Zacks Investment Research



Kinder Morgan Energy Partners, L.P. |(KMP - NYSE) |$90.18 | |

Note: More details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.

Reason for Report: Flash Update: 3Q14 Earnings Results

Prev. Ed.: Jul 24, 2014; 2Q14 Earnings Update (broker material considered till Jul 22, 2014)

Flash News Update [Note: Earnings Update in progress; final report to follow]

On Oct 16, 2014, Kinder Morgan Energy Partners, L.P. announced its 3Q14 financial results. The partnership's second-quarter 2014 earnings from continuing operations of $0.57 per limited partner unit (excluding certain items), missing the Zacks Consensus Estimate of $0.62. The quarterly results however improved from the year-earlier profit level of $0.54.

Revenues increased 19.9% to $3,933.0 million from $3,279.0 million in the year-ago quarter. Also, the top line came above the Zacks Consensus Estimate of $3,573.0 million.

Kinder Morgan is one of the largest publicly traded master limited partnerships (MLPs) and generally serves as a benchmark for the pipeline MLP group. A focus on fee-based and diversified businesses has enabled the partnership to dilute its business risks. Kinder Morgan Inc. (KMI), one of the largest mid-stream energy companies in the U.S., owns the partnership’s general partner interest.

The partnership's cash distribution per common unit was raised to $1.40 ($5.60 annualized), representing 4% year-over-year growth. The distribution is payable Nov 14, 2014. The partnership has increased the quarterly distribution 53 times since the current management team took over in Feb 1997.

Kinder Morgan's payout hike was fueled by outstanding results at Tennessee Gas Pipeline (“TGP”), increased oil and NGL production at Scurry Area Canyon Reef Operators Committee (SACROC), and strong results from its Products Pipelines and Terminals businesses.

The partnership's distributable cash flow – a measure of its ability to make unitholders' payments – before considering certain items was $607 million versus $554 million in the year-ago quarter. Distributable cash flow per unit, excluding certain items, was $1.31, up 3.1% year over year.

Third Quarter Segmental Highlights

Products Pipelines: The business segment's earnings before DD&A and certain items climbed 10% year over year to $222 million. Higher volumes on the Kinder Morgan Crude and Condensate Pipeline, along with the Pacific system contributed to the upside. Total refined products’ volume was up 6.8% from the prior-year quarter.

Natural Gas Pipelines: Earnings before DD&A and certain items from the segment increased 9% year over year to $661 million. The performance was aided by strong performance at its TGP, El Paso Natural Gas (EPNG) and South Texas midstream assets.

CO2: The segment's earnings before DD&A and certain items were $363 million, up 4% year over year on the back of increased yield at SACROC as well as increase in oil production and higher NGL sales volumes.

Terminals: The business segment earned $247 million before DD&A and certain items, up 25% year over year. The segment benefited from incremental earnings from various expansions coming online including the Battleground Oil Specialty Terminal Company LLC and Houston Ship Channel facilities. Strong petcoke volumes, including the impact of the BP plc (BP) operated Whiting facility expansion, and improved steel volumes also contributed to this segment’s earnings improvement.

Kinder Morgan Canada: The segment reported earnings of $50 million before DD&A and certain items, up 13.6% year over year, reflecting favorable foreign exchange rates along with high demand for Trans Mountain Pipeline and higher mainline throughput into Washington.

Financials

As of Sep 30, 2014, Kinder Morgan had cash and cash equivalents of $268 million and long-term debt of $20,810 million. Debt-to-capitalization ratio was 53.9% versus 53.8% in the last quarter.

MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON KMP.

Portfolio Manager Executive Summary [Note: only highlighted material has been changed]

Headquartered in Houston, Texas, Kinder Morgan Energy Partners, L.P. (KMP) is one of the largest publicly traded pipeline limited partnerships in America. Kinder Morgan Energy Partners, L.P. owns and manages energy transportation and storage assets in North America. It operates in five segments: Products Pipelines, Natural Gas Pipelines, CO2, Terminals and Trans Mountain.

Of the 14 firms in the Digest group covering KMP, 5 provided positive ratings, 8 gave neutral ratings and 1 firm provided a negative rating on the stock. Target prices for KMP range between a low of $70.00 (9.1% downside from the current price) and a high of $90.00 (16.9% upside from the current price), with the average being $82.60.

