Kinder Morgan kicked off MLP earnings season on October 17 with a very strong report. I’ll briefly discuss the report and then discuss valuation and expected future returns for the Kinder Morgan family of companies.
Kinder Morgan’s Q3 2012 earnings were very strong. The full press release is here for KMP, here for KMI, and here for EPB. A few words from the release and from Rich Kinder, the Chairman sums up the results nicely.
|Kinder Morgan Energy Partners Increases Quarterly Distribution to $1.26 Per Unit|
Distribution 9% Higher Than Third Quarter 2011
HOUSTON–(BUSINESS WIRE)–Oct. 17, 2012– Kinder Morgan Energy Partners, L.P. (NYSE: KMP) today increased its quarterly cash distribution per common unit to $1.26 ($5.04 annualized) payable on Nov. 14, 2012, to unitholders of record as of Oct. 31, 2012. This represents a 9 percent increase over the third quarter 2011 cash distribution per unit of $1.16 ($4.64 annualized) and is up from $1.23 per unit ($4.92 annualized) for the second quarter of 2012. KMP has increased the distribution 45 times since current management took over in February 1997.
Chairman and CEO Richard D. Kinder said, “KMP had a strong third quarter with all five of our business segments reporting better results than in the third quarter of 2011. In total, KMP produced $1.14 billion in segment earnings before DD&A and certain items, a 21 percent increase over $0.94 billion for the same period a year ago. Third quarter highlights included contributions from the dropdowns of 100 percent of Tennessee Gas Pipeline (TGP) and 50 percent of El Paso Natural Gas (EPNG), record export coal volumes in our Terminals business, strong oil production at SACROC in our CO 2 segment and increased natural gas demand for electric power generation on the TGP system. Looking ahead, we see significant growth opportunities across all of our business segments, and we remain very excited about the additional prospects that we expect KMP to realize from Kinder Morgan, Inc.’s acquisition of El Paso Corporation, which closed in the second quarter. With our large footprint of assets in North America, KMP is well positioned for future growth.”
KMP reported third quarter distributable cash flow before certain items of $455 million, up 15 percent from $394 million for the comparable period in 2011. Distributable cash flow per unit before certain items was $1.28 compared to $1.19 for the third quarter last year. Third quarter net income before certain items was $574 million compared to $451 million for the same period in 2011. Including certain items, net income was $383 million compared to $216 million for the third quarter last year. Certain items for the third quarter totaled a net loss of $191 million versus a net loss of $235 million for the same period last year.
So, great results a 9% year on year distribution increase, good distribution coverage and a great outlook. What’s not to like? KMI and EPB also has similarly strong results. But, the real question is what can an investor expect going forward? Can we expect a repeat of the past which has been stellar as the table below shows?
Spectacular historical returns, with lower risk, but we are not likely to see those kind of results in the future. Kinder Morgan is much larger both in assets and market cap and valuations are higher today as investors have recognized the appeal of MLPs. In the table below I shows what are reasonable expectation for future returns for the Kinder Morgan family of companies.
In the above table the total return is expected is calculated by adding the current yield to the expected distribution growth. This is what I’ve termed the magic dividend formula and have discussed many times on the blog before. The dividend growth figures are directly from Kinder Morgan management and they have a pretty consistent record of meeting and beating their forecasts. Compare these potential returns from what you can reasonably expect from the SP500. In a rosy scenario, take a 2% current yield plus 6% dividend growth per year, which gives you a potential 8% return. So, the Kinder Morgan numbers look quite attractive especially when you consider that will most likely be less volatile as well as the historical returns show. What could prove to be a spoiler? As always, valuation. I see a lot of articles talking about a dividend or a yield bubble, etc… Its something to think about.
Below I show the historical valuations for the KMP going back to 1996. I use two metric for dividend investments; current yield compared to history and the current yield spread to the 10 yr treasury as compared to history.
On a yield basis you could say KMP is over valued. On a spread basis KMP is way under valued. This is the case for many dividend investments today due to the very low interest rates we see. Two things; spreads tend to be a better predictor of future results in my experience and the historical yield is distorted by market cap issues. Even just going back 10 years to 2002, KMP had a market cap of $4.5B whereas today it has a market cap of $20B. They are not the same company. I put more emphasis on the spread and thus I think worst case KMP is fairly valued. But as investor you can take advantage of a market idiosyncrasy by investing in KMR shares vs KMP. Its the same economic entity with the only difference being that the dividend is paid out in shares vs cash (and you get a 1099 at the end of the year instead of the pain in the rear K-1s). With KMR you get a 6.6% yield, almost at the historical average, plus that 7% a year growth. Plus, there is the potential upside of the valuation gap closing between KMP and KMR.
In summary, Kinder Morgan continues to perform great and offers excellent potential future returns with relatively low risk. Personally, I prefer to divide my investment in Kinder Morgan in the general partner, KMI, with it’s higher return potential of almost 17% going forward, plus KMR or EPB for higher current yield. The combination is pretty powerful.
Disclosure: long KMI and KMR