for an F&D cost of $34.91/boe; this was +46% from $23.86/boe in 2012.  KMP replaced only 90% of production with organic PD reserve additions in 2013, versus 91% in 2012, suggesting that its organic CapEx budget is not enough to maintain PD reserves.  KMP's recycle ratio (EBITDA/boe over F&D/boe) was 1.8x in 2013, down from 2.8x in 2012.  Excluding PD revisions, KMP's 2013 F&D cost was $41.88/boe, +15% from $36.50/boe in 2012.  Reserve replacement was 75%, up from 59% in 2012; and KMP's recycle ratio was 1.5x, down from 1.8x in 2012.  All-in-all, KMP's E&P capital efficiency deteriorated significantly in 2013.


KMP: A Close Look at the K - kmp2a




KMP produced 13.8MM boe in 2013.  In our view, proper maintenance CapEx is the cost of keeping production flat, or replacing produced reserves.  With a PD F&D Cost (ex. revisions) of $41.88/boe, it would cost KMP ~$578MM per year to keep production flat with the 2013 level.  This is in-line with KMP's YE13 Future Development Cost per PUD reserve of $40.89/boe, which was up from $31.12/boe at YE12.




While KMP's production increased 7% YoY to 41,922 boe/d, organic growth was only 3%.  Further, production remains below what it was in 2009, 43,103 boe/d.  Over the last 5 years KMP has spent $2.1B of capital for no production growth, with near $0 assigned to maintenance CapEx.  Given the 50/50 IDR split, that's a +$1B wealth transfer from the LPs to the GP, just since 2009.




KMP's all-in costs (cash costs + F&D) are now ~$65-$70/boe, making it one of the highest cost oil producers in North America.  With the WTI curve steeply backwardated, expect margins and returns to come under more pressure unless KMP can get its expenses and capital costs lower.




KMP's E&P Free Cash Flow (open EBITDA - CapEx) came in at the lowest level since 2009, $486MM before acquisitions and $201MM after acquisitions.  This compares to $648MM of E&P Free Cash Flow in 2012.


KMP: A Close Look at the K - kmp3a 


3.  KMP's Goldsmith PV-10 begs further questions......KMP disclosed that the 12/31/13 PV-10 of the Goldsmith Unit was $843MM; this is 3x what KMP paid for it in June 2013, $285MM.  This is highly questionable, in our view, and suggests to us that there is considerable risk to KMP hitting the Goldsmith production forecast in its PV-10 and long-term budget.  The seller, Legado Resources, worked this asset since 2008 and had ROZ plans as KMP does, as this article demonstrates; Legado was not an uninformed seller.  It appears to us that Legado would have valued the PUD reserves that KMP is assigning the Goldsmith Unit (32.4MMboe) near $0, while the KMP PV-10 of the PUDs is $403MM.  The reserve report warns us about these PUD reserves (our emphasis): 


"It should be noted that proved undeveloped reserves for a CO2 flood in the Goldsmith Landreth Unit (Goldsmith Field) account for 63 percent of the reserves included herein. These reserves were based on volumetric oil-in-place volumes for both the Main Pay and Residual Oil Zone intervals for this project estimated and provided by Kinder Morgan and reviewed by Ryder Scott. Nearby pilots or similar established improved recovery CO2 projects in the Permian Basin area in which the Goldsmith Field is located, were used to determine the appropriate recovery of the oil-in-place volumes"  (Ryder Scott, Exhibit 99.2, KMP 2013 10-K).


Curiously, KMP's PV-10 was flat YoY at $2.7B despite the Goldsmith acquisition.  The PV-10 of the legacy asset base declined by ~$800MM YoY, largely due to negative PUD revisions at the Katz field and an increase in overall future development costs, while the Goldsmith acquisition added ~$800MM of PV-10.  A few questions on our mind: Did KMP acquire and then write-up the Goldsmith Unit PV-10 to ~$800MM in order to compensate for the underperformance of legacy assets?  How much credence should we put in KMP's Goldsmith Unit production forecast given the recent issues at Katz that led to negative PUD reserve revisions this year, as well as the wide bid-ask between the acquisition price and KMP’s PV-10?  And lastly, why shouldn’t the $285MM spent on the Goldsmith acquisition be considered sustaining CapEx?


