What’s next for MLPs?

April 30, 2013

For my first post back I want to update the last post I did before my hiatus. On Feb 10, I posted on how well the MLP sector did in January, with it being the second best January ever, and that good early year performance usually leads to strong results going forward. Lets see what the MLP sector has been up to since then.

The chart below shows the performance of the AMJ ETF that tracks the MLP sector. What a year so far is all I can say! The MLP index total return for Q1 2013 was 19.7%, far outpacing the SP500. That’s a dam good year of performance in just 3 months. MLP s have advanced a little further in April as expected, given that April is a dividend capture month and historically does well as I’ve discussed before. I hope you enjoyed some these gains – this was a great risk/reward setup at the beginning of the year and at the end of January.

AMJ chart Apr 30 2013

 

The performance in many individual names has been even more impressive. YTD performance, price-only, even with the recent pullbacks: EPD – 25%, NGLS – 27%, TRGP – 28%, PAA – 28%, WMB – 18%, KMI – 12%, KMP – 18%. OKS was about the only real dog among the big MLPs and even that horrible performance was 2% up plus the dividend. Some of the more spec names like LNG and GEL are up almost 50% and 34% respectively. Needless to say that this kind of performance in such a short time doesn’t come around very often. Obviously, the next question is what now?

A couple items to look at to give us an idea of what MLPs could do from here are valuations and historical patterns. First, historically, May is not a good month for MLPs. Its the second worst month, after November. You get the fade of the dividend capture trade, you get equity issuance by many MLPs, and you get part of the general market ‘sell in May’ effect. Second, MLP valuations are not as compelling as the were in November of last year, nor at the beginning of this year. The chart below is the one I like to use for MLP valuation.

MLP historical yield and spread chart apr 30 2013

 

On a yield basis, MLPs are approaching lows in yield since the 2008 crash, but not by much. On a yield spread basis MLPs are not as compelling either and are approaching the average spread. However, historically even these average spreads have led to good returns in the past. Also, compered to other yield based investments MLPs, even at these ‘low’ yields of 5.8% look pretty darn attractive especially against what I think are over valued yield investments like REITs, Utilities, and Junk bonds. Basically. I’d be looking here for a mild pullback in May generating some good setups for the rest of the year. As always, I prefer individual names vs the ETFs and I prefer to have more growth over yield. WMB, ARP, CLMT, and TRGP are some of the more growth oriented names that I like. And I’m always looking for ways to own some of the big boys especially Kinder Morgan and Enterprise Products and good prices.

Hope that helps.

Disclosure: currently long CLMT, ARP, and WMB with some tight stops.


Kinder Morgan reports spectacular Q3 2012 Results

October 26, 2012

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 2011HOUSTON–(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 COsegment 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


EPD Q2 2012 earnings results – strong and resilient

August 2, 2012

Maybe it’s the contrarian in me but I keep expecting EPD to disappoint. Or maybe I’m hoping they disappoint so I can buy a ton more shares. But alas I was the one disappointed yet again. EPD reported strong Q2 2012 results on Aug 1st. Full release is here. Lets see how strong and resilient their results were.

We are now smack in the middle of MLP earnings season with Kinder Morgan having kicked it off last week. So far the trend in the results has been some weakness in the numbers mainly due to lower oil and NGL prices. In particular, NGL prices were down about 25% from last quarter. This weakness in NGL prices has been mainly felt by the gas processing MLPs. For example, MWE, NGLS, and WPZ all pre-announced weaker Q2 numbers. Even the mighty Kinder Morgan felt some weakness from these lower commodity prices. But then again these results also show the resiliency of the MLP business model. Despite this weak environment all the MLPs I mentioned are sticking to their distribution growth targets for 2012. Their distribution coverage ratios have come down significantly but that’s why they have them in the first place, for times like this. Of course, EPD, along with a few others, has bucked this trend.

