Kinder Morgan Energy Partners LP (
) 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 "
to income from specific sources, including dividends, rents,
interests, capital gains, and mining and
natural resources income identified in Section 613 of the tax
", 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
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.
(click to enlarge)
On the other hand, when looked at from the perspective of
distributable cash flows we discover a much more consistent view of
Kinder Morgan Energy Partners LP. Consequently, we developed the
Funds From Operations metric for our F.A.S.T. Graphs™ research tool
which comes directly from the company's statement of cash flows.
Clearly, it is more reflective of this MLP's ability to make
distributions to its unit holders. With this iteration of
fundamentals based on cash flows, we discover a lot of stability
and consistency with this high-quality MLP and its cash flow
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.
(click to enlarge)
We refer to the light purple line as the "income valuation line
(REIT/MLP)." This overlay pertains more accurately to a REIT than
it does an MLP, because it represents the total distributable cash,
which a REIT is required to distribute 90% of. However, we believe
it is also very useful when evaluating MLPs if looked at properly.
Prior to offering this line as another proxy for ascertaining fair
value, we would ask subscribers to draw a F.A.S.T. Graphs™ where
they deleted the operating earnings line (orange line) and the
normal PE ratio line. This would allow them to draw a graph showing
distributions (dividends) only (light blue shaded area) with
monthly stock prices (the black line) overlaid. The following graph
depicts this iteration.
(click to enlarge)
With the FFO metric added as an additional option, this
measurement of valuation based on distributions (dividends) can now
be revealed without having to take the F.A.S.T. Graphs™ apart. Note
that when the entire graph is drawn with all of its lines, the
entire complement of the distribution (dividend) is displayed on
top of the green shaded area. This is because the distribution
(dividend) is paid out of the green shaded area, which in this case
is Funds From Operations. Consequently, the visual display of the
light purple line or the "income valuation line" appears to be
below the distribution (dividend) area. A closer examination will
show that this actually depicts the precise amount of the blue
shaded area or distributions (dividends) that are paid to unit
(click to enlarge)
When Kinder Morgan Energy Partners LP is looked at from the
perspective of Funds From Operations, it is easy to see why this
company has produced such an excellent record for shareholders. The
following performance table shows that this, perhaps
highest-quality of all pipeline MLPs, has produced a significantly
above-average total rate of return. A one-time $1000 investment in
this MLP on December 31, 1998 and held would have generated more
than twice the original investment in distributions alone.
Moreover, the growth of principal is also quite impressive
averaging almost 12 times the capital appreciation of the S&P
(click to enlarge)
Kinder Morgan Energy Partners LP Business
Kinder Morgan Energy Partners LP operates in five business
segments. According to research from Standard & Poor's, 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 (
) and a 50% interest in El Paso Natural Gas (EPNG) pipeline from
Kinder Morgan, Inc. (
). 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.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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.
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