Kinder Morgan, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Kinder Morgan filed the unaudited report on August 13, 2012. Results include El Paso Corporation (EP) only from its May 25 acquisition date, so the 2012 and 2011 periods are not fully comparable.
Business context
Kinder Morgan operates or has an interest in approximately 75,000 miles of pipelines and 180 terminals. The May 25 acquisition of EP added a major interstate natural gas pipeline business and a 43.5% limited-partner interest, 2% general-partner interest and incentive distribution rights in El Paso Pipeline Partners (EPB). Consideration was approximately $23.0 billion: $11.6 billion cash, 330 million shares and 505 million warrants. Purchase-price allocations remained preliminary.
Key financial metrics
| Metric ($ millions, except per-share amounts) | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | 2,167 | 1,952 | 4,024 | 3,884 |
| Operating income | 260 | 236 | 776 | 601 |
| Income from continuing operations | 37 | 42 | 342 | 192 |
| Net income (loss) attributable to KMI | (126) | 132 | (105) | 287 |
| Class P diluted EPS | (0.15) | 0.19 | (0.14) | 0.31 |
| Declared dividends per share | 0.35 | 0.30 | 0.67 | 0.44 |
| Cash provided by operating activities | Not presented quarterly | 1,013 | 954 |
Q2 revenue rose 11%, while operating income rose 10%. First-half revenue increased 4% and operating income increased 29%. Results attributable to KMI turned to losses, principally reflecting the FTC-mandated pipeline asset remeasurement loss and EP acquisition-related costs; continuing-operations income increased in the first half.
First-half investing cash outflow was $5.790 billion, including $4.970 billion net cash for the EP acquisition and $817 million of capital expenditures. Financing cash inflow was $5.043 billion, primarily reflecting acquisition borrowing. Cash increased by $264 million to $675 million. The company’s stated “cash available to pay dividends” was $610 million for the first half; this is a company-defined measure, not operating cash flow, and excludes specified acquisition-related expenses.
At June 30, cash was $675 million and debt outstanding, excluding debt fair-value adjustments, was $34.324 billion, versus $16.136 billion at December 31, 2011. Current debt was $3.271 billion; the filing reported a working-capital deficit of $801 million. Available borrowing capacity was approximately $757 million at KMI, $1.528 billion at KMP and $480 million at EPB. Total assets were $69.575 billion and total liabilities $46.385 billion.
Material changes and unusual items
- EP contributed $295 million of revenue and a $120 million pretax loss from continuing operations for its 37-day post-acquisition period; the loss included $217 million of acquisition and EP Energy sale expenses. First-half pretax acquisition and sale expenses totaled $394 million, including severance and retention costs, accelerated stock compensation, advisory fees, legal fees and reserves.
- The FTC-required sale of KMP’s FTC Natural Gas Pipelines disposal group resulted in a $755 million after-tax remeasurement loss for the first half ($327 million in Q2). The assets were reported as held for sale at $2.019 billion. The buyer and final sale terms were not yet determined, and final proceeds could differ from the estimated fair value.
- Interest expense was $297 million in Q2 and $481 million for the first half, compared with $174 million and $348 million, respectively, in 2011, primarily due to acquisition financing and assumed EP debt.
- Segment earnings before depreciation, depletion and amortization increased, supported by EP’s partial-period contribution and growth in CO2 and terminals. Products Pipelines earnings were weaker excluding prior-year rate-case adjustments; the filing also cites lower natural-gas-liquids prices and transmix performance pressures.
- Environmental reserves were $303 million at June 30, compared with $80 million at year-end; legal and other litigation reserves, net of estimated insurance, were $399 million, versus $332 million at year-end. Management stated reserves were adequate but outcomes and timing remained uncertain.
Outlook, liquidity and risks
- KMI expected to declare at least $1.40 per share in 2012, a 17% increase from its stated 2011 dividend. The board declared a Q2 dividend of $0.35 per share, payable August 15. KMI’s ability to pay dividends depends substantially on distributions from KMP and EPB; the policy may be amended or suspended.
- KMP expected 2012 distributions of $4.98 per unit, up 8%, but projected distributable cash flow essentially equal to distributions, citing lower natural gas liquids prices. Its 2012 oil-price sensitivity was estimated at about $6 million of cash flow per $1 change in average WTI per barrel.
- EPB expected 2012 distributions of $2.25 per unit, up 17%. KMP’s August 13 acquisition of 100% of Tennessee Gas Pipeline and 50% of El Paso Natural Gas from KMI was valued at approximately $6.22 billion and was financed in part with debt and KMP units.
- Moody’s downgraded KMI senior secured debt to Ba2 from Ba1 on July 17, with a negative outlook. The downgrade increased interest rates on specified KMI facilities by 50 basis points. KMI noted that leverage, credit ratings and access to capital markets could constrain financing and growth.
- Material exposures include unresolved pipeline tariff and rate cases, environmental remediation and pipeline-safety matters, commodity and interest-rate risk, and the FTC divestiture requirement. KMI reported that disclosure controls were effective and that it extended oversight processes to EP.
Important facts for investors to verify
- Final EP purchase-price allocation, integration progress, realized synergies and the acquired business’s contribution beyond the 37-day reported period.
- Timing, buyer, proceeds and final accounting for the FTC-mandated asset sale, including any difference from the recorded fair value.
- Debt maturities, refinancing plans, borrowing costs after the downgrade, and liquidity across KMI, KMP and EPB, whose obligations are generally entity-specific.
- Whether KMP and EPB meet distribution expectations, especially given KMP’s forecast of distributable cash flow roughly equal to distributions and sensitivity to commodity prices.
- Developments in major rate cases, litigation and environmental matters, including whether existing reserves remain sufficient.