KMP: A Close Look at the K - kmp4


Lastly, we note that Goldsmith production as of 12/31/13 was 1,230 bbl/d, down from the 2H13 average of 1,300 bbl/d (2013 10-K, pgs. 8 and 20).


4.  New Sustaining CapEx definition and added disclosure......In the 2013 10-K, KMP made a subtle change in its definition of sustaining CapEx and added more disclosure, in what looks to us like an attempt to more closely match the language used in SEC filings to the language in KMP’s partnership agreement. 


From the 3Q13 10-Q (pg. 68) and 2012 10-K (pg. 73): "We define sustaining capital expenditures as capital expenditures which do not increase the capacity of an asset." 


From the 2013 10-K (pg. 74, our emphasis):


“We account for our capital expenditures in accordance with GAAP. Capital expenditures under our partnership agreement include those that are maintenance/sustaining capital expenditures and those that are capital additions and improvements (which we refer to as expansion or discretionary capital expenditures). These distinctions are used when determining cash from operations pursuant to the partnership agreement (which is distinct from GAAP cash flows from operating activities). Capital additions and improvements are those expenditures which increase throughput or capacity from that which existed immediately prior to the addition or improvement, and are not deducted in calculating cash from operations. Maintenance capital expenditures are those which maintain throughput or capacity. Thus under our partnership agreement, the distinction between maintenance capital expenditures and capital additions and improvements is a physical determination rather than an economic one.

Generally, the determination of whether a capital expenditure is classified as maintenance or as capital additions and improvements is made on a project level. The classification of capital expenditures as capital additions and improvements or as maintenance capital expenditures under our partnership agreement is left to the good faith determination of the general partner, which is deemed conclusive.

A few points on this….

  • KMP added “throughput or” to the maintenance CapEx definition.  This is great....  So which is it, throughput or capacity?  Because they can be very different.  Think of a gathering system – if it’s “throughput,” then new well connections needed to hold volumes flat would be included in maintenance CapEx; if it’s “capacity,” then new well connections would not be included in maintenance CapEx.  There's a lot of discretion here.
  • “The distinction…is a physical determination rather than an economic one” = maintenance CapEx has no relation to income, cash flows, etc.
  • “…the determination…is made on a project level” = KMP will not reserve for CapEx for one project that may be needed to replace organic cash flow declines on another (think KinderHawk). 
  • “…the determination…is made on a project level” = What constitutes “a project”?  Is a single oil well “a project”?  Again, there's a lot of discretion here.
  • “…which is deemed conclusive” = What the GP says, goes.

5.  On KMP's rate cases and potential refunds......At the FERC, both SFPP and EPNG are subject to rate cases (2013 10-K, pgs. 159-60).  In the SFPP case, the shippers are requesting $100MM in refunds and a ~$20MM reduction in annual rates.  EPNG is also subject to a FERC rate case; the potential refunds and rate reductions were not disclosed, though KMP noted that a refund will likely be less than $50MM in the 3Q13 10-Q (pg. 32).


SFPP is subject to a separate rate case at the CPUC (2013 10-K, page 160).  The shippers are requesting refunds of $400MM and annual rate reductions of $30MM.  KMP expects a decision in 2Q14.


It is comical that KMP discloses, "we do not expect any reparations that we would pay in [these] matter[s] to impact the per unit cash distributions we expect to pay to our limited partners for 2014" (2013 10-K, pg. 160).  As if this matters – the distribution payment is purely discretionary.  But these rate cases could result in at least a $50MM reduction in annual DCF, as well as a $500MM refund payment that will be financed 100% by KMP unitholders.




KMP's net regulatory asset/liability moved from a $201MM asset as of 12/31/12 to a $64MM liability as of 12/31/13, largely due to this:


"During the second quarter of 2013, we began applying regulatory accounting to the Trans Mountain pipeline systems due to a newly negotiated long-term tolling agreement approved by the system’s regulator that went into effect in April 2013. The primary impact of applying regulatory accounting was the reclassification of approximately $362 million of current and long-term deferred credits to regulatory liabilities. We expect this regulatory liability to be refunded to rate-payers over approximately the next four years" (2013 10-K, page 120).


