A Look at the MLP Class System and the Kinder Morgan Family

Hinds Howard  |

In light of the 2012 presidential election, taxing the 1% and other class warfare tactics that will be employed in the coming months, I thought it might be a good time to talk about the class structure of the MLP space.  Just like in the real world, in the MLP space there are “haves” and “have nots”.  Some of the haves in the MLP space got that way by inheriting assets from their parents (like trust fund kids in the real world).  Those are the drop down MLPs like Williams Partners L.P. (WPZ), DCP Midstream Partners LP (DPM), Western Gas Partners LP (WES), Spectra Energy Partners, LP (SEP) and others.  These are the Waltons, the Hearsts, the younger Trumps of the MLP space.  Other MLPs, like Enterprise Products Partners L.P. (EPD), MarkWest Energy Partners, L.P. (MWE) and Copano Energy LLC (CPNO) are self-made.  These are the Zuckerbergs, Bezos and Dells of the MLP space.

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The major difference between the MLP space and the real world is that the inherited MLPs, backed by either large private equity or publicly traded corporations, far outnumber the self-made ones.  The days are gone when an MLP without major backing from either from private equity or a publicly traded corporation can grow on its own to a scale of one of the larger MLPs.  Now that the market cap of the sector is approaching $300 billion, it’s become a rich man’s game.

Sometimes, two wealthy MLP families combine via a marriage.  That happened when Kinder Morgan, Inc. (KMI) finalized the acquisition of EP in late May.  Of the children--Kinder Morgan Energy Partners, L.P. (KMP) and El Paso Pipeline Partners, L.P. (EPB)--it was thought when the deal was announced (and discussed by me here) that KMI would treat EPB like the proverbial red-headed stepchild.

That expectation has borne out in the performance of EPB relative to the others since last October when the acquisition was announced. It’s true that KMP will probably get the benefit of the majority of drop down acquisitions of legacy El Paso assets from KMI going forward, but for this quarter at least, EPB was the darling of the family.

With the drop down to EPB of the remaining 14% interest in Colorado Interstate Gas in May, and with today’s 7.8% distribution increase, Daddy Warbucks (KMI) appears to be trying to win over the investors of the new step child (EPB).  EPB reported distributable cash flow per unit of $0.65, which equates to 1.2x coverage of its newly announced distribution. EPB raised its distribution by 7.8% quarter over quarter, which is 14.6% above last year’s second quarter distribution.  14.6% is well above the stated 9% annual distribution growth rate KMI announced when it agreed to acquire EP.  KMI stated today that in 2012, EPB will pay a total $2.25 in cash distributions, which will be a 16.6% increase from 2011, and close to the last 3 years average annual distribution increase at EPB of 18.6%.

In MLP land, it pays to come from the right family.

KMI gets some benefit as well, as the distribution increase will mean an additional $8.2mm in quarterly distributions to KMI from the GP interest and incentive distribution rights that KMI holds in EPB, an increase of 35%. KMI’s L.P. units will also receive an additional $3.6mm in distributions.  That increase, along with distribution increases at KMP allowed KMI to increase its dividend by 9.4% quarter over quarter, and 16.7% year over year, compared with its stated 12.5% annual dividend target.

KMP released weaker than expected earnings yesterday, driven by lower natural gas liquids (NGL) prices that negatively impacted the CO2 segment’s results.  The product pipeline segment also had a weak quarter.  Other segments did OK, but KMP said deteriorating NGL prices will reduce KMP’s 2012 distribution coverage to 1.0x, compared with 1.04x in the budget released in January.  On the positive side, management expects the combination of asset divestitures combined with drop downs of Tennessee Gas Pipeline and 50% of the El Paso Natural Gas Pipeline to KMP to be slightly accretive.  Below is an update of what management said about its segments on its earnings call yesterday afternoon.

Given that the KMI family is now the largest combined pipelines company in the U.S., its segments are as large on their own as some MLPs.  For that reason, when KMP reports, its segment reporting is watched very closely by the sector.  What is obvious from the results is that NGL prices will negatively impact results of many upstream and midstream MLPs.  MLPs operating export terminals on the gulf coast should have solid results.  MLPs with product pipelines should have weak results.  MLPs with natural gas pipelines should continue to feel the effects of lower natural gas drilling activity, but MLPs that deliver natural gas to demand centers should have decent results.

Disclosure: The author is long EPB and KMI.

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