Image published June 18, 2015. © Valuentum Securities
The image above was taken from Valuentum’s President Brian Nelson’s article published onwww.valuentum.com June 18. If you’re interested in learning more about how to identify mispricings in the stock market such as that with Kinder Morgan when it was trading at $40 per share (now ~$15), please consider becoming a member to www.valuentum.com. You’ll gain access to Brian Nelson and the Valuentum Team. Click here to subscribe today!
Updated December 11, 2015 for the “Leverage Across the MLP Space Is Not Contained!” section that follows.
By The Valuentum Team
Revisiting the 10 Reasons Why Valuentum Thought Kinder Morgan’s Shares Would Collapse, released June 2015 when shares were trading at ~$40 each
1) The valuation paradigm has changed.
2) Kinder Morgan’s dividend growth endeavors will disappoint.
3) The company’s net debt load is $40+ billion.
4) The company is trading at 40+ forward earnings.
5) The natural reaction from shareholders will be skepticism and disbelief.
6) Kinder Morgan’s dividend is in part organic, in part financially-engineered.
7) The traditional “blind” use of the dividend discount model does not apply to Kinder Morgan.
8) The company’s implied leverage is 19 times after considering all cash, debt-like commitments, at least in the eyes of shareholders.
9) Bondholders will start to care. Equity holders will start to care. They will – and then it all unravels.
10) Highly-publicized insider purchases are not a sign of support, in the case of Kinder Morgan, but an admission of vulnerability.
On June 11, Valuentum’s President Brian Nelson wrote ‘5 Reasons Why We Think Kinder Morgan’s Shares Will Collapse,” removing the company from Valuentum’s Dividend Growth Newsletter portfolio that day at $40 per share.
The piece was highlighted by Barron’s in ‘The Bear Case Against Kinder Morgan’ later that evening. The controversial call did not go unnoticed. Shares of Kinder Morgan (KMI) and most of the master limited partnership arena fell ~2% on the opening the following day. Credit Suisse’s John Edwards released a rebuttal to Valuentum’s “5 Reasons” piece point by point June 15, reiterating Credit Suisse’s Outperform rating and $52 price target at the time, quipping that his team had agreed that the ‘natural reaction from shareholders would be skepticism and disbelief.’
Valuentum’s President Brian Nelson then countered June 18 with ‘5 More Reasons Why We Think Kinder Morgan’s Shares Will Collapse’ defining how Valuentum’s thesis was separate and distinct from Barron’s and Hedgeye’s February 2014 piece, which focused primarily on the MLP and a questioning of the MLP’s measure of sustaining capital expenditures, something that the company had already refuted. Shares of Kinder Morgan, the corporate, had peaked at nearly $45 per share in April 2015, up from the low-$30s range in February 2014 when the Barron’s piece had been released.
Barron’s said Nelson was back as the “Kinder Morgan Bear: 5 More Reasons to Worry,” released June 19.
Unlike the traditional “short case,” which searches for a “fire” within a company’s accounting or some other tragic situation, Nelson’s 10 reasons, published in June 2015, were based purely on a valuation and credit assessment of the corporate, which he felt was severely misaligned in the context of the entity’s fundamentals. The Kinder Morgan MLP units, formerly trading under the symbol KMP, the security which Barron’s and Hedgeye’s February 2014 piece had primarily focused on, had since been retired after the closing of the deal November 2014. KMP unitholders benefited from a 12% premiumthe day of the deal announcement.
Nelson then publicly released his $29 per share fair value estimate of Kinder Morgan on June 30, “Kinder Morgan’s Fair Value: $29 Per Share, with shares of the third-largest energy company in North America trading in the high $30s.” On Kinder Morgan’ssecond-quarter conference call July 15, investors continued to confuse Mr. Nelson’s 10 reasons with the previous thesis on the MLP outlined in 2014, with an investment management firm proclaiming that shares were being punished by “the timely or untimely resurrection of what I thought was a wholly discredited bear attack by a tabloid claiming that your investment grade debt is not serviceable.” Mr. Nelson’s thesis was genuine and unique.
Valuentum agrees that the “short thesis” published on February 2014 by Barron’s had been “discredited” once Kinder Morgan had rolled up its MLP structure. After all, the security KMP had ceased to exist. Nelson’s thesis had only focused on the Kinder Morgan corporate, the ticker symbol KMI, shares of which were trading at $37.50 in mid-July. Nelson then took the show on the road, presenting his concerns about Kinder Morgan and MLPs, in general, at the AAII chapters in Cleveland, Silicon Valley, Milwaukee, and Madison in the subsequent months, hoping to help investors avoid any further collapse in shares that was to come.
As his concerns grew, Nelson then published, “Warning: The Master Limited Partnership Model May Not Survive” in late September and shared it with Barron’s as a follow up to the Kinder Morgan call, published as “Why the MLP Business Model May Be a Goner.” By September 29, shares of Kinder Morgan, the corporate, had collapsed to ~$26 each. Shares of the Alerian MLP ETF (AMLP) had collapsed from $16.15 per share on June 11 to $11.51 over the same time frame.
