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Kinder Morgan: The Start of MLP Compression?

15 August 2014 in Trading Ideas

Relax, investors: There’s no more need to distinguish between all companies with “Kinder Morgan” in their title.

The company said earlier this week that it plans to consolidate its vast oil-and-gas pipeline empire into a single company in a $44 billion deal amid investor worries about its growth prospects.

As part of the move, the Wall Street Journal reported, the new company will abandon its master limited partnership structure, which essentially gives special tax breaks to companies that get almost all their revenues from natural-resource businesses. That has typically meant pipeline companies, which charge toll-like fees to move oil and gas.1


These partnerships don’t pay corporate taxes to the federal government, distributing most of their cash flow to shareholders – and to the general partners who run the MLPs – in dividend-like payments.

Those payouts have also become increasingly popular with investors, the Journal explained, especially baby boomers hungry for high yields in an era of extremely low interest rates.

The Energetic MLPs motif, for example, has gained 14.1% in 2014. In that same time, the S&P 500 has increased 5.9%.

Over the past month, the motif is up 0.9%; the S&P 500 has slipped 2%.

But for Kinder Morgan investors, concern began to grow that with a $37 billion market value, the company’s flagship partnership, Kinder Morgan Energy Partners, is so big that it would be increasingly difficult for the partnership to achieve substantial revenue growth – and thus increase its distributions to shareholders.

The Journal said that analysts also have cited the hefty payments – about 46% of its cash – that the partnership has been making to the parent Kinder Morgan.

“The biggest problem facing Kinder Morgan is how to maintain growth,” Morningstar analyst Jason Stevens wrote last month, according to the Journal. To increase its distributions by a projected 5% to 6%, he continued, Kinder would have to put “$3 billion-$4 billion to work each year on attractive projects, a daunting task for any firm.”

A logical question for investors, of course, is whether Kinder’s move portends more sector players choosing the same strategy.

According to Forbes contributor Loren Steffy, probably not. For starters, the MLP structure remains hugely popular – Steffy noted that at least 16 MLPs have either filed or announced plans for going public, and more are expected to follow.2

Ironically, Steffy writes, Shell just became the first oil major to enter the MLP fray just two months ago.

Ultimately, however, Steffy believes Kinder Morgan’s size constraints put its decision in a separate category. Few other partnerships have reached Kinder’s size limitations, and nothing about the company’s move changes the inherent benefits for investors: namely, that the structure eliminates the double taxation of dividends.

With equities essentially treading water for nearly three months, an increasingly tighter embrace by investors for high-yielding stocks could allow for more upside in MLPs.

1Alison Sider and Russell Gold, “Kinder Morgan to Consolidate Empire,” wsj.com, Aug. 10, 2014.

2Loren Steffy, “Kinder Morgan Eats Its Own; Will Other MLPs follow Its Lead?”, forbes.com, Aug. 10, 2014, http://www.forbes.com/sites/lorensteffy/2014/08/10/kinder-morgan-eats-its-own-will-other-mlps-follow-its-lead/.

Investors should be aware of unique risks and tax consequences involved with MLPs. Distributions are treated differently than stock dividends. Income distributions received from MLPs are typically reported on a Schedule K-1. Certain MLPs that have operations in multiple states may need to file tax returns within each state, based on income limits. Income limits may also make investments in MLPs inappropriate within retirement accounts. Investors may wish to consult with their tax advisor prior to making an investment decision.