Far be it from us to question someone who yesterday made more money then we will perhaps ever make, but we do think it is important to consider KMI’s risk profile in the context of some basic financial metrics.
"Mistakes are the portals of discovery."
- James Joyce
There is nothing like a mistake to enhance our learning. At times, defining a mistake can be a nuanced exercise. For stock market operators, though, a mistake is very easy to define. Simply: if a stock price goes against you meaningfully and over a sustainable period, you are wrong.
The most successful investors are often those investors that are effective at both learning from and minimizing their mistakes. Many successful portfolio managers implement a stop loss so as to ensure that their mistakes are minimized. Others buy value plays with little perceived downside to minimize mistakes.
About a year ago, we introduced Hedgeye’s Best Idea list. The idea of the list was to focus our research team on developing deep dive investment ideas with asymmetric reward characteristics. Overall, the list has had some really strong performers. Not surprisingly we’ve also had some stocks that have not performed very well. Due to a light global macro calendar this morning, we are going to do a deep dive on one of our very public “mistakes”.
Back to the Global Macro Grind . . .
Yesterday, one of our Best Ideas, Short Kinder Morgan Energy Partners (KMP), went against us and decidedly so. Rich Kinder, the CEO and Company’s namesake, decided to consolidate the group of companies that existed under the Kinder Morgan umbrella. In the announced deal, KMI, the C-Corp GP, will acquired its two MLPs, KMP/KMR and EPB in a ~$71B transaction comprised of 56% KMI equity, 38% assumed debt, and 6% cash.
On one hand, it is worth applauding Kinder for this move. After a long and successful run, we thought he was out of tricks, but he wasn’t. On the other hand, in implementing this dramatic corporate restructuring, Kinder readily acknowledged our thesis, which was that transparency was limited, cost of capital was very high, and growth options were limited for the Kinder Morgan complex. And by bidding for our favored short of the group, KMP, at premium, he also marked the idea against us by about 15%.
It doesn’t matter that we’ve had some great calls on other MLPS, such as Linn Energy (LNCO) and Boardwalk Partners (BWP), on KMP we are now seriously in the red. As always though, the question is what to do with the stock from here (even if you have been long and taking the other side of our trade it is worth considering). As my colleague Kevin Kaiser writes:
“On 2014 Pro Forma (“PF”) metrics, we have PF KMI valued at 17x EV/EBITDA, 24x EV/EBIT, 27x market cap/pre-tax earnings. If we strip out the E&P segment at a $5.5B valuation ($1.0B of EBITDA x 5.5x multiple), PF KMI Midstream is valued at 19x EV/EBITDA. On an absolute basis, the valuation multiples are very high, in our opinion (19x EBITDA for a capital intensive, fully-taxable, highly-leveraged business), but even relative to peers, PF KMI seems mispriced here. EPD – which is not subject to federal income taxes – is valued at 17x EV/EBITDA, two EBITDA turns below PF KMI Midstream”
Combined with this egregious valuation is the more interesting point of KMI’s ability (or inability) to pay out its massive distribution going forward. As Kevin also writes:
“On a cash flow basis, assuming a full tax shield, PF KMI will generate ~$5.3B/year in operating cash flow. Run-rate total CapEx is ~$4.1B/year (excluding Trans Mountain), putting run-rate, pre-tax Free Cash Flow at $1.2B, or $0.56 per PF KMI share. PF KMI is trading at a 1.4% pre-tax FCF yield. Its annual distribution burden will be $4.3B starting in 2015, putting its annual funding gap around $3.1B. These are rough metrics, but a good guide for how much capital PF KMI will need to raise on a go-forward basis.”
In the Early Look today, we’ve included two charts. The first chart is a comp table that Kinder Morgan showed in their presentation yesterday comparing KMI against blue chip companies with growing dividends. Included in the table are companies like McDonald’s, Cisco, Altria and so on. The title of the table is quite explicit, “KMI Compares Favorable to its Mid-Stream Energy Peers and S&P 500 High Dividend Companies.” Since the Company is guiding us to 10% dividend growth and a yield of 4.5%, on these basic metrics, KMI does look great! But beauty, as always, is in the eye of the beholder.
In the second chart in today’s note, we’ve included, “The Comp Table KMI Didn’t Publish.” In this table we look at payout ratios, valuation metrics, and leverage ratios. Far be it from us to question someone who yesterday made more money then we will perhaps every make, but we do think it is important to consider KMI’s risk profile in the context of some basic financial metrics.
Now perhaps we’ve lost all credibility because we didn’t see this corporate restructuring coming (we thought Kinder Morgan was in a proverbial box), but if you are contemplating owning KMI here, you do need to take the Company’s advice and look at your options, like S&P 500 high dividend companies.
On a basic level, would you rather own a company like Cisco that grows its dividend at ~7.9%, trades at ~6.0x EBITDA, and has $30 billion in net cash, or a company with the financial profile of KMI that trades ~19.0x EV/EBITDA, has debt/EBITDA at 5.5x, and has a dividend payout ratio of 130 – 200%. Perhaps we are just simpletons, but to us the answer is obvious.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: ICSC Sales decelerate, but setup through Oct is good as compares ease – IF consumer holds up. AMZN picking the wrong fight w the wrong guy.
EVENTS TO WATCH
KATE - Earnings Call: 10:00am
FOSL - Earnings Call: 4:30pm
M - Earnings Call: 10:30am
WMT - Earnings Call: 7:00am
KSS - Earnings Call: 8:30am
JCP - Earnings Call: 4:30pm
JWN - Earnings Call 4:45pm
Takeaway: This week's 3.2% is a respectable number in its own right. Unfortunately we're coming off a seven-week run of stellar growth -- with most weeks coming in above 4%. Important to keep in mind that sales growth last year took a notable dive in the back half of August and remained weak through most of October. The point is that assuming all else is equal with the consumer (which might not be a safe bet) we should see respectable readings in this index for the next 10 weeks. If they're not, it won't be a good indicator of the consumer's health.