Despite NGLs being their largest business, and the weak NGL environment, EPD reported strong numbers and continued strong distribution coverage ratios. The distribution coverage ratio was 1.4x for Q2 2012 after excluding one time gains. From the release:

“Enterprise reported strong results for the second quarter of 2012 with four of our five business segments posting higher gross operating margin than the second quarter of last year,” stated Michael A. Creel, president and CEO of Enterprise. “Gross operating margin for the second quarter of 2012 increased 12 percent from the second quarter of 2011 primarily due to higher volumes of NGLs, natural gas and crude oil handled by our integrated midstream system of assets. The partnership set records with respect to fee-based natural gas processing volumes, natural gas pipeline volumes and NGL fractionation volumes.”

Business is doing well and growth opportunities look great. While EPD is my favorite large cap MLP, results at the other big boys look pretty good too. KMP reported decent numbers despite some weakness. OKS also continues to shine. And I expect PAA which reports this week will also do well. In tougher times the MLPs with diversified business models will tend to perform better. As far as the smaller cap MLPs these tough times may present nice buying opportunities for patient long term investors.

Disclosure: long EPD, KMI


Kinder Morgan Q4’11 earnings – steady & increasing growth

January 22, 2012

Kinder Morgan announced Q4 2011 earnings after market on Jan 18, 2011. Being one of the top 3 MLPs by size, having the most diverse business, and being one of the best managed MLPs I think its illustrative of what is going on in the MLP sector to look at their earnings. This coming week KMP will also hold their annual investor day. The details of KMP’s earnings can be found here.

At a high level, Kinder Morgan had yet another record quarter and again increased distribution to their limited partners. Distributions increased to $1.16 per unit from $1.13 per unit in the same quarter last year, a 3 percent increase. More importantly, for the full year 2011 KMP distributed $4.61 per unit, beating their $4.60 target and an almost 5% increase over the full year 2010 distribution. For this year, 2012, KMP is targeting a distribution of $4.98 per unit, an almost 8% increase over the 2011 annual distribution. This 2012 outlook does not account for the El Paso acquisition which is expected to be immediately accretive to distributions.

I find that I say the same thing every quarter about KMP, ‘steady as she goes’. These guys continue to perform. They make plans, commit to them, and just execute. No other MLP provides such detailed outlooks and forecasts and then just goes out and nails them. This is very comforting to long term investors. Since inception in 1996 they have missed their distribution target only once. Since 1996 investors have enjoyed a 25% CAGR. Their business continues to become more diverse and steady. Here is a summary I did of their business.

As the table shows, KMP has a very well diversified business that is predominantly fee based and not subject to commodity prices. They do have some commodity exposure to oil prices in their CO2 business but they hedge most of that exposure away for the year. So, how about going forward and what can investors expect in terms of returns going forward?

Based on KMP, KMR, and KMI’s closing prices as of Friday, Jan 20th here are the returns investors can expect going forward excluding the effect of the El Paso and including the effect of the El Paso acquisition which is increasing future Kinder Morgan growth. These returns are calculated using the magic dividend formula which states that total return is equal to dividend yield plus dividend growth plus change in valuation. For this table I’m assuming the change in valuation for this year is zero.
I’m using the post EP numbers as a basis for an investment decision due to the very high probability of the acquisition going through. These are solid returns in any environment but even more so in today’s volatile market and in a market where investors are searching for yield. I continue to prefer KMI , with an almost 17% annual forecasted return, over KMR or KMP for the higher total returns but some investors desire higher current yields and thus would prefer those shares.
In summary, Kinder Morgan continues to execute and is the most stable and diverse MLP in the space.
Disclosure: long KMI

MLP valuation at August end

September 1, 2011

It’s been since May that I updated my table on MLP valuation. With the recent volatility in the market and the month of August coming to an end it is a good time to take a look at MLP valuation. Lets jump right in.