Nelson thesis was then validated. On October 22, Kinder Morgan revised lower its dividend growth plans and detailed how it would engage in sophisticated financing needs to stay afloat. Shares of the corporate fell even further. Credit Suisse’s John Edwards downgraded the rating of Kinder Morgan from Outperform to Neutral and reduced the price target to $39 per share, noting “in the 13 years of following KMI, we don’t recall management having to reduce guidance…ever.” That day, Nelson reiteratedthe low end of his fair value estimate range for shares of $23 each.
Even more downgrades followed.
Argus subsequently cut Kinder Morgan’s price target to $35 per share from $50 per share November 10, still rating the company a “buy.” (The rating was subsequently lowered to hold shortly thereafter.) On December 2, Moody’s then downgraded Kinder Morgan’s credit rating outlook, an integral part of Mr. Nelson’s thesis and what he described as “the circular flow of unsubstantiated support” on Kinder Morgan’s shares, the corporate, trading under the symbol KMI. Even more downgrades followed. Shares of Kinder Morgan are now exchanging hands in the mid-teens, at the low end of Valuentum’s fair value range, updated following Kinder Morgan’s 75% cut in the dividend just this week – something that was unimaginable by most market participants.
Note: Moody’s revised Kinder Morgan’s credit outlook to stable after the dividend cut, but still-collapsing energy resource pricing, and net leverage approaching 7x on an annualized reported basis (see calculation below) does not warrant investment-grade marks, in our view.
Leverage Across the MLP Space is Not Contained!
The Securities and Exchange Commission performs a vital function when it comes to truth in reporting, helping investors sort through what’s true and what’s not. The Form 10-K (annual) and Form 10-Q (quarterly) can be used to compare what a company’s reported, actual net leverage is to what management says it is – in their presentation slide deck or on some of the more popular business channels. Investors in midstream equities have long been “pitched” the idea that leverage is contained, but from our perspective, it is not. Bondholders deserve to know the actual, reported net leverage of companies in the midstream space because they won’t hear it from management, at least it seems.
Let’s take Kinder Morgan (KMI), as an example. In its slide deck presentations and in most communications, the midstream giant notes that its leverage as measured by net debt to EBITDA is under 6 times. However, a close examination of the company’s Form 10-K and Form 10-Q suggests that such a measure is far from reality. Through the first nine months of the year, Kinder Morgan has generated ~$2.7 billion in operating income and ~$1.73 billion in depreciation and amortization, amounting to roughly ~$4.43 billion in EBITDA through the first nine months of the year. Generously, let’s annualize that measure to arrive at annualized reported EBITDA of ~$5.9 billion. At the end of 2014, Kinder Morgan had total short and long-term debt of $43 billion and at the end of the third quarter of 2015, it registered total short and long-term debt of $44.6 billion. Kinder Morgan’s cash is negligible.
Kinder Morgan is more than 7.6x leveraged on the basis of its total short and long-term debt load at the end of the third quarter, relative to its annualized EBITDA mark for this year. If we were to back out the company’s loss on impairments and dispositions of assets, we could assume ~$6.54 billion in annualized EBITDA, but that’s quite the optimistic case, in our view, in light of still-collapsing energy-resource pricing. Importantly, even if we give credit for these “one-time items,” which may end up recurring in nature, Kinder Morgan is still 6.8x leveraged ($44.6/$6.54). We understand that the executive team and the credit rating agencies are doing some non-GAAP “massaging” with the numbers, but bondholders should know the truth. We encourage all stakeholders to look at the data that we are looking at in Kinder Morgan’s Form 10-Q, which can be downloaded here (pdf).
The situation with Energy Transfer Equity (ETE) is even worse. We were letting this issue go to rest, until we noticed that Energy Transfer Equity had stated emphatically that its measure of net debt to EBITDA was 4.5x, a level it believes to be “sacrosanct.” We were in disbelief. The SEC requires that companies disclose their financials for a reason, and we pay very close attention to what’s submitted in the 10-K and 10-Q far and above what we see in slide deck presentations or hear on television. In the nine months ended September 30, Energy Transfer Equity’s operating income was $2.16 billion, while depreciation and amortization was $1.53 billion, good for $3.69 billion in EBITDA, or $4.92 billion in EBITDA on an annualized basis.
The company noted short and long-term debt of $36.3 billion and cash and cash equivalents of $1 billion, resulting in a net debt position of $35.3 billion. Please download its 10-Q here (pdf). By our calculations, Energy Transfer Equity is nearly 7.2x leveraged ($35.3/$4.92). Say what you will just how far the company should be rated in “junk status,” but we think there may be a large number of investors that believe Energy Transfer Equity is ~4.5x leveraged. This just simply isn’t true, in our view. The SEC filings tell a completely different story.
We encourage management teams in the midstream space to disclose actual, reported measures of leverage and non-GAAP free cash flow, as measured by cash flow from operations less all capital spending. The degree of “misinformation,” in our view, has become egregious. Investors should continue to use a wide variety of information in the investment-decision making process, but the SEC filings are a great place to find the most accurate and unbiased information.
Kinder Morgan is ~6.8x leveraged. Energy Transfer Equity is nearly 7.2x leveraged, and this is before its tie-up with Williams Co (WMB). Please be careful out there. The bondholders will eventually care when they get a hint of the recent SEC filings. There’s too much non-GAAP “massaging” going on. Pasted below is the link to the video that implies Energy Transfer Equity’s leverage is 4.5x: http://video.cnbc.com/gallery/?video=3000464044
Please stick to the SEC filings. They are there to protect investors.
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