The following is a summarized opinion of the diverse firms’ viewpoints:

Neutral or equivalent (57.2% or 8/14 firms): These firms believe that KMP’s project-rich portfolio will be fueled by its extensive infrastructure and its current valuation will account for its stable and diverse cash flow stream. The firms expect Kinder Morgan to manage its capital expansion portfolio and associated financing requirements.

The firms believe that asset drop-down from Kinder Morgan Inc. (KMI) provides expansion opportunities for KMP. The partnership sees growth opportunities on Tennessee Gas Pipeline (TGP) as well as El Paso Natural Gas (EPNG) systems beyond current projects in the Marcellus and near the Mexico border. It also indicated for the first time that it is evaluating a potential gas-to-crude pipe conversion on a portion of EPNG to transport West Texas crude to refineries in California as well as intends to construct a pipeline to provide supplies to Florida Power and Light.

The firms believe that the Kinder Morgan Crude and Condensate pipeline (KMCC) in the Eagle Ford will see volume expansion as the partnership adds more projects to the system. The product pipeline segment, in general, is expected to exceed expectations in the future owing to contributions from the Transmix and Cochin assets.

Further, the firms believe that KMP’s CO2 operations will be the fastest-growing segment, while at the same time it presents the largest risk for the investors over the long term. A significant amount of capital will be necessary to maintain crude oil production, which could weigh upon distribution growth if volumes plunge faster than anticipated or service costs escalate sooner than expected.

KMP’s management team remains focused on its strategy of acquiring and building stable fee-based assets that are crucial to the North American energy infrastructure. It is also intent on leveraging its assets footprint to seek attractive investment opportunities as well as control costs simultaneously. The partnership’s valuation appropriately reflects its risks and growth opportunities.

However, the partnership faces risks that include cost overruns using up project accretion, credit rating downgrades, high gross profit burden, exposure to commodity price risk in the CO2 segment, decrease in crude oil prices and an increase in interest rate.

Positive or equivalent (35.7% or 5/14 firms): The firms with a positive stance are of the opinion that KMP is one of the largest and the most diverse Master Limited Partnerships (MLP). The partnership’s size allows it to pursue investments at a scale its peers cannot. The company’s scope of operations includes areas where other MLPs do not operate, thus giving it a competitive advantage.

The firms view the dropdown of assets from KMI following the closure of the El Paso acquisition to be immediately accretive to KMP unitholders. Besides the EPNG drop-down, KMP has numerous growth opportunities that include the Connecticut Expansion project ($77 million), Cameron LNG expansion project ($138 million), Sierrita Pipeline project ($204 million), DK Southwest expansion ($120 million), Yellow Jacket Central Facility expansion ($210), Doe Canyon expansion ($255 million), Cochin Pipeline Reversal project ($260 million), the KMCC pipeline expansion ($109 million), the Parkway Pipeline ($230 million) and BOSTCO Project ($485 million).

Kinder Morgan is believed to have an average life of 9 years of interstate pipeline contracts. With the completion of the Copano acquisition, the partnership will now focus on organic growth with a capex budget of $14.4 billion for the next 5 years. Under this budget, the distribution to different segments are $5.4 billion for Kinder Morgan Canada, $2.8 billion for natural gas pipelines, $2.7 billion for CO2, $2.1 billion for Terminals and $1.2 billion for Product pipelines.

Kinder Morgan’s diversified asset footprint and vertically integrated midstream supply chain as well as foresight in recognizing and capitalizing profitable opportunities augur well. A strong balance sheet enables the partnership to pursue strategic organic growth along with other joint ventures or acquisition prospects as they arise.

Kinder Morgan is one of the biggest MLPs with a long track record of delivering results to its unitholders, and is thus generally preferred by investors. This is affirmed by the fact that KMP has historically traded at a premium over the past few years.

Negative or equivalent (7.1% or 1/14 firms): The firms believe that Kinder Morgan’s distribution growth prospects are closely linked to the successful completion of organic growth projects, which in turn might be adversely affected by operational hindrance, cost inflation and overruns, and delays in completion. As several projects are expected to come online in 2014, any delay in their commissioning would affect the partnership’s growth plans and profitability.