It's not clear to us how KMP will account for these revenues and expenses as they run through the non-GAAP financials.  Will the $362MM of refunds to be paid over the next 4 years be "Certain Items"?


6.  Other key quotes, comments, and questions from the 10-K……

  • How much of the $504MM Northeast Upgrade expansion project was really maintenance CapEx?  The project’s scope included, “system upgrades at four existing compressor stations and one meter upgrade in New Jersey” (pg. 7).
  • Texas Intrastate relies on new well connections to keep throughput flat, though that CapEx is likely not considered maintenance: “While our intrastate group does not produce gas, it does maintain an active well connection program in order to offset natural declines in production along its system and to secure supplies for additional demand in its market area” (pg. 14).
  • Midcontent Express’s long-term contracts begin to expire in August 2014: “Capacity on the Midcontinent Express system is 99% contracted under long-term firm service agreements that expire between August 2014 and 2020” (pg. 19).
  • Qualifying language regarding the St. John’s CO2 project suggests caution: “As of the date of this report, we are continuing to perform predevelopment activity and test wells; however…” (pg. 21).
  • The completion date of Trans Mountain has shifted back slightly, from “late 2017” to the “end of 2017” (pg. 26).
  • We note the lack of organic volume growth in the entire Natural Gas Segment (pg. 58), CO2 and oil production (pg. 61), and bulk transload tonnage (pg. 66).
  • G&A “Certain Items” totaled $75MM in 2013, with the majority of the expense related to acquisition costs (pg. 70-71); KMP is in business of making acquisitions – these should not be Certain Items, in our view.
  • Management’s quantitative financial performance objectives – which, in part, determine their bonuses – are based only on what KMI, KMP, and EPB pay out in dividends / distributions (pg. 88-89).  This is ridiculous, as distribution payments are discretionary – management can set the distribution at whatever price it wants.
  • Despite the fact that management wants us to believe that DD&A is irrelevant, “When assets are put into service, we make estimates with respect to useful lives (and salvage values where appropriate) that we believe are reasonable. However, subsequent events could cause us to change our estimates, thus impacting the future calculation of depreciation and amortization expense. Historically, adjustments to useful lives have not had a material impact on our aggregate depreciation levels from year to year” (pg. 116).
  • The APT/SCT Jones Act Tanker acquisition became effective on 1/17/14 (pg. 124), yet KMP/KMI still left out its impact on the 2014 budget that is put out at the 1/29/14 Analyst Day.
  • The average ATM financing price in 2013 was $83.22/unit (pg. 138).
  • KMP’s legal reserve increased $207MM YoY to $611MM as of 12/31/13 (pg. 162).
  • KMP discloses the Slotoroff suit, and of course, “Defendants believe that this suit is without merit and intend to defend it vigorously” (pgs. 162-63).


Kevin Kaiser

Managing Director

[VIDEO] Reality Check: 10 Charts on #InflationAccelerating


Starboard Value announced in a 13D filing this morning that it has retained former Olive Garden President Brad Blum to serve as an advisor in its battle against Darden Restaurants.  Starboard will pay $50,000 in cash to Mr. Blum who will, in turn, use the proceeds to purchase Darden stock.


We view this as a favorable development and continue to believe there is the potential for significant shareholder value creation.  I have known Brad since his days at Olive Garden.  In all my conversations about DRI I have made no secret of the fact that I consider Brad uniquely qualified to head up a restructuring and turnaround at the company.  I believe his expertise and experience make him an extremely valuable asset.  A large part of our thesis revolves around the company’s ability to fix the crown jewel: Olive Garden.  We think Mr. Blum could play a critical role in this turnaround and, apparently, Starboard does as well. 


We’ve been publishing extensively on Darden over the past year, including a research note titled “DRI: A Generational Opportunity.”  We continue to believe there is significant upside in DRI as the stock is still trading at a notable discount to its underlying asset value.  The activists recognize this and we believe Starboard’s agreement with Mr. Blum is very bullish for Darden shareholders. 



Howard Penney

Managing Director


Thought Leader Discussion: What’s the Matter with MLP Non-GAAP Metrics?


