KMP: A Closer Look at Kinder Morgan Energy Partners’ 2011 Distributable Cash Flow

In an article titled Distributable Cash Flow (“DCF)” I present the definition of DCF used by Kinder Morgan Energy Partners LP (KMP) and provide a comparison to definitions used by other master limited partnerships (“MLPs”). KMP’s definition and method of deriving of DCF (what KMP refers to as “DCF before certain items”) is complex and differs considerably from other MLPs I have covered. Using KMP’s definition, DCF per unit for 2011 was $4.68, up from $4.43 in 2010. How do these figures compare with what I call sustainable DCF for these periods?
 
The generic reasons why DCF as reported by an MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to KMP’ results with respect to sustainable cash flowing to the LPs generates the comparison outlined in the table below:

Table1, Figures in $ Millions

The principal differences of between sustainable and reported DCF numbers in 2011 and 2010 are attributable to risk management activities and a host of other items grouped under “Other”. Risk management activities present a complex issue. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. In this case, the KMP risk management activities items reflect proceeds from termination of interest rate swap agreements rather than commodity hedging and I therefore exclude them.

Items in the “Other” category include numerous adjustments as detailed below:

Table 2, Figures in $ Millions

These adjustments further illustrate the complexity and subjectivity surrounding DCF calculations. They also highlight the difficulty of comparing MLPs based on their reported DCF numbers, which is another reason why I exclude them from my definition of sustainable DCF.

Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:

Table 3

These are solid coverage ratios. However, Table 1 clearly demonstrates the extraordinarily high proportion of cash generated by this partnership that is claimed by Kinder Morgan Inc, (KMI), KMP’s general partner. I would therefore also like to evaluate the sustainability of cash flows from the perspective of all partners (i.e., LPs and GP). This requires a closer look at net cash provided by operating activities:

Table 4, Figures in $ Millions

Table 4 shows that in 2011, sustainable net cash from operating activities only just covered distributions to partners and to non-controlling interests. The bulk of these distributions were made to LPs and KMI (distributions made to KMI reflect its incentive distribution rights as well as the units it holds). Amounts distributed to non-controlling interests are not significant (~$28 million in 2011 and $24 million in 2010).

As always, I also generate a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded in the last two years.

Table 5, Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $446 million in 2011 and by $434 million in 2010. The good news is that KMP is not using cash raised from issuance of debt and equity to fund distributions. The bad news, as I see it, is that most of the excess over this two year period was generated by non-sustainable cash items.

Following KMI’s acquisition of El Paso Corp. (EP), I think it is a question of time before KMI attempts to simplify its structure in order to avoid the complication, expense and potential conflict of interest inherent in being the general partner of three distinct MLPs (KMP, KMR, EPB) in which incentive distribution rights are eliminated and a single EPD-like entity remains. In any event (i.e., whether or not a structure simplification takes place), the EP acquisition will significantly impact the underlying Kinder Morgan MLPs. The numbers will change significantly once the drop downs commence.