Kinder Morgan’s Worth $86 Due To Defensive And Diversified Business Model

by Trefis Team
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KMP
Kinder Morgan Partners
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Kinder Morgan Energy Partners (NYSE: KMP), a subsidiary of Kinder Morgan Inc. (NYSE: KMI), is a diversified energy company primarily engaged in pipeline transportation and storage of petroleum products, ethanol, and natural gas in North America. The firm’s other businesses include production and transportation of carbon dioxide and operating terminal capacity for a variety of dry and liquid products.  The firm had revenues of around $8.2 billion in 2011 and EBITDA margins of around 33%. Here we provide a brief overview of the firm’s business model, its key operating segments and the factors that are currently driving them.

KMP is viewed as a good defensive stock in the energy sector, thanks to its largely fee-based and diversified business model. Most of the firm’s revenues are tied to the volumes of the commodities that it carries rather that the prices of the commodities. While the firm is not impacted significantly by the volatility of energy prices, higher commodity prices could enable it to charge better rates due to better bargaining power with customers. The firm’s diversified business model gives it exposure to different sectors of the energy market ranging from natural gas (via the pipelines business) to oil (via the CO2 business) to coal (via the terminals business), allowing it to mitigate the effects of weak performance in an individual segment.

Natural Gas Pipelines

The natural gas pipelines business is the firm’s bread and butter, accounting for over 50% of revenues in 2011. The division has EBITDA margins of around 15%. The operations consist of interstate and intrastate natural gas transmission pipelines, gathering lines and storage treatment and processing facilities.

Recent Developments And Factors Driving The Business: The outlook for natural gas demand looks strong as utilities and industries are beginning to capitalize on the abundance of cheap natural gas in North America. For instance, many electric utility companies are choosing natural gas over coal fired plants thanks to lower cost of fuel, lower emissions and lower capital investments per megawatt. Higher demand for gas could drive up demand for transmission capacity in the firm’s pipelines and allow the firm better bargaining power.

This year, KMP’s parent firm KMI acquired El Paso Corporation, a natural gas pipeline operator. To get clearance from the Federal Trade Commission (FTC), KMP had to divest some of its natural gas pipeline and processing operations and acquire the Tennessee Gas pipeline (TGP) and a 50% stake in the El Paso Natural Gas Company from KMI. While we do not expect these deals to have a significant impact on overall revenues, the TGP could provide growth opportunities given its access to the Marcellus and Utica shale plays and connectivity to large cities like New York and Boston.

Terminals

The firm’s terminals business is involved in transloading (transferring from one mode of transport to another) and storing refined petroleum products and dry and liquid products, including coal, cement, alumina. The firm has over 115 terminals across the United States and Canada with a large portion of terminal capacity in the eastern part of the US. The division has EBITDA margins of around 45% and accounts for about 16% of the firm’s sales.

Recent Developments And Factors Driving The Business: While demand for thermal coal in the US has been subdued due to stricter environmental norms and competition from cheaper natural gas, US coal producers have been pushing for exports. Thermal coal imports are strong in regions like Asia, and KMP is well poised to benefit given its terminal capacity in the US East And Gulf coasts which are relatively close to coal mines in the Eastern and Southeastern United States. During 2012, Peabody Energy (NYSE: BTU) and Arch Coal (NYSE: ACI) inked contracts with KMP to access some of its terminals on the Gulf coast for their coal exports. [1]

CO2 Business

The CO2 division has been one of the company’s strongest performing businesses. Although the division is the second largest in terms of revenue behind the natural gas pipelines business, it is by far the most profitable with EBITDA margins of around 67% in 2011.  The CO2 division produces, markets and transports carbon dioxide (CO2) that is used to improve production from mature oil wells (often referred to as enhanced oil recovery or EOR). The business owns or has interests in 8 billion cubic feet of carbon dioxide reserves located in New Mexico and Colorado and also operates the pipeline infrastructure required to transport its production. In addition, the CO2 division operates oil fields and a gas pipeline in West Texas.

Recent Developments And Factors Driving The Business: The firm supplies CO2 primarily to the Permian basin which contains several legacy oil fields. Most of these oil fields saw their production peak in the 197o’s and have fallen significantly since. This has caused an increase in demand for production enhancement services and the basin is current home to almost half the country’s EOR projects. (( The Future of Co2, PBPA Magazine)) However, oil production from the basin’s EOR fields has been stagnant  for the last five years due to a shortage of CO2. In order to meet the shortfall and rising demand, KMP has announced several investments towards growing  its CO2 operations, including the expansion of production at its Doe Canyon unit in Colorado. (See Also: The Value Of Kinder Morgans CO2 Business)

Products Pipeline

The products pipeline business transports and stores refined petroleum products, including gasoline, diesel fuel, jet fuel and natural gas liquids. Pipelines are used by various oil producers in the United States to ship produce from the oil fields to refineries and also from the refineries to the terminals located near consumers. The shipping services are generally provided on a long term contract basis. The division accounts for around 11% of the firm’s revenues and has strong EBITDA margins of around 41%. The business’ revenue depends on the demand for gasoline, diesel and other products in the areas serviced by the pipelines.

We have a price estimate of around $86 for Kinder Morgan Energy Partners, which represents a 10% premium over the current market price.

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Notes:
  1. Peabody Energy, Kinder Morgan in coal-export deal, MarketWatch []
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