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|Kinder Morgan, Inc. |(KMI - NYSE) |$106.82 |
Note: All new or revised material since the last report is highlighted.
Reason for Report: Minor Change in Estimates Previous Edition: January 26, 2007
Overview
Texas-based Kinder Morgan, Inc. (KMI) is one of the largest mid-stream energy companies in the US with 43,000 miles of natural gas and product pipelines, 1.1M natural gas distribution customers and more than 150 terminals. KMI also has a significant presence in electric generation. It owns the general partner interest of Kinder Morgan Energy Partners, L.P. (KMP: NYSE), one of the largest publicly traded pipeline limited partnerships in the US. Combined, the two companies have an enterprise value of more than $35B. The company’s business segments include the Natural Gas Pipeline Company of America (NGPL), a major interstate natural gas pipeline and storage system; Kinder Morgan Retail, a natural gas retail arm for regulated sales to residential, commercial, and industrial consumers (KMI is selling its natural gas retail distribution operations to GE Energy Financial Services, for $710M); Power & Other, which involves the operation of natural gas fired electric generation facilities and various other activities; Terasen Gas, the largest natural gas distribution company in British Columbia, which transports up to 14.2B cubic feet (bcf) per day through approximately 25,000 miles of pipelines to approximately 892,000 retail customers in Western Canada; and Kinder Morgan Canada, a petroleum transportation industry leader, with almost 13,000 miles of pipelines that transport approximately 2.7M barrels per day of refined petroleum products and crude oil. KMI has entered into a definitive agreement under which investors led by Richard Kinder will acquire KMI in a transaction valued at approximately $22B. Upon closing, KMI’s stockholders will be entitled to receive $107.50 in cash for each share of KMI common stock. The deal is expected to close in early 2007. The corporate website is .
Analysts have identified the following factors for evaluating investment merits of KMI:
|Key Positive Arguments |Key Negative Arguments |
|Compelling fundamentals |EPS constraints |
|Low cost operator |Heavily dependent on KMP partnership for growth; half of KMI’s earnings |
|Strong free cash flow generation |come from KMP |
|Strong performance at KMP and NGPL |Execution risks on expansion projects and acquisitions |
|Strong balance sheet that does not require further debt pay down |Regulatory constraints |
|Strong dividend growth | |
|Transportation and storage revenue driven by contractual agreements |Macro constraints |
|Growth |Operations subject to federal, state and local regulatory environment |
|History of revenue and earnings growth |Volatile commodity prices |
|Buyout nearing completion | |
Note: KMI’s Fiscal Year ends on December 31.
Recent Events
On April 3, 2007, KMI entered into an agreement to purchase and operate Vancouver Wharves from British Columbia Railway Company. The transaction is expected to close in the second quarter of 2007.
On April 2, 2007, KMI completed the sale of its US natural gas retail distribution and related operations to GE Energy Financial Services and Alinda Investments LLC for $710 million plus working capital.
On March 5, KMI announced an agreement to sell the shares of Corridor Pipeline System to Inter Pipeline Fund in Canada for approximately C$760 million including debt. Additionally, Inter Pipeline will assume all of the debt associated with Corridor’s ongoing expansion. Proceeds from the transaction shall primarily be used to reduce debt.
On March 2, 2007, KMI announced that state regulatory utility commissions in Colorado, Nebraska, and Wyoming have approved the proposed acquisition of KMI by its investors.
On February 28, 2007, KMI announced its plans to invest up to $100 million to expand its terminal facilities to help serve the growing biodiesel market.
On February 26, KMI announced a definitive agreement to sell Terasen Inc. to Fortis Inc. for approximately C$3.7 billion including cash and assumed debt. The transaction is expected to be closed in mid-2007, subject to certain closing conditions and regulatory approvals.
Revenue
|FY ends Dec. 31 ($ in M) |4Q05A |3Q06A |1Q07A |2006A |2007E |2008E | |
|Company Guidance | | | | | | | |
|Digest Average |$1.29 |$1.02 |$1.48 |$1.57 |$5.06 |$5.61↓ |$6.18↓ |
|Estimated Min. |
|Positive |14% |
|Neutral |86% |
|Negative |0% |
|Average Target Price |$109.10↓ |
|Digest High |$116.00 |
|Digest Low |$107.00 |
|Number of Analysts with Target Price/Total |5/7 |
Risks to the price target include volatile commodity prices, a decline in economic growth, execution risk on expansion projects and acquisitions, adverse regulatory environment, and interest rate risks.
