Is Kinder Morgan a Sell?

Kinder Morgan (KMI) reported its first quarter 2016 results on April 20th. The company posted a mixed result. The refined products segment performed very well on one hand while on the other hand, the CO2 segment did poorly as expected, primarily due to lower commodity prices.

To summarize the segment performance on earnings before DD&A and certain items basis, three of Kinder Morgan’s five segments grew year over year.
The gas segment was up 4 % despite transport volumes coming down 2 %. The products pipeline segment was up 17 % primarily due to the completion of the Houston Ship Channel in 2015. The terminals segment was up 2 %.

On the other hand, the segments that were down were Kinder Morgan Canada and CO2. Kinder Morgan Canada would have been up if the Canadian dollar would not have gone weak during the same period. And the CO2 segment was down 21 % as a result of lower commodity prices although its average production volumes dropped 6 %. Hence, we can expect Kinder Morgan to not invest much into CO2 or enhanced oil recovery wells keeping in mind the low commodity prices.

The cut in forecast:

Kinder Morgan's CEO mentioned in the Q1 conference call that the company now expects slightly less earnings in the current year than projected earlier this year. Due to the potential impacts of factors like weak commodity prices, reduction in backlogs, bankruptcy of some major customers etc., the company now expects its full year 2016 EBITDA to be 3 % less than that it predicted in January. This reduction in expected EBITDA would result in a 4 % reduction in DCF.

One of the major factors behind this deterioration in forecast is the lower production at Eagle Ford. The oil production at Eagle ford was down by 28% from its peak while gas production was down 15 %. Since the products of Eagle Ford are inputs to the midstream and the downstream segments, their volumes will also be affected by this.

The other big factor causing a revision to the forecast is the coal customer bankruptcies. Arch Coal, one of Kinder Morgan's coal-producing customers, went bankrupt last quarter.

Backlog reduction:

Then there were project cancellations resulting in the reduction of expected revenue, which will also make the earnings and cash flows smaller than earlier projected. The project backlog is now $ 14.1 billion down from the previous $ 18.2 billion. Two of the biggest project cancellations for Kinder Morgan were the Palmetto Pipeline project, which is a reduction of $ 550 million, and the market portion of the Northeast Energy Direct (NED) project, which is a reduction of $ 3.1 billion. The Palmetto project had to be given up largely due to the reluctance shown by the Georgia government to enforce eminent domain. And the Northeast Energy Direct pipeline project was cancelled due to lack of firm customer commitment.

Despite the reduction in backlog from$ 18.2 billion to $ 14.1 billion, at this point, Kinder Morgan has sufficient projects in its pipeline compared to some of its peers. For instance, Enterprise Products Partners (NYSE:EPD) has a $ 6.8 billion project backlog and Energy Transfer Partners (NYSE:ETP) has a backlog of $ 9 billion. You can see how Kinder Morgan is not going to sit idle for years to come with many different projects toward which to divert capital.

The company has actually high-graded its backlog in this process. It has kept and added the highest return projects while shedding the least viable ones, which is the wisest thing to do in this low-commodity price environment. So, the reduction in backlog should be seen as a welcome sign by investors that the company is making the best use of the cash it saved by cutting dividends last quarter. By focusing on a fewer number of projects at the moment, the company is also expected to save $ 1.3 billion of cash by reducing the growth CAPEX from $ 4.2 billion to $ 2.9 billion in 2016.

Conclusion:

The revenue and earnings decline that Kinder Morgan has suffered in the first quarter is not a rare sight in the state of the landscape that the industry is standing on. But the more controllable things like segment performance, cash preservation, backlog high-gradation etc. have been dealt with well enough by Kinder Morgan yet again. I think the effect of the positive displayed in the Q1 results has already been factored into the price by now. So, due to a lack of enough potential upside, Kinder Morgan may not prove to be a better buy in the pipelines sector.
Published on Jul 14, 2016
By Subhen Mittra

Copyrighted 2016. Content published with author's permission.

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