As I’ve done before, I updated my top 5 MLP table which also includes the MLP index, AMZ. I like to use both relative and absolute value metrics for any investments and I think the two best are dividend yield and the spread to the 10yr treasury note. Here is the updated table.

MLPs, the AMZ, are trading at a yield of 6.5% and a spread of 4.31%. In relation to their historical trading ranges, MLPs are trading at a lower dividend yield than average but way above their historical spread to treasuries. And here is lies the dilemma when looking at MLP valuation in today’s market. Usually, especially at the extremes, these two metrics move together. In other words, when spreads indicate the MLPs are cheap then the dividend yield is also signaling the same thing. This was definitely the case in the 2008 crises which was the extreme of extremes for MLP history. But this time is different, or so it seems. The question is whether the dividend yield is more correct or the spread to treasuries. Hard to tell, there are many many factors involved. For example, the MLP sector is much bigger, more stable, and more mature than it was 20 years ago. This alone would indicate that the sector would and should trade at a lower dividend yield than in the past. Personally, I lean toward the spread to treasuries as being the better indicator, especially short term, of value which indicates to me the sector is undervalued. However, even better is to focus on individual MLP names which I think is the best way to invest in the sector as I’ve discussed here and here.

As far as the big 5 MLPs are concerned, there is quite a difference in valuations. The lowest valued relative to its history is ETP. It is the only MLP trading at a discount to its historical yield and spread. KMP would be next on the list, trading at only a slight premium to its historical yield. And even better you can increase the yield on KMP by buying the other share class, KMR, at a 14% discount to KMP. At the other end of the spectrum you have EPD and WPZ both of which are trading at good premiums to historical yields. However, in both these companies investors should consider the individual factors that are driving these valuations. For example, EPD is one of the few MLPs without a general partner so its cost of capital is significantly lower than other MLPs. In the WPZ case they have an E&P business that will be spun off later in the year which is impacting valuation. These details matter a lot. Personally, I like KMP and EPD at these levels.

In summary, while MLPs have had quite a ride during the recent market volatility there is good value in the sector. With continues volatility there may be even better buying opportunities coming to a quote screen near you.

 


KMP reports Q2 2011 results

July 21, 2011

Earnings season for the MLP sector officially got underway last night with Kinder Morgan reporting Q2 2011 results. The highlight of the release was a distribution increase to $1.15 per unit or $4.60 annualized. KMP currently yields 6.3% on this dividend. From the release:

HOUSTON, July 20, 2011 – Kinder Morgan Energy Partners, L.P. (NYSE: KMP) today increased its quarterly cash distribution per common unit to $1.15 ($4.60 annualized) payable on Aug. 12, 2011, to unitholders of record as of Aug. 1, 2011. The distribution represents a 6 percent increase over the second quarter 2010 cash distribution per unit of $1.09 ($4.36 annualized).

KMP is on track to beat their financial plan for 2011. As in Q1 they re-iterated on the call that they are ahead of plan and if the current environment continues in the second half they should beat their $4.60 distribution target for this year. The only negatives in the report were a slight decrease in their refined product pipeline volumes due to the weak economy and a non-cash legal reserve charge they took due to a legal rate case in California which they intend to fight. On the positive side the natual gas pipelines segment, the CO2 segment, and the terminals business are all doing very well. There is no better diversified MLP than KMP and they continue to show the strength of their diversification. The table below shows their business breakout as of Q2 2011

The highlight of the earnings announcement was the earnings call that took place after the market closed. It just goes to show how important it is to listen to every earnings call for your stock holdings. On the call there were several important hightlights;

  • Rich Kinder said the current opportunties in the midstream MLP space are the greatest he’s seen in his 30 years in the business. These are important words from the man who basically created the energy MLP sector. This echoes similar comments from other MLPs, like EPD.
  • KMP has taken a preliminary look at 2012 and from a high level they expect to do better than their long term average projections of 5% distribution growth for KMP and 10% for KMI. This bodes well for investors in 2012. Part of this optimism is due to them being able to lock in higher hedge prices for their CO2 and crude oil production. Their 2012 hedges are $18 above their 2011 hedges for example.
  • Current opportunities in the coal export sector, the CO2 sector have the opportunity to drive strong growth. Also, they see more opportunity in the Eagle Ford shale. BHP Billiton’s recent acquisition of Petrohawk (HK) is expected to have a positive impact in drilling in that shale play. They are also very optimistic about the Haynesville shale.