Please refer to Zacks Research Digest spreadsheet of KMI for more details on valuation and ratings.
Capital Structure/Solvency/Cash Flow/Governance/Other
Purchase of Terminal Assets
KMI has entered into an agreement to purchase and operate Vancouver Wharves, a bulk marine terminal, from British Columbia Railway Company on April 3, 2007. The Vancouver Wharves facility, located at the entrance to the Port of Vancouver, consists of five vessel berths situated on a 139-acre site. The terminal assets include significant rail infrastructure, dry bulk and liquid storage, and material handling systems, which allow the terminal to handle over 3.5 million tons of cargo annually. Vancouver Wharves also has access to three major rail carriers connecting to shippers in western and central Canada, and the U.S. Pacific Northwest. The transaction is expected to close in the second quarter of 2007.
US Retail Gas Operations of KMI Acquired by GE Energy Financial Services and Alinda Investments LLC
KMI has completed the sale of its US natural gas retail distribution and related operations serving over 260,000 customers in Colorado, Nebraska, Wyoming, as well as Hermosillo, Mexico, to GE Energy Financial Services and Alinda Investments LLC for $710 million plus working capital on April 2, 2007. The retail business serves residential, commercial, agricultural, and industrial customers through more than 11,900 miles of distribution and transmission pipelines, underground storage fields, and related facilities. The transaction, previously announced on August 14, 2006, has received all required regulatory approvals.
Sell of Terasen Inc. to Fortis Inc.
KMI has announced a definitive agreement to sell Terasen Inc. to Fortis Inc., a Canadian company with investments in regulated distribution utilities, for approximately C$3.7 billion including cash and assumed debt on February 26, 2007. The transaction is expected to be closed in mid-2007, subject to certain closing conditions and regulatory approvals. The sale does not include assets of Kinder Morgan Canada (formerly Terasen Pipelines). KMI expects to recognize a substantial book loss from this transaction. Proceeds from the sale will be used to pay down debt. This sale along with the proposed sale of the U.S. retail assets to GE Energy Financial Services will enable KMI to exit fully from the retail utility business. Terasen's main assets include Terasen Gas Inc. and Terasen Gas (Vancouver Island) Inc., a distribution business that delivers natural gas and piped propane to about 900,000 customers in British Columbia. Separately, Fortis said the acquisition agreement includes the assumption of about $2.3 billion of debt. Fortis also said it expects the deal to immediately add to per-share earnings. One firm (Merrill) states that if all the proceeds are used to retire debt then 2006 pro forma leverage at KMI will decrease to 8.0 x from 8.4x.
Cash Flow
Discretionary cash flow (DCF) was $279M, or $2.06 per share, in the quarter, compared to $195M, or $1.53 per share, in 4Q05.
Balance Sheet
At the end of 4Q06, the debt to capitalization ratio (including minority interest) stood at 53% (on a deconsolidated basis) compared to 54% at the end of 4Q05. Management stated during the conference call that it has reduced debt by $160M at the end of the year 2006, but there was minimal change during 4Q06.
KMI reduces its payout by $20M in 4Q06 to pay employee bonuses
As a result of KMP missing its 2006 budget target of $3.28 in distributions per unit, the partnership had no obligation to fund its employee bonus plan. Nevertheless, the Board of Directors of KMI determined that it was in KMI's long-term interest to fund a partial payout of KMP's bonuses through a reduction in the general partner's incentive payment. Thus, the general partner of KMP waived approximately $20M of its incentive payment for the fourth quarter, which equates to KMP's bonus payout for 2006 (representing roughly 75% of KMP's budgeted full bonus payout for 2006 of $26.5M).
Dividend and Cash Distribution
The Board of Directors declared a quarterly dividend of $0.875 ($3.50 annualized), which will be paid on February 14, 2007, to shareholders of record as of January 31, 2007.