AMZN, WMT, BBY - Disney-Amazon Dispute Concerns More Than Pricing
Takeaway: We respect the power of the Amazon business model as much as even the biggest Bull. But is Bezos serious on this one? He wants margin support (basically markdown money) from studios and publishers simply to offset the fact that WalMart, Target and Best Buy use media as a loss leader to driver traffic into the store, and capitalize on purchases in other categories? Sorry Jeff, but that's where a brick and mortar business model actually has an advantage versus being 100% virtual. This is like if WalMart were to complain that it has to pay Associate Comp, Rent, and Utilities. Something tells us that AMZN is just going to have to suck it up and live with this one.
WWW - Two Million Moms Love Stride Rite®
SHLD, Kmart - Sears Holdings Names Alasdair James As Kmart's President And Chief Member Officer
Record imports expected in August
NYC’s first enclosed mall in 40 years officially opens
DEST - Anthony Romano Appointed As Destination Maternity's Chief Executive Officer
GME - GameStop streamlines trade-in pricing policy
Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.
This note was originally published at 8am on July 29, 2014 for Hedgeye subscribers.
“You see, I’m the event. I am the news.”
That’s a beauty quote from a book that finally made it to the top of my reading pile this summer – Flash Boys, by Michael Lewis. Brad Katsuyama and I have a few things in common. Well, sort of. We’re both Canadian – but I’m more of a High-Frequency-Tweeter than a trader.
The context of Brad realizing that his Old Wall order-flow from the Royal Bank of Canada was “news” to the machines front-running his (lack of) technology may have been enlightening to him at the time, but so were late 17th century concepts like the sun rising in the East.
The better one-liner came before the aforementioned one when Katsuyama’s IT guys reminded him that “you aren’t the only one trying to do what you’re trying to do” (pg 33). Everyone and their brother who is trying to short spoos (SPY), at the same time, should always remember that.
Back to the Global Macro Grind …
On the “news” at 10AM yesterday that US Pending Home Sales “missed” (again), the Housing stocks (ITB) dropped to -1.6% on the day, and Consensus Macro hedgies started shorting SPY, feverishly. If you want to beat your competition in this game, don’t do that.
The time to short Housing (ITB) and the Russell 2000 (IWM) was last week (Tue-Wed) when:
Hope, obviously, is not a risk management process. And, despite my addiction to tweeting, Twitter is not Facebook. We call selling/shorting on green and buying/covering on red Fading Beta because that’s what it is – fading the machines. You see, consensus capitulating on both the upside and downside is the event. In an oversupplied industry of short-term performance chasers, it is the news.
Don’t get me wrong, for longer-term investors, recent US #HousingSlowdown (see our Q2 Macro Theme Deck for details on why) data is downright frightening. To put some meat on that bone, today’s Chart of The Day shows what our Housing team calls the Hedgeye Housing Compendium – it rolls Hedgeye-style, in rate of change terms. And it’s color coded (red/green) so that even a Mucker can understand it.
USA’s Pending Home Sales are now trending down -7.2% year-over-year (versus growing at +12% year-over-year when we were bullish on US Housing last year). At the same time, the mother of all behavioral factors (last price) in US Housing has seen US Home Price Inflation (HPI) slow from its CoreLogic data peak of +11.8% last year to a preliminary estimate for June of +7.7%.
Now, if you think in absolutes (instead of rate of change), you might say that Housing is still “good.” Even if I gave you that, in my risk management model going from great to good is bad – and the stocks agree.
It’s not just the Housing stocks that aren’t horning people up YTD – it’s a lot of things US domestic consumer:
So why would you be long any of that stuff when you could be long the following:
Those are the Top 3 performing sectors in the SP500 and they are clean cut ways to be long of either A) #InflationAccelerating and/or B) the slow-growth #YieldChasing born out of it. One of our favorite ways to be long Healthcare inflation is being long the hospitals (HCA).
If you’re not into the US stock market naval gazing thing and want to diversify, across asset classes, you could also be long things like:
Remember, “you aren’t the only one trying to do what you’re trying to do.” So try to stop guessing what the spoos or Dow are going to do next, and line up your investable Macro Themes with the asset allocations that will help you front-run your performance chasing competition.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.45-2.54%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Expert call today @ 1pm. New Best Idea (short HAIN) call Thursday @ 1pm.
Toll Free Number:
Direct Dial Number:
Conference Code: 515973#
MATERIALS LINK: CLICK HERE
TODAY, August 12th @ 1PM
This call will feature guest speaker Bob Burke, Principal at Natural Products Consulting Group.
Since 1998, Bob Burke has provided assistance in bringing natural, organic and specialty products to market across most classes of trade. This includes work in strategic planning, writing sales, marketing and business plans, building distribution, broker selection and management, organizational development and compensation, strategic options, financing, branding, trade spending and assistance around M&A, due diligence and venture strategy groups. He is also the co-author of the Natural Products Field Manual, 6th Edition and The Sales Manager’s Handbook. Prior to consulting, Bob was with Stonyfield Farm Yogurt for 11 years as Vice President, Sales & Corporate Development.
During the call, Mr. Burke will focus on:
TODAY’S S&P 500 SET-UP – August 12, 2014
As we look at today's setup for the S&P 500, the range is 51 points or 2.01% downside to 1898 and 0.62% upside to 1949.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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