All in all it was another good quarter for KMP. Investors in KMP today get a 6.3% dividend yield with about a 6% growth in distributions this year and it looks like another 6% at least next year. That’s a total return expectation of 12.3% going forward. And its tax deffered. Not bad for the most dividersified, lowest risk MLP in the sector. KMP is the bar which other MLPs should be compared against.

For an even better deal, investors can buy KMR shares which yield 7.1% and have the same growth potential. Also, KMP’s general partner, KMI, yields 4.2% (and also increased its dividend in Q2, to $0.30 per unit) and has a growth potential of 12%, double that of KMP.

Disclosure: long KMP


MLP taxation: the upside of ending the tax break

June 17, 2011

In my last post I described what I consider the worst case scenario for MLPs in the event that their tax favored status ends overnight. Today I want to look at a few of the upsides of such an event. Yes, I do think there are upsides to ending the MLP tax favored status. I can think of four upsides right away; incremental share demand, potential higher valuations, expanded business opportunities, and pricing power. Lets look at each of these possibilities.

While the MLP sector has enjoyed strong and increasing investor demand over the years the tax complications and tax risk has kept many investors away. An ending of the tax break for MLPs would lead to a large incremental demand for shares from several sources. First, many individual investors simply don’t want to deal with the tax complications of K-1 filings or take the risk that the tax advantage goes away thereby hammering share prices. Also, besides a few special share classes, also for tax reasons (UBTI income) MLPs are not suitable investments for retirement accounts. On the institutional side, mutual funds and pension funds, are not large owners of MLPs for similar reasons to those of individual investors. And lastly, no MLPs are included in any of the major indexes like the S&P500. They are not allowed to be. All of these would be the source of incremental share demand for the MLPs, especially the large caps. For example, consider ETP or KMP. ETP has a market cap of $34B and KMP has one of $22B. For the S&P500 index the average market cap is $23B. ETP and KMP would be candidates for the index after the tax change. Choosing an example mid tier S&P500 company, CHK, lets look at the volume of shares traded. CHK has a market cap of $17.8B and its average daily volume is 10.5 million shares. ETP and KMP, with larger market caps, have average daily volumes of 1.3M shares and 0.75M shares respectively. After a tax change, as normal operating companies, EPD and KMP could be added to the index. Needless to say this would lead to more demand for shares in the companies. In short, incremental demand from individuals, institutions, and potentially indexes would be a positive catalyst for MLP post a tax change.

The next potential upside for MLPs post a tax change is higher valuations. The tax complications and risk keep a lid on valuations. The best comparison I can make to MLPs is the utility sector. The company structures, stability of cash flows and dividends, and regulatory environment are very similar. Taking a look at the utility sector, using the utility sector ETF, XLU, we can compare valuations to the MLP sector. The XLU trades at a dividend yield of about 4% and the MLP sector, using AMZ, trades at a yield of about 6%. That’s about a 33% premium for XLU vs AMZ. That’s remarkably similar to the US corporate tax rate of 35%. Coincidence? Maybe but probably not. Post a tax change MLPs would most likely trade at higher valuations than they do today, a big reason of which would be the incremental share demand I described in the first paragraph.

A third potential upside for MLPs from a tax change would be potential new business opportunities. Today, to qualify for MLP status MLPs are limited to businesses that have to do only with energy and energy infrastructure. With an end to the MLP tax status MLPs could potentially pursue other types of infrastructure projects. For example, several MLPs have expressed interest in pursuing water pipelines. And a few have even sought regulatory approval for water pipelines that are related to energy projects.

