Kinder Morgan's Brush with Enronitis


By Heesun Wee At the beginning of 2002, Houston-based Kinder Morgan Inc. (KMI) was flying high. The energy-pipeline operator's strong growth prospects landed it on a Standard & Poor's list of stocks to watch, and it was expected to outperform the broad S&P 500-stock index.

In mid-January, the company reported a 27% jump in fourth-quarter net income of $0.60 per share, up from $0.47 a year ago. Investors had been paying attention too. Kinder Morgan stock was trading around $57 at the time, close to the 52-week high of $60 that it hit in March, 2001. But Kinder Morgan's hot streak didn't last.

NOT EXACTLY THE SAME. Chief among the culprits: Enronitis. The stock tumbled to a yearly low of $37 on Feb. 28 amid concerns that management might be shuffling and hiding poorly performing assets through a master limited partnership (MLP) -- one kind of vehicle used at Enron. But savvy investors may want to withhold judgment and take a closer look.

"While this type of financing has been embraced by Wall Street, the SEC, and the credit-rating agencies, the abuse of partnership structures by Enron Corp. has raised red flags over all types of creative accounting techniques," Carol Coale, a Prudential Securities analyst, noted in a recent report. Also, KMI has squelched rumors that it was under investigation by the Securities & Exchange Commission. And the company's MLP is a publicly traded entity -- unlike Enron's controversial partnerships, which were privately held.

Furthermore, rules governing MLPs, which have been used on Wall Street for years, generally allow for the transfer of only specific stable assets, such as a pipeline. Kinder Morgan can't simply transfer any low-performing asset, points out Larry Pierce, a spokesman for Kinder Morgan.

"NOTHING WRONG." Also, Kinder Morgan's growth prospects -- which have allowed the once-staid pipeline operator to morph into one of the largest natural-gas pipeline transportation and storage operators in the U.S. -- remain intact. And that could mean a buying opportunity for long-term investors. The company still sees growth of at least 8% to 10% annually over the next four years, excluding any additional acquisitions. And despite its many past purchases, Kinder Morgan's debt is on par with that of its peers. No credit-rating agency has downgraded it.

Some investors seem reassured. In early March, the stock rebounded to around $47. "There's nothing wrong with the financial structure that they have. It's just some people find it complicated," says Richard Leader, an analyst who follows Kinder Morgan for Burnham Securities. But until Enronitis blows over, that complicated structure will probably weigh on the stock -- even though no evidence has turned up showing that the company's accounting is questionable.

One aspect of Kinder Morgan's financial complexity: It's among three related companies that are independently traded on the New York Stock Exchange. Kinder Morgan is a corporation founded in 1936 as Kansas Pipeline & Gas Co. Its prize asset is a 10,000-mile natural-gas pipeline transportation and storage system -- one of the largest in the U.S. -- that stretches from lucrative markets in Chicago down to Texas.

TAX BENEFITS. Then there's Kinder Morgan Energy Partners (KMP), the master limited partnership that was founded in 1997 after current CEO Richard Kinder acquired a limited partnership from Enron, his former employer. Through the revamped partnership, Kinder Morgan completed $6 billion in acquisitions in the past five years. Some $1 billion of those assets were transferred from the corporation to the partnership, in part to take advantage of the tax benefits of MLPs, including tax-free status for certain kinds of interest and dividend income.

Past investors of KMP were attracted to its high quarterly cash distribution of roughly $0.55 per unit -- an annual rate of about $2.20. (Under partnerships, shares are called units.) Those units now trade at $33, recovering 27% from a yearly low of $26 on Feb. 28. The partnership houses pipelines, storage facilities, and bulk terminals that transport and store a variety of commodities including gasoline, jet fuel, diesel fuel, natural-gas liquids, and coal.

Through aggressive cost-cutting and an acquisition binge, KMP has been able to boost cash flow. Also, Kinder Morgan charges fees -- to everyone from refiners to utilities -- for storing and shipping commodities, which protects it against wild swings in commodity prices. "It doesn't matter if gasoline at the pump is $1 or $5 a gallon. [Either way] we get paid a fee by our customers," says Pierce.

INTENSELY VOLATILE. A third entity, Kinder Morgan Management (KMR), is a limited-liability company whose only significant assets are the units it owns in KMP. It went public in 2001 primarily as a way to allow institutional investors to hold stakes in KMP, since tax laws prevent most of them from buying MLP units directly.

No one can predict how long Enronitis will last or how wide it'll spread, and in the short term, Kinder Morgan shares may be intensely volatile. But if you keep that in mind, these stocks could be attractive at today's prices. Wee covers financial markets for BusinessWeek Online in New York


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