We have initiated coverage on Kinder Morgan Inc. (KMI) with a long-term Neutral recommendation and a target price of $41.00. The company’s widespread opportunities owing to its master limited partnership’s (MLP) – Kinder Morgan Energy Partners, L.P. (KMP) – expansion program in the Eagle Ford as well as the positive impact of the pending acquisition of El Paso Corp. (EP) remain well balanced considering the risk associated with the fluctuations in natural gas markets.
Texas-based Kinder Morgan Inc. is one of the largest midstream energy companies in North America, operating approximately 37,000 miles of pipelines transmitting natural gas, refined petroleum products, crude oil, carbon dioxide and additional products. It has more than 180 terminals that store petroleum products and chemicals, as well as ethanol, coal, petroleum coke and steel.
We believe the company will seize attractive investment opportunities over the coming quarters, particularly in the Eagle Ford and Haynesville shale plays owing to KMP’s major foothold in the region. Kinder Morgan had recorded an impressive fourth quarter in 2011, and continues to profit from the performance of its publicly traded limited partnership, KMP. The partnership contributes approximately 98% to the distributions that the company currently receives on the back of its stable and incremental cash flow from diversified assets in virtually every market condition.
Importantly, in October last year, Kinder Morgan announced its plans to acquire El Paso in a bid to create the largest natural gas pipeline system in North America. This accord is believed to be one of the largest energy transactions in recent years and is expected to be immediately accretive to Kinder Morgan’s earnings. The deal will also generate $350 million a year in cost savings, or about 5% of the combined companies’ earnings before interest taxes, depreciation and amortization (EBITDA).
The company also expects a boost in its dividend payments upon closure of the Kinder Morgan-El Paso merger. Kinder Morgan expects its annual dividend to increase 12.5% through 2015, which is up from its previous expectation of 10%. Management has also set a dividend target of $1.35 a share for the current year that excludes El Paso and a 13% increase over the 2011 declared dividend of $1.20 per share.
We believe the asset mix will eventually boost the company’s natural gas pipelines exposure. The combined entity will be the owner of 67,000 miles of natural gas pipelines in North America as well as 13,000 additional miles of pipelines for the transportation of refined products.
Kinder Morgan is a holding company of the KMP general partnership interest. Therefore, its risks reflect that of the parent operating unit. The unpredictability of KMP’s cash flows mainly stem from its CO2 segment, which contributes more than one-third of the partnership’s total cash flow and is expected to fluctuate with crude oil prices in the long term. Again, sustaining crude oil production in this segment involves a considerable amount of capital. This could impede KMP’s distribution growth in the event of faster-than-expected production decline or a rise in service costs.
Additionally, the company’s results are vulnerable to fluctuations in natural gas markets. The ongoing liquid-rich drilling activities by the company clearly indicate that low natural gas prices are not likely to go up in the near term.
Hence, we see Kinder Morgan performing in line with the broader market.
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