The last potential upside is the pricing power that MLPs have. Actually, I think this is more of a mitigating factor. One of the core strengths of MLPs is their economic moats. Because of the huge upfront capital investments and lead times required to build energy infrastructure MLPs are able to enter long term contracts, 10-20 years, with their customers. Also, these contracts tend to be predominantly fee based and not subject to commodity price movements. This dynamic leads to strong competitive positions – once a $1B pipeline is built someone is not going to come along and build another $1B pipeline right next to it to compete. In the event of a tax change, where the economic returns of projects go down suddenly, the MLPs would be in a position to renegotiate the contracts with their customers. The impact of the tax change would not just be born by the MLPs but also by their customers, the energy exploration and development companies. I’m not saying the MLPs could make up all the impact but they could certainly offset some of it.

In summary, there are some potential upside catalysts to an MLP tax change. While there is no doubt that in the short term such a change would be painful to existing shareholders it is not all bad. I showed in my previous post, the downside impact is not as bad as it appears on the surface and here I describe a few potential positives from such a change. I don’t think such a tax change is a risk anytime soon, probably not until late 2013 at the earliest, and even then it is only a small risk. But its always good to be prepared and think about the potential consequences of such an event.


Update on MLP valuation

May 24, 2011

Well, the MLP correction I discussed earlier seems to have run its course for now. I thought this would be a good time to see what this correction has done for MLP valuations relative to history. I last did this back at the end of Q1 2011 and was planning to hold off until the end of this quarter but I thought readers would be interested in a more timely update considering the recent drop in MLP prices.

First, a few words on the correction. The MLP index, AMZ, hit bottom on May 17th at 351.19 representing a correction of -9.96% from its recent peak of 390.02 on April 28th. As of May 2oth it was at a level of 365.90 still leaving it -6.9% of the highs. To put things in historical perspective the AMZ has corrected over 10% 7 times in its history, over 25% 3 times, and over 40% one time. All in all this was not a major correction given its history. The range of corrections for the individual MLP names was quite broad even among the large cap names with KMP correcting -6.49% and ETP correcting -14.6%.

As for valuations, the table below shows my updated valuation table for the AMZ index and the top 5 MLPs by market cap. The top section shows the values from the end of Q1 2011 and the bottom section shows the recent values using prices as of the close on May 20 2011.

The most recent data shows that MLPs have increased in yield, dropped in price, showing the results of the correction but are still trading below their historical yields. However, they are now trading slightly above their historical spread. By this metric they are fairly valued. This is mainly due to the drop in 10yr treasury yields in the last month. While it would be great to have both metrics flashing green this is an encouraging sign particularly if you expect the low interest rate environment to continue.

As for the individual MLP names, all are less expensive than at the end of Q1 2011 and ETP and KMP still represent the best value. As a matter of fact, ETP now trades at both a discount to its average yield and average spread. Its the least expensive by far among the big cap MLP names. Investors were disappointed with their Q1 results but as I discussed in this post the future looks bright for ETP. As for KMP, it is a better value than it seems on the surface. Investors can purchase the different share class of KMP, listed under symbol KMR, which trades at a 12% discount to KMP and represents the exact same economic interest as KMP. The difference is that an investor received shares instead of cash distributions and a 1099 instead of a K-1 tax form. Investing in KMR gives the investor a yield of 6.94% which puts it above the historical average for KMP.

In summary the recent correction in the MLP space was minor based on historical metrics. The sector is now trading at a slight discount in terms of spreads to the 10 year treasury but still at a premium based on historical yields. Cheaper but not cheap is how I would summarize it. In the continued low rate environment we are in the sector seems to offering slight but nor overly compelling value. However, there are some individual MLP names that seem to be offering good value at current prices, specifically KMR and ETP.


