You've probably read or at least heard about the Barron's article by Andrew Bary that dropped a bomb on the Kinder Morgan family of energy companies.
For anyone who needs a quick review, Kinder Morgan Energy Partners is one of the largest and most popular master limited partnerships traded today. Richard Kinder cobbled the company together from pipeline assets he purchased from Enron in the 1990s, and proceeded to grow it into a pipeline empire. Kinder Morgan Inc. (KMI, Financial) is the general partner responsible for managing Kinder Morgan Energy Partners (KMP, Financial). Richard Kinder himself keeps most of his personal wealth in shares of KMI.
It bears noting that most of Bary's bearish arguments are from research firm Hedgeye, which published a headline-generating slam piece on KMP last September. There is nothing particularly new in Bary's article, but because it was written in a well-respected journal like Barron's, the arguments carry a little more weight than they did when Hedgeye alone was making them.
In the article, I found truths, half-truths, and what appear to me to be, if not lies, then certainly some pretty significant misunderstandings.
Truths
“Kinder Morgan MLP, it bears noting, is burdened by an unfavorable financial relationship with Kinder Morgan Inc. It foots the bill for virtually all new capital projects, but pays nearly half of its distributions to the general partner.”
This is absolutely, 100% true. And it is why we invest in KMI rather than KMP. KMI’s disproportionate share of the distributions is a major reason why I love KMI as a long-term investment. And in any event, this is a “known issue” that hasn’t prevented KMP from generating great returns over the years.
Half-Truths
"Kinder Morgan is expensive based on conventional measures. It trades at 33 times 2013 earnings per partnership unit and 16 times estimated 2014 earnings before interest, taxes, depreciation, and amortization, after factoring in payments to the general partner."
Earnings per share and its derivatives (such as the P/E ratio) are not the best way to value MLPs, though Bary tries to adjust for this by stripping out the effects of depreciation. But given that MLPs are primarily yield investments, the other side of this argument is that KMP is considerably cheaper than utilities based on dividend yield, and KMP's "effective" yield is higher than its stated yield due to its preferential tax treatment.
KMP currently yields 6.9%, which is substantially all tax-free (technically tax-deferred, as the return of capital lowers your cost basis, but for all intents and purposes the yield is tax-free for years at a time). In contrast, the Utilities Select SPDR ETF (XLU, Financial) yields 3.75% at current prices. KMP's taxable-equivalent yield would be 8.6%, well over double the yield offered by utilities. It's hard for me to call KMP "overvalued" relative to other yield investments.
Lies or Gross Inaccuracies
“Kinder Morgan looks unattractive [i.e. overpriced] compared with other big MLPs, as well.”
I would argue that this is simply not true. Comparing KMP to two of its largest pipeline rivals, Enterprise Products Partners (EPD, Financial) and Magellan Midstream (MMP, Financial), by measuring enterprise value (value of all equity plus debt) divided by earnings before interest, taxes depreciation and amortization, KMP is actually significantly cheaper than its rivals. Its valuation is barely half that of MMP.
Why did I use this metric instead of, say, a P/E ratio? Because with MLPs, earnings tend to get wildly skewed by high depreciation charges. The EV/EBITDA calculation is the best available metric for comparing “apples to apples.”
To be fair, EPD and MMP should have higher valuations, as both are growing at a faster rate and neither has the high general partner payouts that KMP does. But it’s hard to make a case that KMP is overvalued here.
But there is one final argument that I would argue debunks the bear case, and it centers around insider ownership. If KMI were nothing but a vehicle for looting KMP, then why is KMI one of KMP’s largest unit holders? In addition to the general partner interests, KMI owns about 10% of KMP’s limited partner shares (the same shares that you or I could buy on the market). The KMP shares account for about 9%-10% of KMI’s market cap. KMI requires a healthy KMP to prosper. So even if you buy the argument that KMI is a parasite (which is a stretch), it’s a parasite that cannot afford to let its host die.
