Kinder Morgan, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Amounts are in millions of U.S. dollars except per-share data. Results include El Paso Corporation (EP) from its May 25, 2012 acquisition; therefore, comparisons with 2011 are not like-for-like.
Business context and financial performance
Kinder Morgan reported a substantially expanded pipeline and midstream business following the EP acquisition. The company reported interests in or operation of approximately 75,000 miles of pipelines and 180 terminals.
- Revenue: Q3 revenue was $2,870, up 35% from $2,122. Nine-month revenue was $6,894, up 15% from $6,006.
- Profit: Q3 operating income was $852 versus $381; income from continuing operations was $386 versus $29; and net income attributable to KMI was $200 versus $152. For the first nine months, operating income was $1,628 versus $982 and continuing-operations income was $728 versus $221. Nine-month net income attributable to KMI fell to $95 from $439.
- Per-share results and dividends: Q3 basic EPS was $0.19 for Class P and $0.17 for Class A, including discontinued-operations losses. Nine-month basic EPS was $0.11 and $0.04, respectively. Declared dividends were $0.36 per share for Q3 and $1.03 for the first nine months.
- Cash flow: Nine-month operating cash flow was $1,927, up from $1,596. Investing used $6,365, including $4,970 for the EP acquisition, net of cash acquired, and $1,399 of capital expenditures. Financing provided $4,789. Cash and cash equivalents ended at $775, up from $411 at year-end 2011.
- Debt and liquidity: Debt outstanding, excluding debt fair-value adjustments, was $33,729, versus $16,160 at December 31, 2011. Current debt was $3,949; long-term debt was $29,780. The company reported a $1,738 working-capital deficit. At quarter-end, stated borrowing capacity was approximately $619 for KMI, $1,000 for KMP and $522 for EPB.
- Cash available for dividends: Management’s measure was $362 for Q3 and $972 for the first nine months, compared with $188 and $623, respectively, in 2011. This measure excludes specified acquisition-related costs and is not equivalent to GAAP earnings or operating cash flow.
Material changes versus the prior period
- The EP acquisition added major natural-gas pipeline operations and materially increased assets, revenue, debt and share count. KMI issued about 330 million shares and 505 million warrants and paid approximately $11.6 billion in cash; purchase-price allocation remained preliminary.
- Reported segment earnings before depreciation, depletion and amortization and amortization of excess investment cost rose 137% in Q3 and 71% for the nine months. Management attributed most underlying growth to acquired EP operations, alongside improvement in several existing segments.
- Despite stronger continuing operations, nine-month net income attributable to KMI declined because discontinued operations included a $934 after-tax loss related to the FTC-mandated sale of KMP’s natural-gas pipeline disposal group, along with EP acquisition and sale-related costs.
- Interest expense increased substantially with acquisition financing and assumed debt. Nine-month net interest expense increased 96% year over year.
- Q3 2012 included $179 of after-tax disposal-group remeasurement and selling-cost losses. Nine-month results included $468 of pretax EP acquisition and EP Energy sale-related expenses.
Outlook, risks and unusual items
- KMI outlook: Management expected to declare at least $1.40 per share in dividends for 2012, 20% above the stated 2011 amount. Dividends depend substantially on distributions from KMP and EPB; the policy may be changed or suspended.
- Partnership outlook: KMP expected 2012 distributions of $4.98 per unit, up 8%, and said the asset sale/drop-down combination was expected to be slightly accretive in 2012 and more accretive thereafter. KMP expected distributable cash flow slightly above distributions but below budget, citing lower natural-gas-liquids prices. EPB expected $2.25 per unit for 2012, up 17%.
- FTC disposal: After quarter-end, KMP completed the sale on November 13, 2012, receiving approximately $1.76 billion net of selling costs. Proceeds were intended to repay and terminate its bridge facility, which had $1.685 billion outstanding at quarter-end.
- Leverage and refinancing: Moody’s downgraded KMI’s senior secured debt ratings to Ba2 with a negative outlook in July; borrowing costs on specified facilities increased by 50 basis points. The filing cites capital-market access, interest rates and ratings as risks to financing, growth and dividends.
- Commodity exposure: Management estimated each $1 change in average WTI crude price would affect KMP’s 2012 CO2 segment cash flow by about $6. Lower NGL prices were projected to have a negative impact exceeding $50 for 2012.
- Legal, regulatory and environmental contingencies: Recorded reserves included $385 for legal, rate-case and other litigation matters and $413 for environmental matters. Significant proceedings include pipeline tariff disputes, California rate cases, environmental remediation claims and the Mission Valley Terminal lawsuit; outcomes and potential costs remain uncertain.
- Other notable items: The FTC disposal group’s assets were classified as held for sale at $1,909. The filing reported no goodwill impairment from the May 2012 test. KMI said disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether final EP purchase accounting, integration and expected operating benefits differ materially from preliminary estimates.
- Whether KMI and its partnerships can refinance near-term maturities, manage higher leverage and preserve access to capital markets.
- Whether KMI’s and the partnerships’ distribution and dividend expectations are supported by recurring cash flows, particularly given KMP’s NGL-price exposure.
- The final cash, debt and earnings effects of the FTC disposal and associated bridge-loan repayment.
- Developments in pipeline-rate proceedings, environmental claims and other contingencies, including whether recorded reserves remain adequate.
- The potential dilution and capital effects of the warrants issued in the EP acquisition and subsequent warrant repurchases.