Opportunity brewing in MLP land

May 5, 2011

There looks to be a correction developing in the MLP sector that may bring up a significant opportunity that income investors should begin to have a plan for. Lets look at the drop in prices recently, potential reasons for the drop, and what it means for the sector and more importantly investors.

As of 1PM or so Eastern time most of the MLP names are down between 5-13% off their highs. Here are recent prices for the MLPs that I follow and how much they are off their 52 week highs.

Definitely looks like a correction is brewing if not here. But rumor in the MLP investor universe is that this is something more sinister, that the government is considering changing the tax status of MLPs and forcing them to pay corporate taxes. A few articles and the comments on Seeking Alpha are on fire with this rumor. Personally, I first heard about it on Mad Money from Jim Cramer – yes, sometimes he does add value. This is not the first time in MLP history that this rumor has come up. So, is it true and is it cause for the recent price drops in MLPs?

First, there appears to be some truth to the rumor. Credit Suisse put out a note on the topic three days ago where they said.

Proposal to Tax Pass Through Entities: The National Association of Publicly Traded Partnerships (the lobby group for MLPs) has informed its members that the Obama Administration is working on a proposal to tax pass-through entities. We checked with our DC Policy Group and they said this is not new and it is too late for any proposal to gain traction in the near term. Our Key Takeaways: 1) Any tax reform is unlikely until 2013 and at this juncture still we view taxation of MLPs as a low probability. 2) There are more pressing issues that have to be tackled. These are the debt ceiling and then the budget. 3) After these two issues are tackled we are likely to be in the fall and all attention will be focused on the 2012 election. We See Headline Risk but No Substance at this Juncture: To be clear, this is not an issue that is being taken lightly by the MLP lobby group. They continue to actively engage and inform Congress on the vital role that energy MLPs provide in building and maintaining US infrastructure. This in turn means US jobs.

I agree 100%. Also, I’ not convinced the recent price moves in MLPs are mainly attributable to this rumor. I’m sure you’ve noticed that the market in general is down and in particular the energy sector is down more than other sectors of the market. I decided to compare the move in MLPs (using AMJ, AMLP, EPD, KMP, and MMP) to the move in the energy sector (XLE), a large US royalty trust (BPT), and a large Canadian royalty trust (PWE). Neither XLE, BPT, or PWE have any of the tax advantages of MLPs. See the chart below.

As the chart shows, if anything, MLP are down less than these other energy sensitive investments. Also, the MLP space has had a record run, was at all time highs, and was trading at levels relative to historical yields and spreads to treasuries that have caused me to say many times here on the blog that the sector was frothy. So, based on the evidence to date, I think the sector is in a normal correction potentially based on fears of demand destruction from higher energy prices and yes, in part, due to the rumor of upcoming tax changes for MLPs. Personally, I think there is a great buying opportunity developing here. My personal trigger is a 15% correction in the likes of EPD, KMR, WPZ, and ETP.

Having said all the above, it does not mean MLP investors should ignore the MLP tax issue. It is a real risk even if remote and down the road, a fat tail risk as they say. I’m starting to look at one, the worst case scenario if the tax law change were to happen and two, the historical example of the Canadian royalty trusts and what effect the Oct 2006 tax law change (known as the Halloween massacre in Canada) has had on the income and performance of the Canadian trusts. I’m not done with my research but what I’ve found so far tells me that the Canadian change did not end up being as bad as everyone thought, although the initial reaction was a 30% price drop for the trusts. Also, on the MLP side it is important to remember that taxes are paid on net income, not distributable cash flow, so the impact on MLP distributions is not as large as the corporate tax rate would indicate. For example, KMP in Q1 2011, had DCF per unit of $1.21 and net income of $0.43 per unit. If the company had to pay the full corporate tax rate of 35% on net income they would pay about $0.15 per unit in taxes which represents only 12% of the DCF. And that is before considering that they pay about 45% of their cash flow to their general partner, KMI. As a worst case scenario that is not so bad.

