Chuck Carnevale | Nov 04, 2012 04:50AM ET
Kinder Morgan Energy Partners LP (KMP) is the country’s largest pipeline master limited partnership. Perhaps the clearest way to think about a pipeline MLP is as a toll road. According to their website, Kinder Morgan Energy Partners LP owns an interest in or operates approximately 75,000 miles of pipelines and 180 terminals. The company’s pipelines transport natural gas, refined petroleum products, crude oil, carbon dioxide (CO2) and store a variety of energy-related products and materials at their terminals. These would include gasoline, jet fuel, ethanol, coal, petroleum coke and steel.
Master Limited Partnerships (MLPs) were authorized in 1997 by Congress under the Internal Revenue Code Section 7704 in order to promote investment in the energy sector. The law greatly facilitated the formation of midstream MLPs such as Kinder Morgan Energy Partners LP. Midstream energy is mainly the transportation of oil and gas through pipelines. Since an MLP must by law derive 90% of their income from “sources related to income from specific sources, including dividends, rents, interests, capital gains, and mining and natural resources income identified in Section 613 of the tax code”, we believe that cash flow is more relevant than earnings as a gauge for valuation.
As we will soon demonstrate, Kinder Morgan Energy Partners LP has produced a consistent record of growth in distributable income. This is important, because when a master limited partnership such as Kinder Morgan Energy Partners LP is looked at in the traditional sense based on its record of operating earnings, a distorted picture of its performance is presented. The following F.A.S.T. Graphs™ on Kinder Morgan Energy Partners LP based on operating earnings produces a vivid example of what we are stating. From this perspective, we find no clear correlation between Kinder Morgan Energy Partners LP’s operating earnings and its stock price over time. In other words, the black monthly closing stock price line is disconnected from the orange earnings operating line. Consequently, it’s very difficult to ascertain whether or not this largest of all MLPs is fairly valued or not based on earnings.
In this example, we would argue that the most important lines on the graph that demonstrate fair value are the dark blue normal price/FFO line and the light purple income valuation line. Therefore, a brief explanation of each of these lines and how they relate to fair value are in order. The normal P/FFO (price to Funds From Operations) of 9.7, clearly depicts a valuation that the market has historically considered a fair value to place on Kinder Morgan Energy Partners LP. Consequently, it seems only logical to state that the best times to invest in this high-quality MLP would be when its P/FFO is below 9.7 as it is now.
Kinder Morgan Energy Partners LP operates in five business segments. According to research from Standard & Poor’s Corp. the natural gas pipeline segment is the largest representing 29.5%, the CO2 pipeline segment comes in at 24.4%, the products pipeline segment at 21.9%, the terminal segment at 18.9% and the Kinder Morgan Energy Partners LP Canada segment at 5.3%.
MorningStar believes that the natural gas pipeline business will be a key beneficiary of drop-down assets from their acquisition of 100% of Tennessee Gas Pipeline (TGP) and a 50% interest in El Paso Natural Gas (EPNG) pipeline from Kinder Morgan, Inc. (KMI). Consequently, MorningStar believes that Kinder Morgan Energy Partners LP’s business profile is moving back to its roots, and expects that the pipeline segment could increase to approximately 41% of their cash flows by the year 2016. This is important, because MorningStar also expects the important CO2 segment to slow somewhat. However, they also indicate that Kinder Morgan Energy Partners LP’s management is aware of the problem and working to rectify it in the future.
MorningStar also believes that Kinder Morgan Energy Partners LP’s other businesses should continue producing solid growth and that Kinder Morgan Canada could see major growth and expansion projects are approved. Consequently, we believe that Kinder is well-positioned and capable of continuing to produce the consistent above-average growth in Funds From Operations that unit holders have become accustomed to.
Summary and Conclusions
We believe that Kinder Morgan Energy Partners LP represents a very attractive total return play based on valuation and prospects for continued long-term growth. Strong internal growth and strategic acquisitions, coupled with a strong financial base give us high confidence as we look to the future. Perhaps as importantly, we believe that Kinder represents one of the best combinations of value and yield among all of its peers. Consequently, we rate this high quality MLP with a consistent record of growth of both capital and distributions to unit holders a solid long-term buy. Therefore, investors close to retirement, or already retired, seeking an above-average yield with growth potential may want to take a closer look.
Disclosure: No positions at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.