Julie Hilt Hannink, CFA, Head of Energy Research, CFRA Research

Kevin Kaiser, Managing Director, Energy Sector, Hedgeye Risk Management


Call Details:

Wednesday, February 26th at 11am EST

Participant Dial-In:

Participant Code: 198965#

For anonymous Q&A, send questions to  and 


About the Call:

Julie Hilt Hannink, CFA, of CFRA Research will join Kevin Kaiser of Hedgeye Risk Management for an in-depth discussion of key accounting and regulatory topics in the Master Limited Partnership (MLP) sector: the use and purpose of common non-GAAP metrics (for example, “distributable cash flow” and “maintenance CapEx”); the focus of the SEC’s new Financial Reporting and Audit Task Force, and how it might impact MLPs; the Incentive Distribution Right (IDR) and IDR “forgiveness”; corporate governance issues; and more… 


About Julie Hilt Hannink:

Ms. Julie Hilt Hannink is the Head of Energy Research for CFRA. In this capacity, she is responsible for CFRA’s research and screening on independent oil and gas producers, master limited partnerships, integrated oil companies, refiners and oil services. Ms. Hannink brings more than 25 years of experience in financial and fundamental research and analysis to CFRA. Prior to her tenure at CFRA she was the Director-Oil and Gas at Medley Global Advisors and a Managing Director at J.P. Morgan Asset Management where she was the senior North American oil & gas analyst.  Ms. Hannink holds a BS in Commerce (concentration Accounting) from the University of Virginia.


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CFRA Research is co-hosting this conference call at the invitation of Hedgeye Risk Management.  Both CFRA and Hedgeye are individually responsible for their respective contributions to this conference call; neither CFRA nor Hedgeye has verified the accuracy or completeness of the other’s information.  Opinions expressed by Hedgeye and its employees do not necessarily reflect the opinions of CFRA and its employees, and vice versa.


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The content and opinions expressed by CFRA are those of CFRA. Analysis provided by CFRA has not been submitted to, nor  received approval from, the United States Securities and Exchange Commission or any other regulatory body. While CFRA exercised due care in compiling its analysis, CFRA AND ALL RELATED ENTITIES SPECIFICALLY  DISCLAIM  ALL WARRANTIES, EXPRESS OR IMPLIED, regarding the accuracy, completeness or usefulness of this information. and assumes no  liability with respect to the consequences of relying  on this information for investment or other purposes. In particular, the research provided is not intended to constitute an offer, solicitation or advice to buy or sell securities. CFRA, CFRA Accounting Lens, CFRA Legal Edge, CFRA Score, and all other CFRA product names are the trademarks, registered trademarks, or service marks of CFRA or its affiliates in  the United States and other jurisdictions. 

Initial Claims: Two Steps Back, One Step Forward...

Takeaway: The labor market catches its breath this week with modest sequential improvement.

Editor's note: This is a complimentary excerpt from a research note written by Hedgeye's Financials team. For more information on how Hedgeye can help you click here or ping sales@hedgeye.com.

Recent Pressure Abates

Labor market data had been deteriorating steadily for the last 4 weeks in a row. This week it got slightly better. The year-over-year rate of improvement in rolling NSA initial jobless claims accelerated to -5.5% from -5.1%, marking an inflection from the decelerating trend we had been seeing for the previous month. On a one-week basis, the rate of improvement was fairly impressive at -7.9% vs -0.9% the week prior. As a reminder, we monitor deviations from the trendline rate of improvement in claims as the best real-time indicator for labor market turning points. It's important to remember that claims hit a frictional support level of ~300k, so as the data approaches 300k the rate of improvement should be expected to converge towards zero. We're mindful of this, which is why we look for trendline deviations.