Stay tuned for more on this issue.


KMP delivers strong Q1 – yet again

April 21, 2011

Kinder Morgan (KMP, KMR, KMI) reported Q1 2011 results last night after market close. Here is the summary from the press release.

Kinder Morgan Energy Partners Increases Quarterly Distribution to $1.14 Per Unit

Distribution 7% Higher Than First Quarter 2010
HOUSTON, Apr 20, 2011 (BUSINESS WIRE) — Kinder Morgan Energy Partners, L.P. (NYSE: KMP) today increased its quarterly cash distribution per common unit to $1.14 ($4.56 annualized) payable on May 13, 2011, to unitholders of record as of April 29, 2011. The distribution represents a 7 percent increase over the first quarter 2010 cash distribution per unit of $1.07 ($4.28 annualized). KMP has increased the distribution 40 times since current management took over in February of 1997.

KMP reported first quarter distributable cash flow before certain items of $382.2 million, up 8 percent from $353.7 million for the comparable period in 2010. Distributable cash flow per unit before certain items was $1.21 compared to $1.18 for the first quarter last year. First quarter net income before certain items was $423.5 million versus $383.1 million for the same period in 2010. Including certain items, net income was $340.9 million compared to $227.4 million for the first quarter of 2010. Certain items totaled a net loss of $82.6 million versus $155.7 million for the same period last year. Virtually all of the $82.6 million was attributable to an accounting entry for a one-time bonus payment to non-senior management employees that KMP and its unitholders are not responsible for and will never pay any portion of. The amount must be reflected on KMP’s income statement, however, for GAAP purposes.

Chairman and CEO Richard D. Kinder said, “We are pleased to increase our cash distribution per unit for the fifth consecutive quarter. All five of our businesses produced stronger first quarter results than in the comparable period last year. Total segment earnings before DD&A were $879.4 million, up 6 percent from $826.9 million for the first quarter of 2010. Given our solid asset performance, along with current oil prices and interest rates, we are on pace to generate excess cash flow of almost $100 million for 2011, versus our annual budget of $37 million. We previously announced that KMP is expected to declare cash distributions of $4.60 per unit for 2011, which would be a 4.5 percent increase over 2010, and we expect to meet or exceed that target.”

Kinder Morgan is the one of the largest most consistent and most stable of the MLPs. Distribution for Q1 2011 was $1.14, a 7% increase from Q1 2010 and more importantly they generated coverage of the distribution that was above plan. On the conference call they said that if things continued to go well during the rest of 2011 then they would be looking at raising the distribution above their $4.60 target for the year. They mentioned the dividend growth for 2011 could be as high as 7.5% vs the 4.5% currently planned. These are impressive results for such a large and stable company.

All of Kinder Morgan’s business segments were up over last year with their CO2 business and their terminals business showing the largest growth. Here is the breakout by business segment. As the table shows Kinder Morgan is a very stable and diversified business, more so than any other MLP which are more pure plays on one segment or the other.

Three Months Ended March 31,
2011 2010
Segment earnings before DD&A and amort. of excess investments (1)
Products Pipelines $ 180.3 $ 163.9
Natural Gas Pipelines 222.6 219.3
CO2 258.3 247.8
Terminals 170.3 150.9
Kinder Morgan Canada 47.9 45.0
Total $ 879.4 $ 826.

As far as the shares go, KMP is trading at a 6% yield even as the shares hit a 52 weeks and all time high today. KMR shares are trading at a 12% discount to KMP so they yield about 6.8% based on the planned $4.60 distribution for this year. With a 4.5% growth rate with a potential upside of 7.5% growth KMR shares represent very good value. For investors looking for more growth KMI is trading at a 4% yield with a 2011 growth rate planned for 9% and with potential upside of 14%. Also, very good value.

In summary, Kinder Morgan remains the most stable, most diversified MLP in the business but also with great growth prospects.


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