The company increased its quarterly cash distribution per common unit to $0.83 ($3.32 annualized) from $0.81 per unit, payable on February 14, 2007, to unit holders of record as of January 31, 2007. The distribution is a 4% increase over 4Q05 cash distribution per unit of $0.80 ($3.20 annualized). In total, KMP declared cash distributions for 2006 of $3.26 per unit compared to $3.13 per unit for 2005, but below its published annual budget of $3.28.
Signing of ‘Going Private’ proposal for $107.50 per share, up from $100 per share
On May 29, 2006, KMI received a 100% buyout proposal of all the outstanding shares of the company for a cash price of $100 per share from a group of investors led by Richard D. Kinder.
On August 28, 2006, KMI announced it had entered into a definitive agreement under which investors led by Richard Kinder will acquire KMI in a transaction valued at approximately $22B (which includes $7B in debt). Under terms of the agreement, upon closing, KMI’s public stockholders will be entitled to receive $107.50 in cash for each share of KMI common stock. The purchase price represents a 27% premium over the closing price of $84.41 on May 26, 2006 (the last trading day before the proposal to take the company private) and a 7.5% increase over the original offer of $100 per share.
On December 19, 2006, KMI stockholders voted to approve the proposed agreement. The transaction, subject to receipt of regulatory approvals and the satisfaction of other customary closing conditions, is expected to close in 1Q07.
On January 25, 2007, Kinder Morgan, Inc. announced that it has received Hart-Scott-Rodino Antitrust Improvements Act clearance for the proposed acquisition of KMI by the management-led investment group, which includes several Kinder Morgan executives and private equity firms, The Carlyle Group and Riverstone Holdings LLC. The Federal Trade Commission (FTC) had challenged the participation of Carlyle and Riverstone because of a joint venture between those entities own interests in another energy company, Magellan Midstream Partners LP., a competitor of Kinder Morgan that also transports gas and other petroleum products. Carlyle and Riverstone reached a settlement with the FTC that clears the way for the acquisition of KMI to proceed.
On March 2, 2007, KMI received approval for the proposed acquisition of the company by investors including Chairman and CEO Richard D. Kinder, other senior members of KMI management, co-founder Bill Morgan, current board members Fayez Sarofim and Mike Morgan, and affiliates of Goldman Sachs Capital Partners, American International Group, Inc., The Carlyle Group and Riverstone Holdings LLC, from the state regulatory utility commissions in Colorado, Nebraska, and Wyoming.
Previously, KMI shareholders voted in December 2006 to approve the proposed merger agreement, and the only remaining approval is from the California Public Utilities Commission (CPUC). The CPUC previously issued a procedural schedule, which could delay the closing of the transaction until the second quarter of 2007, but the company is working diligently to try to expedite the matter. Because all of the regulatory approvals have not yet been obtained, the termination date for the going private transaction has been extended to August 28, 2007, in accordance with the merger agreement.
National Energy Board approves Trans Mountain Anchor Loop Project
On October 31, 2006, Kinder Morgan Inc. said that Canadian regulators have approved an expansion of its Trans Mountain oil pipeline, part of a project that will boost capacity by a third to 300,000 Bbls/d in three years. The company said that the National Energy Board gave the go-ahead for the "looping" project on the pipeline system, which runs to Vancouver, British Columbia, and Washington state's Puget Sound region from Edmonton, Alberta. The work will add almost 160 km (100 miles) of new pipeline through Jasper National Park and a British Columbia provincial park in the Rocky Mountains. The looping project, when complete in 2009, will further boost capacity to 300,000 barrels a day. The project is one of a number of new and expanded oil lines planned for Western Canada as output from the Alberta oil sands is expected to nearly triple to 3M barrels a day by 2015.
On November 30, 2006, Kinder Morgan Canada received approval from the National Energy Board for a new five-year Incentive Toll Settlement that will govern the economic terms and service standards for the Trans Mountain pipeline system from 2006 through 2010. The agreement provides the commercial support for the first phase of expansion of the Trans Mountain pipeline system, which will increase capacity to 300,000 bpd. The C$660M project includes the Trans Mountain pump station expansion that will increase pipeline capacity from 225,000 bpd currently to 260,000 bpd by April 2007, as well as the Anchor Loop expansion, which will add another 40,000 bpd of new capacity to the west coast of British Columbia and Washington state by late 2008.
