Nothing out of the 1Q14 results changes our negative view on Kinder Morgan Energy Partners (KMP/KMR). A few takeaways from a rather uninteresting quarter (we’ll have more after the 10-Qs are out) from the Kinder Complex:
- KMP Financial Results Mixed, But Below Budget……KMP reported EPU (before items) of $0.73, below the budgeted $0.74, and up 11% from $0.66 in 1Q13. DCF/unit was $1.55, missing the budgeted $1.57, and up 6% from $1.46 in 1Q13. Segment EBDA + JV DD&A was $1,591MM, below the budgeted $1,599MM. DCF-to-Distribution coverage was 1.12x in 1Q14, down slightly from 1.13x in 1Q13 (and 1.14x in 1Q12). As is typical, KMP builds “excess coverage” in the seasonally-strong 1Q and will give it back in 2Q and 3Q. KMP’s Payout Ratio (Distribution-to-EPU) was 189% in 1Q14, improving from 198% in 1Q13. KMP’s annualized return on tangible assets (net income before items / average assets ex. goodwill) was 3.6% in 1Q14, an improvement from 3.3% in 1Q13.
- KMP Natural Gas Midstream Has Huge Growth CapEx and Doesn’t Grow……KMP’s long-haul natural gas transportation businesses are growing well (total volumes were +5.5% YoY), driven by increased demand for north-to-south capacity on Tennessee Gas (TGP) and export opportunities to Mexico via El Paso Natural Gas (EPNG). This strong volume growth should continue going forward with additional TGP back-haul projects, expansions into New England, and increased Mexican demand. (Related Note: Kinder was super bullish re: demand for north-to-south natural gas transportation – bullish read-through to Boardwalk Pipeline (BWP), which has a new, underutilized south-to-north system in Texas Gas Transmission that it can repurpose.) However, KMP’s Natural Gas Midstream segment is not growing, with natural gas sales volumes down 4.4% YoY and natural gas gathering volumes down 0.6% YoY in 1Q14. The key questions are 1) How much capital was invested into these midstream businesses over the last year for flat-to-down volumes? And 2) How much of that capital was included in KMP’s sustaining CapEx budget? Stand-alone CPNO was projected to spend $458MM of growth CapEx in 2013 according to the “Case I Projection” in CPNO’s 4/22/13 8-K. Excluding CPNO, we estimate that KMP spent ~$400MM in its Midstream Segment (G&P + TX Intrastate) in 2013. Pro forma, that’s +$800MM in annual growth CapEx, of which a significant portion is likely needed just to maintain midstream volumes. This maintenance CapEx understatement is another major source of low-quality DCF for KMP and KMI, and is not appreciated by consensus, in our view.
- Soft Quarter for KMP E&P……KMP’s CO2 segment EBDA (before items) was down $22MM (-7%) QoQ as both oil production and the realized oil price slipped 2% sequentially. The Midland Basin crude differential blew out in 1Q and remains at a steeper-than-normal discount to WTI. KMP doesn’t hedge basis, and is budgeting for a -$1.50/bbl differential vs. the current -$9.25/bbl; that was a minor headwind in 1Q and should be a drag again in 2Q (see chart below). Encouragingly, SW Colorado net CO2 production ticked up to 0.6 Bcf/d for the first time in more than two years with a Doe Canyon expansion coming online. The most important data point for KMP CO2 is CapEx, which we won’t have until the 10-Q is out.
- KMP Gets into the Coal Royalty Biz ……KMP made its first coal royalty purchase in 1Q13, a $25MM acquisition. We’ll look to the 10-Q for more detail. As far as we know, KMP will not include a replacement CapEx reserve to account for the fact that coal royalties are depleting assets, just like oil fields. Every coal royalty acquisition that KMP makes strengthens our conviction on the short side.
- On KMI's Quarter……Mixed results with EPS of $0.28 missing the budgeted $0.31, but cash available for dividends of $573MM beating the budgeted $552MM. In the quarter KMI bought back $94MM of stock and $55MM of warrants at an average price of $1.77/warrant.
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