KINDER MORGAN, INC. annual report, FY2012

Business context and reporting period

Kinder Morgan, Inc. (KMI) filed this Form 10-K for the fiscal year ended December 31, 2012. The company owns or operates about 75,000 miles of pipelines and 180 terminals, principally through Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB). Results include El Paso Corporation (EP) from its May 25, 2012 acquisition date; therefore, 2012 and 2011 are not directly comparable. KMP’s FTC-mandated pipeline divestiture is presented as discontinued operations.

Financial performance and position

Management’s segment earnings before depreciation, depletion and amortization and amortization of excess equity-investment cost (EBDA) were $5.108 billion, up 68%. This is a company performance measure, not net income. Results attributable to KMI were weighed down by a $777 million discontinued-operations loss, including a $937 million after-tax loss related to remeasurement and sale of the FTC disposal group.

For the fourth quarter, revenue was $3.079 billion, operating income $965 million, income from continuing operations $476 million, and net income attributable to KMI $220 million (Class P EPS $0.21). The comparable 2011 quarter showed revenue of $1.937 billion, operating income of $441 million, continuing income of $228 million, and KMI-attributable net income of $155 million (Class P EPS $0.22).

At December 31, 2012, consolidated cash was $714 million and debt was approximately $32 billion including fair-value adjustments. Debt excluding those adjustments was $31.810 billion, including $2.401 billion current. Working capital was negative $1.535 billion. Available borrowing capacity was about $2.989 billion across KMI, KMP and EPB credit facilities. Operating, investing and financing cash flows were $2.795 billion, negative $5.084 billion and positive $2.584 billion, respectively. KMI declared dividends of $1.40 per share for 2012; reported cash available to pay dividends was $1.411 billion. Pension and postretirement plans were underfunded by $552 million and $426 million, respectively.

Material changes versus prior period

• The EP acquisition materially expanded the natural-gas business and consolidated assets and debt. Revenue rose 26%, while reported net income attributable to KMI declined, reflecting unusual charges and the divestiture loss.
• Management cited more than $400 million of first-year post-acquisition cost savings implemented in 2012. Natural Gas Pipelines segment EBDA increased substantially, primarily from acquired EP operations.
• KMP sold the FTC Natural Gas Pipelines disposal group effective November 1, 2012 for approximately $1.8 billion before selling costs ($3.3 billion including KMI’s share of joint-venture debt), recognizing the reported disposal loss.
• Consolidated debt increased significantly following the acquisition. KMI also issued approximately 330 million shares and 505 million warrants as part of EP consideration, and repurchased about 66 million warrants for approximately $157 million.

Outlook, commentary and risks

For 2013, KMI expected to declare dividends of $1.57 per share, 12% above the 2012 declared amount. KMP forecast distributions of $5.28 per unit, up 6%, and approximately $2.9 billion in expansion investment; EPB forecast distributions of $2.55 per unit, up 13%. Management forecast approximately $3.1 billion of combined expansion capital spending, excluding the proposed Copano acquisition. These are forecasts, not guarantees.

KMP agreed to acquire Copano Energy for approximately $5 billion, including assumed debt, subject to approvals and unitholder vote; closing was expected in the third quarter of 2013. The company also described major pipeline and terminal expansion plans, many dependent on regulatory approvals, customer commitments and construction execution.

Key risks include substantial leverage and interest-rate exposure (approximately $11 billion, or 35%, of consolidated debt was variable-rate or effectively variable-rate); reliance on KMP and EPB distributions to fund KMI dividends; regulatory rate challenges, particularly on West Coast products pipelines; pipeline safety, environmental compliance and project cost or schedule risks; and commodity-price exposure in the CO2 segment. Environmental reserves were $397 million, with a disclosed estimated range up to $529 million. Litigation, rate-case and other legal reserves totaled $423 million. The filing states that outcomes and ultimate costs may differ from estimates.

Important facts for investors to verify

• How much of the reported earnings and cash-flow improvement reflects EP consolidation versus underlying growth, and whether announced cost savings were sustained.
• The final purchase-price allocation for EP, which remained preliminary when the filing was prepared, and the resulting goodwill and impairment sensitivity.
• Debt maturity, refinancing and variable-rate exposure, credit-facility availability, and the capacity of KMP and EPB to maintain distributions to KMI.
• Whether the $1.57 KMI dividend and partnership distribution forecasts were achieved, and the cash generation supporting them.
• Outcomes and potential financial effects of pipeline rate proceedings, environmental matters and other litigation, including whether reserves prove sufficient.
• Progress, approvals, costs and returns for major expansion projects and the proposed Copano transaction.