July 24, 2014

Overview [Note: only highlighted material has been changed]

The firms identified the following factors for evaluating the investment merits of KMP:

|Key Positive Arguments |Key Negative Arguments |

|Compelling Fundamentals |Growth Impediments |

|Fee-based diversified asset portfolio poses challenges to competitors |KMP's Products Pipelines segment has contracts that are fee-based and |

|and generates stable earnings |dependent on volumes. The partnership has experienced weak demand growth |

| |for refined products such as jet fuel. With the US economy still fairly |

|Extensive scope of operations in areas where other MLPs do not operate |weak and gasoline prices high, gasoline demand may come under pressure. |

|provides competitive advantage for acquisitions and organic growth | |

|projects |Change in supply and demand fundamentals for oil and gas |

| | |

|The CO2 business is expected to be a major long-term growth driver, |With a large inventory of growth projects, KMP is exposed to risks of cost|

|propelling distribution growth as the company works on preliminary |inflation and project delays resulting in cost overruns |

|engineering for a major expansion (size of the opportunity yet to be | |

|announced) in its CO2 production and delivery |Widening credit spreads, equity market volatility and weak economic |

|Growth |conditions could adversely impact energy transportation and storage demand|

|Asset dropdowns from KMI contribute to growth and add cash flow stability |and margins |

| |Macro Issues |

|Concurrent with Kinder Morgan's (KMI) purchase of El Paso, KMI sold to KMP|A material slowdown in the U.S. economy could impact KMP’s earnings |

|all of Tennessee Gas Pipeline and El Paso Natural Gas. The combination of | |

|divestitures and acquisitions is expected to be accretive to DCF/unit in |Equity market volatility and weak economic conditions |

|2014. | |

| |Valuation may suffer in a rising interest rate environment |

|KMP's attractive risk-reward proposition is particularly evident amid the | |

|volatile capital markets |Higher gasoline and feedstock prices marginally increased the risk profile|

| |of the partnership’s refined product pipeline assets |

|KMP enjoys high distribution yield, growth potential of its distributions,| |

|tax-deferred features of these distributions, and strong market position |Sovereign debt defaults would likely increase the risk premiums on |

| |yield-oriented investments pushing the price of KMP units lower. |

|Visibility is supported by Haynesville and Eagle Ford expansions, higher | |

|hedged crude oil prices, terminal capacity build out (including coal | |

|exports) and low interest rates | |

Kinder Morgan Energy Partners, L.P. (KMP) is one of the largest publicly traded pipeline limited partnerships in America. Headquartered in Houston, Texas, KMP owns or operates more than 54,000 miles of pipelines and 180 terminals in North America. Its pipelines transport natural gas, gasoline, crude oil, CO2 and other products, and its terminals store petroleum products and chemicals and handle bulk materials like coal and petroleum coke. Kinder Morgan is also the leading provider of CO2 for enhanced oil recovery projects in North America. One of the largest publicly traded pipeline limited partnerships in America, KMP has an enterprise value of over $55.6 billion. For more information visit its website: . KMP’s fiscal year ends on Dec 31.

A Master Limited Partnership is an investing vehicle similar to a real estate investment trust (REIT). Like REITs, MLPs distribute practically all of their free cash flow to unit holders. The unit holders are categorized as either a general partner (the managing partner) or a limited partner. MLPs do not pay taxes at the corporate level. Income tax and associated tax shields are passed on to unitholders instead. The benefits of accelerated depreciation are passed on to unitholders, and as a result, growing MLPs pass through distributions that are largely tax deferred. However, distributions reduce the taxable basis of the investment and if these are held for a long period of time, a large ordinary taxable gain generally occurs upon selling the shares. The unique tax advantage that an MLP has for retail investors is generally discouraged as an investment for institutional investors.

However, Kinder Morgan has developed another vehicle to enable broader ownership. Kinder Morgan Management (KMR) pays dividends in kind (additional shares), and as a result, owners have no income allocated to them until they sell their shares (at which time a capital gain or loss is realized).

July 24, 2014

Long-Term Growth [Note: only highlighted material has been changed]

The firms are of the opinion that the partnership is expected to benefit from the synergies related to the El Paso acquisition. Given the recent decline in capital costs and Kinder’s disciplined approach towards capital allocation, the firms believe the partnership will continue to deliver above-average distribution growth relative to its peers.

