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Why is Kinder Morgan an attractive investment?

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Thesis overview

Kinder Morgan, Inc. (KMI) was formed in 1992. It is engaged in energy transportation and storage in North America. It owns the general partners of KMP and EPB and approximately 10% of the LP interests of KMP and approximately 41% of the LP interests of EPB. The company also owns a 20% equity interest in NGPL Pipe Co. LLC, a major interstate natural gas pipeline and storage system that it operates. Through its subsidiaries, the company operates or owns an interest in approximately 82,000 miles of pipelines and approximately 180 terminals. These pipelines transport natural gas, gasoline, crude oil, carbon dioxide, and other products. The company’s strategy is to focus on fee-based energy transportation and storage assets, increase utilization of its existing assets while controlling costs, and leverage economies of scale from incremental acquisitions and expansions of assets.

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KMI investment highlights include:

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  • The shale oil revolution makes KMI a long-term growth opportunity, but investors have lost confidence in the story after a FERC rate revision caused growth to slow in 2014. Typical market myopia!
  • Highly talented and invested ownership team led by Richard Kinder, who owns over a billion dollars worth of stock and recently bought $28 million under $34.
  • KMI has increased its cash flow nearly 10 times in the last decade.
  • KMI’s size as the fourth largest energy company in North America and track record delivering projects on time and on budget gives it a seat at the table for nearly every new expansion project in North America.
  • Over half of EBITDA comes from the Nat Gas Pipeline segment, which is stable fee-based revenue.
  • Significant, identified growth opportunities over the next five years of $14 billion; 90% of backlog is for fee-based pipelines, terminals, and associated facilities.

Company and investment highlights overview

Kinder Morgan (KMI) is the largest pipeline company in the United States. It has a world-class management team and a portfolio of irreplaceable assets with monopoly-like market positions. America’s shale oil and gas revolution puts KMI at the center of one of the greatest opportunities this country has had in the last several decades. A recent rate case with the Federal Energy Regulatory Commission (FERC) lowered the toll on one of its big pipeline systems and caused investors to question the growth story. (For more details, please click here.) We believe this to be a temporary pause in the company’s long-term growth, which has created an opportunity to buy shares of KMI at very attractive prices.

Investing highlights and interesting data points

  • Recurring revenues are 80% of KMI’s top line and should grow to 82% in 2014.
  • ROIC (return on invested capital) for 2012 was 13.6% and has averaged over 13% since 2000.
  • ROE (return on equity) for 2012 was 24% and has averaged over 22% since 2000.
  • Complicated ownership structure leads to investor and analyst confusion.
  • A negative analyst report this summer (which has been largely debunked) from Kevin Kaiser, Hedgeye, put pressure on the stock and helped create the present opportunity.
  • Discount to CUSH Net Asset Value (NAV) creates 15% to 30% total return opportunity over the next 12 to 18 months; 30% upside if you believe management, which thinks it can take the stock to the mid-$40s in the next three years.
  • Price/Earnings/Growth (PEG) ratio = 0.75; EV/EBITDA = 12.9
  • Net debt/EBITDA consistently at 3.5x since 1997
  • Unparalleled asset footprint
  • Significant, identified growth opportunities over the next five years of $14B; 90% of backlog is for fee-based pipelines, terminals, and associated facilities.
  • KMI expects to declare a total of $1.72 in dividends per share during 2014. That’s a 7.5% increase from the $1.60 it’ll end up declaring for 2013; a nearly 5+% yield with 7+% growth.

A good way to get a feel for Kinder Morgan is to review its fact sheet. You can find it on the website here.

The Market Realist Take

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In its latest financial projections for 2014, KMI said growth is expected to be driven by continued strong performance at general partners KMP and contributions from EPB. The growth at KMI from KMP and EPB will be partially offset by the loss of income from the 2013 and expected 2014 sales (drop downs) of certain assets to KMP and EPB. Subject to board approvals, KMI expects to sell its 50% interest in Ruby Pipeline, its 50% interest in Gulf LNG and its 47.5% interest in Young Gas Storage to EPB during 2014.

On December 23, Kinder Morgan Energy Partners announced the acquisition of American Petroleum Tankers (APT) and State Class Tankers (SCT) from affiliates of The Blackstone Group and Cerberus Capital Management for $962 million in cash. APT and SCT are engaged in the marine transportation of crude oil, condensate, and refined products in the United States domestic trade, commonly referred to as Jones Act trade. The transaction is expected to close in the first quarter of 2014 and will be immediately accretive to cash available to KMP unitholders. APT currently generates about $55 million of annual EBITDA. After completion of construction of the four SCT vessels, KMP expects combined annual EBITDA of approximately $140 million, which is an EBITDA multiple of 8.4 times. KMI has agreed to waive its incentive distribution amounts of $16 million in 2014 and $19 million in 2015 and $6 million in 2016 to facilitate the transaction.

The oil and gas shale boom in the U.S has attracted a huge investments in the sector. Investing in master limited partnerships (MLPs) in the oil and gas pipeline segment is one way to take advantage of this trend. Pipeline operators like KMI and its peers Williams Partners L.P. (WPZ), Enterprise Product Partners (EPD), Plains All American Pipeline LP (PAA), and Energy Transfer Partners, LP (ETP) have stable business models that are more dependent on the volume of the products. They are less likely to be impacted by the fall in prices of natural gas due to an increase in supply and continue to see growth in their top and bottom lines. Investing in these MLPs has assured robust growth potential and attractive dividend yields.

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