Over the last few weeks, the Kinder Morgan companies: Kinder Morgan, Inc. (KMI) and Kinder Morgan Energy Partners LP (KMP) have been the target of a shareholder lawsuit and a highly critical article in Barron’s. The result of these news events has been a moderate so far – 8% and 4% respectively – share price drops, and more importantly, investors in KMI and KMP have become worried about the safety of their investment positions. Fear can cause an investor to sell shares at the wrong time, resulting in unnecessary losses and also missing out on the possibility of attractive future share price gains and dividend payments.
Allegations of Fraudulent Bookkeeping
The charges against the Kinder Morgan group revolve around how Kinder Morgan Energy Partners accounts for growth vs. maintenance capital spending, known as capex in the lingo. KMP is a master limited partnership, which means the company must pass through as dividends the majority of free cash flow to investors, more properly called distributions in the MLP world. Kinder Morgan, Inc. owns the general partner share of KMP, which means it controls the operation of KMP. KMI owns a large percentage of the outstanding KMP units as well as the incentive distribution rights from KMP, which means as the KMP dividend rate grows, the portion received by KMI as GP grows even faster.
Back to capex. An energy MLP like KMP uses capital spending to either pay for growth and acquisition projects or to maintain the pipelines, storage facilities and oil wells it already owns. Growth capex money comes from the sale of more LP units and issuing bonds. Maintenance capex is viewed as an ongoing business expense and is paid for out of regular business revenues. The difference to investors is maintenance capex reduces the cash available to pay out as distributions and growth capex does not affect – in the short run – an MLP’s dividend paying capacity. There are no hard-and-fast guidelines concerning how an MLP like Kinder Morgan must account for its capex spending.
The attack point of the negative reports on Kinder Morgan is that the company has not been accounting for enough maintenance capex, thus paying artificially high dividends to KMP investors, resulting in a fraudulent benefit to KMI due to its control of KMP and the more rapidly growing incentive distribution rights payments KMI receives. If you see the irony here, raise your hand. Yes, Kinder Morgan has been accused of cooking the books so that investors in Kinder Morgan Energy Partners received higher dividends than they should have according to those making the complaint.
It’s All a Pile of B…s…!
I was one of the first among the investing press to get a copy of the lawsuit filed in Delaware, and having read through all 37 pages of legal arguments, the case has more holes than Swiss cheese. It was quite surprising to read a host of different arguments that in effect contradicted each other. To the casual bystander who does not understand the function of the MLP business structure, the inflammatory nature of the claims may raise concern, but there is no fire there.
What has happened is that an industry analyst who is working to make a name for himself believes he has found the golden bullet that will bring down a giant $100 billion energy company. However, this time the argument just doesn’t wash, and investors who sell on the fear will be the losers. I could spend several pages in counter arguments, but I think a few facts will prove that the Kinder Morgan companies are and will remain a premier energy infrastructure conglomerate.
A History of Setting Guidance and Meeting Expectations
The biggest point in favor of Kinder Morgan is the company’s history. As one of the earliest companies to adopt the MLP structure, KMP has traded on the NYSE since 1996. Over its 18 year history, the company has increased the distribution paid to investors every single year. This period includes two major stock market bear markets and the 2007-2008 financialcrisis.
At the beginning of each year the Kinder Morgan companies provide guidance for the upcoming year on management’s expectations concerning sales, profits, growth spending and the distribution to be paid to investors. Since 2000 KMP has met or exceed the distribution guidance every year except for one. In 2006, KMP paid $3.26 per share, just missing the guidance of $3.28. For a growth reference, in 2013, KMP investors earned $5.33 per unit in distributions.
Kinder Morgan is a tightly managed company. Managers start the year with budget and earnings projections, and then each week every manager must report how his unit is doing in regards to the budgeted expectations. Many companies wait for the quarterly financial reports to get a measurement of success or failure. Kinder Morgan knows on a weekly basis what areas are doing well and where extra attention should be focused.
Investment Potential of KMI and KMP
At yesterday’s close price of $74 and change share price, Kinder Morgan Energy Partners yields 7.3% based on the latest quarterly dividend payment. Historically, the KMP yield camps in a range of 6.5% to 7%. Guidance from Kinder Morgan is that the distribution will grow by 5% in 2014. A simple MLP investing rule of thumb is that the share price should increase by the rate of distribution growth. Using this rule, the return outlook for KMP is the 7% dividend plus 5% share price growth for a 12% total return in 2014. Also, remember that the dividend amount will be increased every quarter.
Kinder Morgan, Inc. now yields 5.2% and has forecast at least 8% dividend growth for 2014. The rule-of-thumb produces a 13% return potential for KMI, about the same as KMP. However, if KMP does grow its distribution faster than the forecast, the growth rate will be multiplied in the dividend from KMI.
Since the share prices of the Kinder Morgan companies have been hit by the negativity attacks, once the market gets its thinking straight, I expect the share prices of both to recover. The result will be 15% to 20% total returns in 2014 and a growing future income stream for buy-and-hold investors.