The firms project KMP's ability to produce predictable, steady cash flow as its business asset. With many of its contracts being of the long-term, take-or-pay variety, KMP has little price or volumetric risk. Growth is primarily achieved through upsizing capacity at existing locations, bolt-on expansions, and periodic tariff increases. The firms also believe that Kinder Morgan has the ability to capitalize on profit opportunities in emerging shale plays (Haynesville, Eagle Ford) over the long term.

Again, all of KMP's business sectors have strong long-term growth potentials. Drivers for the Natural Gas Pipeline segment include demand growth and shifting supply basins which, in turn, lead to pipeline/storage expansions and extensions and greenfield development. For the Products Pipeline segment, the main long-term driver will be the development of shale play liquids infrastructure. Terminal segment growth will be driven by newbuild and expansion of export coal and petcoke terminals, petroleum exports and Canadian crude oil merchant tankage. In the CO2 segment, long-term growth should be driven by solid demand to recover the billions of barrels of oil in place in grown-up oil fields.

KMI’s acquisition of EP and subsequent asset dropdowns to KMP should provide additional growth potential. The Copano acquisition is expected to be another significant step by KMP. Apart from EPNG drop-down, KMP has numerous growth opportunities ($14.4 billion in the next 5 years) that include Connecticut Expansion project ($77 million), Cameron LNG expansion project ($138 million), Sierrita Pipeline project ($204 million), DK Southwest expansion ($120 million), Yellow Jacket Central Facility expansion ($210), Doe Canyon expansion ($255 million), Cochin Pipeline Reversal project ($260 million), the KMCC pipeline expansion ($109 million), the Parkway Pipeline ($230 million) and the BOSTCO Project ($485 million).

July 24, 2014

Target Price/Valuation [Note: only highlighted material has been changed]

Provided below is the summary of valuation and ratings as compiled by Zacks:

|Rating Distribution |

|Positive |35.7%↓ |

|Neutral |57.2%↑ |

|Negative |7.1%↑ |

|Average Target Price |$82.60↓ |

|Digest High |$90.00↓ |

|Digest Low | $70.00↓ |

|Number of Firms with Target Price/Total |10/14 |

The general risks to achieving the target price include a decrease in NGL prices, supply chain disruptions, a decline in demand for refined products or natural gas due to higher prices, regulatory risks, cost overruns on expansion projects, the ability to integrate future acquisitions, and rising interest rates.

Recent Events [Note: only highlighted material has been changed]

On Jul 16, 2014, KMP reported 2Q14 financial results. Highlights are as follows:

• Total revenue was $3,652 million versus $2,661 million in 2Q13.

• Net income was $788.0 million versus a net income of $655.0 million in 2Q13.

• Earnings from continuing operations were $0.73 per limited partner unit versus earnings per unit (EPU) of $0.66 in 2Q13.

Revenue [Note: only highlighted material has been changed]

The partnership reported total revenue of $3,652.0 million in 2Q14 versus $2,661.0 million in 2Q13, representing a y-o-y increase of approximately 37.2%.

Projects Backlog

The natural gas segment has a backlog of approximately $2.6 billion. The partnership also plans to add projects to the segment in the near future. Since Jul 1, 2014, the partnership has entered into new firm transport capacity commitments for 2.3 Bcf/d. The majority of this capacity is projected to be commissioned between 2014 and 2017.

In the CO2 segment, backlog amounts to $2.5 billion. With plans to explore the segment, the partnership has obtained a long-term CO2 contract that will be beneficial to oil production in the future. The partnership foresees a steady demand for CO2 from its customer base in the Permian basin.

The additional compression prospects present in Southwest Colorado and a new source field at the St. Johns Field will likely increase production to over 2.0 billion cubic feet per day (Bcf/d) over the coming years (by 2017), up 53.8% from its current yield of 1.3 Bcf/d. This is likely to augment returns in the future.

KMP explores growth opportunities through projects like the acquisition of Copano Energy, acquisition of Goldsmith Landreth San Andres Unit in West Texas from Legado Resources, expansion of the Yellow Jacket Central Facility at the Mc Elmo Dome, expansion of its Doe Canyon Unit, expansion of the Battleground Oil Specialty Terminal Company (BOSTCO) and construction of the Cochin Pipeline Reversal Project.

Outlook

The firms believe that the expansion of Trans Mountain, new CO2 contracts and expansion projects in its terminals business will be significant growth drivers for KMP. Again, KMI’s acquisition of EP and the subsequent asset dropdowns to KMP should provide additional growth potential.