Potentially Severe Problems
There are none other than those discussed in other sections of this report.
Long-Term Growth
Kinder Morgan is considered one of the best managed US natural gas pipeline companies, and is among the industry’s lower-cost operators. KMI is focused on owning and operating predominantly fee-based, mid-stream energy assets in strategic markets necessary to meet the growing demand of energy products across America. The company’s attractive portfolio of assets generates stable and relatively low-risk earnings and cash flow. In recent years, management has focused on increasing dividends. Of the seven analysts covering the stock, only one analyst (RBC Cap.) has projected a long-term EPS growth rate of 13%, the average being the same.
Analysts believe the Terasen acquisition remains a major driver for the stock over the longer term due to expansion opportunities gained through the acquisition. This acquisition has given KMI the access to the rapidly growing crude oil production from the Alberta oil sands. In addition to the Terasen acquisition, KMP made 10 acquisitions for approximately $470 million, mostly in the terminals business. In order to enhance its focus on the core competency of building and operating midstream infrastructure assets, the company is divesting all its retail natural gas distribution assets located in the U.S. and in Canada. Additionally, KMI’s GP interest in KMP, combined with the ongoing growth projects both at KMI and KMP will help KMI unlock long-term value for shareholders. The investments made in both KMI and KMP are designed to capitalize on growing trends in the energy industry.
Kinder Morgan’s attractive portfolio of mid-stream energy infrastructure assets generates stable and relatively low-risk earnings and cash flows which enable it to return substantial amounts to shareholders. Given the company’s strong financial condition, track record, and growth prospects these positive distribution-growth trends are expected to persist going forward. The company also remains active on the share buyback front, re-purchasing more than $900 million of shares since the initiation of the program in August 2001.
On October 19, 2006, KMP’s Board of Directors approved the investment of about $388M to further expand the 550 mile CALNEV pipeline system, which transports gasoline, diesel and jet fuel. The pipeline expansion involves construction of a new 16 inch diameter pipeline from Colton, California, to Las Vegas, increasing the system’s capacity to about 200,000 Bbls/d when it is complete and possibly to over 300,000 Bbls/d with the addition of pump stations. Startup of the new pipeline is scheduled for late 2009 or early 2010, based on environmental approvals and rate determinations.
Upcoming Event
On April 18, 2007, KMI is expected to release 1Q07 earnings.
Individual Analyst Opinions
POSITIVE RATINGS (14%)
Merrill – Overweight (no target price) – (02/26/07): The brokerage firm has maintained an Overweight rating.
NEUTRAL RATINGS (86%)
Zacks Investment Research – Hold ($107.00 − target price) – (03/06/07): The firm reiterates a Hold rating and a target price of $107.00.
Bear Stearns – Market perform – (01/18/07): The firm has maintained a Market perform rating.
Citigroup – Hold – ($107.50 − target price) − (03/20/07): The firm reiterates a Hold rating and a target price of $107.50.
Lehman – Equal weight ($107.50) – (01/19/07): The brokerage firm has maintained an Equal weight rating and 12-month price target of $107.50 per share.
RBC Cap. – Sector perform ($116.00) - (01/18/07): The brokerage firm has maintained a Sector perform rating but raised the price target from $112 to $116 per share.
UnionBankSwitz. – Neutral ($107.50) – (01/18/07): The brokerage firm has reiterated a Neutral rating and 12-month target price of $107.50 per share.
NEGATIVE RATINGS (0%)
No brokerage firms have given a negative rating on the stock.
Research Associate: Sharbari Nath
Reviewed By:
Copy Editor: Salma Islam
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April 11, 2007
Research Associate: Sharbari Nath, M.Fin..
Zacks Research Digest Editor: Lynnette Woolery, M.Sc. (Fin.), CFA
Sr. Editor: Ian Madsen, CFA; imadsen@; 1-800-767-3771 x9417
111 N. Canal Street, Suite 1101 ( Chicago, IL 60606
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