Initial Claims: Two Steps Back, One Step Forward... - stein2

The Numbers

Initial jobless claims (SA) fell 3k to 336k from 339k WoW, as the prior week's number was unrevised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 2.5k WoW to 338.5k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -5.5% lower YoY, which is a sequential improvement versus the previous week's YoY change of -5.1%


Initial Claims: Two Steps Back, One Step Forward... - stein1

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Conservative Guidance, Bullish Commentary - stronger corporate group pace plus strengthening rate = upside leverage to the cycle




  • Protea:  will close April 1 2014; paid 10x EBITDA
  • Transactions to date:  completed London Edition (netted $240MM), Renaissance Barcelona sales (netted $60MM, closed in Jan 2014)
  • US supply grew <1% in 2013
  • STR US 2014 supply forecast:  +1.2%
  • AC brand:  1st opening in early 2015
  • MOXY - have 12 in pipeline and 15 in discussion; expect 150 MOXY hotels in Europe in a decade
  • China:  economic growth has moderated; aggressively pursing domestic leisure market  
  • Worldwide STR REVPAR for MAR brand:  increased 1% full point in 2013
  • In last 7 wks, did $880MM in transactions
  • Expect $1.25-1.5BN in share repurchases in 2014
  • All Marriot branded hotels (500) will be available for mobile check-in in 2014
  • Unit growth is sustainable in developed and developing world, including US
  • Q4 Fee revs strong -  better REVPAR in international markets and strengthening group business in NA
  • Better branding fees and profit from leased hotels added $0.02
  • G&A:  $0.06 unfavorable from certain items
  • Tax line helped 4Q by 3 cents due to several discrete items
  • NA
    • Strong REVPAR in San Fran, Houston and Miami
    • NY had tough comps due to Hurricane Sandy
  • Bookings pace for MAR brand was up 4% for 2014 - similar to what they reported in 3Q.  Corporate group pace at 10%.  Since corp demand is quite short-term, the trend is very encouraging for 2014 
  • Group performance outperformed competitiors in 2013
  • 4Q Europe REVPAR:  +3% 
    • UK: +6%; Germany: +9%, Caribbean/Latin America:  +4% (constant currency), ME&A: -9%, Asia-Pacific:  +5%, Greater China: +3%
  • NA incentive fees: +34%; outside NA incentive fees:  -2%
  • FY 2013 worldwide incentive fees: 39% (32-33% in 2012)
  • 2014 REVPAR outlook:  Mid-single digit in Asia/ME; low single digit in Europe; high single digit in Caribbean/Latin America
  • 2014 incentive fees growth:  Low double digit rate
  • Outlook reflects lower termination fees, slightly higher preopening expenses, stronger profits from owned/leased and affinity credit cards
  • 1% REVPAR 2014 outlook sensitivtiy:  $20MM in fees, $5MM owned/leased line pre-tax
  • Plan to renovate several owned hotels; build the Fairfield Inn in  Brazil to launch that brand and to complete Protea acquisition
  • Sept 8 Analyst Day Washington DC Marquis hotel

Q & A

  • 2014 looking a lot like 2013
  • About 3,000 hotels in US;  expect DC to continue to be weak
  • MAR Marquis DC:  not likely to be terribly impactful
  • D&A changes - more transparency and better comparability
    • Contract amortization line broken out in CF statement
  • 4Q G&A unusual items:  Through 3Q, 33,000 signed rooms. By end of year, had 67k rooms; the record quarter signings drove more legal costs ($8MM), transaction costs related to Protea ($10MM), writeoff/impairments ($6MM)
    • Ex items, about $3-5MM of G&A above previous 4Q guidance
  • 2014 Group trends (does not include new DC hotel):  first 3Qs (+6%), 4Q weaker
  • Great December period for 2014 bookings
  • 2014 Non-room revenues will grow a few tenths of a % faster than REVPAR
  • Full-service/select-service:   full service doing better than select service - partly due to distribution and strong group business.  Residence Inn may be at lower end of REVPAR guidance.
  • Brand growth:  top-end brands + Courtyard
  • EDITION sales:  long list of bids for London
  • NY EDITION:  will open 1Q 2015 (about $350MM)
  • Miami EBITION will close for $200-230MM in late 2014.
  • European REVPAR guidance conservative?  Well, last year, Euro REVPAR was only up 1.5% YoY.  3%ish guidance is about right. 
  • Possibly more Courtyard sales in Europe:  $20-30MM each
  • 2014 REVPAR will be driven by rate
  • Group business always lags
  • There is more growth opportunities in US

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