Margins [Note: only highlighted material has been changed]

In 2Q14, operating income was $933.0 million versus $784.0 million in 2Q13.

In the quarter, the partnership incurred $2,088.0 million in operating expenses versus $1,341.0 million in the year-earlier quarter.

For KMP, earnings before DD&A were widely followed and estimated. The segments’ earnings reflect cash flow before common general and administrative (G&A) and allocated interest expense.

Segmental Details as Provided by KMP

Product Pipelines

The business segment experienced a 2% year-over-year improvement in earnings before DD&A and certain items to $204 million in the second quarter. The higher volumes on the Kinder Morgan Crude and Condensate Pipeline along with higher volumes and revenues from its Southeast Terminals aided the growth. This was accompanied by higher transmix volumes and margins with improved contributions from the Parkway Pipeline. Total refined products volume was up 5.3% from the prior-year quarter.

Natural Gas Pipelines

Earnings before DD&A and certain items from the business climbed 45.5% year over year to $723 million. The performance was aided by the dropdown of TGP and EPNG as well as higher contributions from the Copano transaction.

Overall, transport volumes moved up 5% from the year-ago quarter, mainly attributable to robust volumes in the Eagle Ford and strong transport volumes on the Texas intrastate pipeline system due to increased deliveries to Mexico. Again, a new supply project at TGP and colder weather in the Northeast also added to this.

CO2 Pipelines

The segment’s earnings before DD&A and certain items were $366 million, up 7.6% year over year on the back of increased yield at the SACROC as well as higher CO2 sales and transport volumes. Increased output at the Katz field and Goldsmith Unit along with higher oil and natural gas liquids (NGL) prices also aided earnings growth.

Terminals

The business segment earned $228 million before DD&A and certain items in the second quarter, up 21.9% year over year. The segment benefited from higher earnings from various expansions coming online including the Edmonton Terminal, BP Whiting, BOSTCO, International Marine Terminal and additional liquids tankage at Galena Park. Moreover, robust performance by its liquids terminals in the Gulf, improved petcoke results and its recent acquisition of APT contributed to the growth.

Kinder Morgan Canada

The segment reported earnings of $48 million before DD&A and certain items in the second quarter compared with $52 million in the year-ago quarter. The decline was mainly due to unfavorable foreign exchange rates despite high demand for the Trans Mountain Pipeline, with higher mainline throughput into Washington and strong activity at Westridge Terminal.

Earnings per Unit [Note: only highlighted material has been changed]

Kinder Morgan reported 2Q14 earnings of $0.73 per limited partner unit, up 10.6% from the year-ago quarter level of $0.66 per unit.

The partnership’s Limited Partners’ interest in net income decreased 17.9% to $299.0 million in 2Q14 from $364.0 million in 2Q13.

Distribution

On Jul 16, 2014, quarterly cash distribution per common unit was raised to $1.38 ($5.52 annualized), representing 6% year-over-year growth. The dividend is payable on Aug 15 to unitholders of record as of Jul 30. Including this hike, the partnership has increased the quarterly distribution 51 times since its current management took over in Feb 1997.

Kinder Morgan's payout hike was fueled by increased contribution from the Copano acquisition, dropdown of the entire Tennessee Gas Pipeline and 50% of El Paso Natural Gas, from its parent company Kinder Morgan Inc., growth opportunities in the coal export business as well as robust oil yield.

The partnership's distributable cash flow – a measure of its ability to make unitholders' payments – before considering certain items was $693 million versus $550 million in the year-ago quarter. Additionally, distributable cash flow per unit, excluding certain items, was $1.55, up 6.2% year over year.

Outlook

Some firms raised their 2014 earnings as well as discounted cash flow as they believe KMP will be able to enhance cash flow in its Natural Gas Pipeline segment due to the dropdown of the El Paso assets from Kinder Morgan Inc. that is expected to provide visible cash flow growth for KMP over the next few years. Also, the Copano acquisition is expected to boost production and increase the cash inflow for KMP.

|Analyst | Nilendu Saha |

|Copy Editor | |

|Content Ed. | |

|Lead Analyst | Nilendu Saha |

|QCA | Nilanjan Choudhury |

|No. of brokers reported/Total | |

|brokers | |

|Reason for Update | Flash |

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October 16, 2014

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