Why did KMI's net income decline in 2012 even though operating income increased sharply?

Operating income rose to $2.59 billion from $1.42 billion, but net income attributable to KMI fell to $315 million from $594 million. The main drivers were a $937 million loss from remeasuring and selling KMP's FTC Natural Gas Pipelines disposal group (reported in discontinued operations), $310 million after-tax of El Paso acquisition-related expenses, a $200 million pre-tax impairment of the NGPL Holdco investment, and higher interest expense of $1.43 billion versus $703 million in 2011 due to acquisition debt.

How secure is KMI's dividend, given its reliance on KMP and EPB?

Distributions from KMP and EPB represented about 81% of the cash generated for KMI's dividends in 2012, so a decline in MLP cash flows, higher MLP debt costs, or changes in incentive distribution rights would directly affect KMI's dividend capacity. The company covered its 2012 declared dividend of $1.40 with cash available to pay dividends of $1.55 per share, but the dividend policy is discretionary and the board may amend it. KMP's general partner has also waived incentive distributions to support acquisitions, which reduces KMI's near-term cash flow.

What is the status of the El Paso acquisition and its expected benefits?

The El Paso acquisition closed May 25, 2012, for approximately $23.0 billion in total consideration. KMI implemented more than $400 million of year-one cost savings and dropped down Tennessee Gas Pipeline and 50% of El Paso Natural Gas to KMP for about $6.2 billion to de-lever acquisition debt. The purchase price allocation remains preliminary and is expected to be finalized in the second quarter of 2013. The EP operations were excluded from management's internal control assessment for 2012, as they represented 56% of total assets and 19% of revenues.

What are the main litigation and regulatory risks disclosed?

KMP's most significant exposures involve SFPP's West Coast products pipeline rates at FERC and the CPUC, where shippers seek roughly $100 million in FERC refunds and $375 million in CPUC reparations, though KMP believes the amounts would be substantially lower. Other notable matters include the Union Pacific easement dispute, a $30 million+ Severstal crane claim, a City of San Diego MTBE/Mission Valley suit (dismissed by the court in January 2013 with an appeal filed), and environmental reserves of $397 million. Total legal and rate-case reserves were $423 million at year-end 2012. The company also faces climate-change and pipeline-integrity regulatory costs that could be material.

KMI/EP-PC 10-K Filed Mar 1, 2013

01—Abstract

Summary

Summary of the 10-K filed March 1, 2013. Cited figures are marked; the original filing is the authoritative source.

Kinder Morgan, Inc. (KMI) reported 2012 results that reflect a transformational year, anchored by its May 25, 2012 acquisition of El Paso Corporation (EP) for roughly $23 billion^a in total consideration ($11.6 billion cash, ~330 million Class P shares, and ~505 million warrants).

Revenues rose to $9.97 billion^b from $7.94 billion, and operating income climbed to $2.59 billion from $1.42 billion. However, net income attributable to KMI fell to $315 million from $594 million, weighed down by a $937 million pre-tax-equivalent loss on the remeasurement and sale of KMP's FTC Natural Gas Pipelines disposal group (reported as discontinued operations), $310 million of after-tax EP acquisition expenses, and a $200 million pre-tax impairment on the NGPL Holdco investment. Management reported cash available to pay dividends of $1,411 million ($1.55 per share) and declared 2012 dividends of $1.40 per share, up from $1.05 (prorated) in 2011, with guidance of $1.57 per share for 2013.

Investors should recognize that KMI's cash flow is heavily dependent on its master limited partnerships: distributions from KMP and EPB represented about 81% of the cash generated for KMI's dividends in 2012. Consolidated debt rose to roughly $32 billion^c (about $30 billion excluding fair value adjustments), with roughly 35% variable-rate, and Moody's downgraded KMI's senior secured rating to Ba2 in July 2012 (outlook later revised to positive in February 2013). Consolidated total assets grew to $68.2 billion from $30.7 billion, and goodwill to $23.6 billion, so future impairment risk and integration execution are material considerations.

Looking ahead, the 2013 outlook centers on KMP's pending roughly $5 billion^d acquisition of Copano Energy, a 2013 capital expansion program of about $3.1 billion at the combined level, growth projects such as the Trans Mountain expansion (about $5.4 billion, pending NEB approval), and planned drop-downs of EP assets (EPNG and EPMIC) to KMP. Key risks include litigation (notably SFPP rate proceedings and CPUC refund claims), regulatory and climate-related costs, a $397 million environmental reserve, and the reliance on MLP distributions and incentive distribution waivers.

02—Key points

Key Highlights

Revenue rose 26% to $9.97 billion (from $7.94 billion) and operating income rose 82% to $2.59 billion, driven largely by the May 2012 El Paso acquisition, which contributed $1.5 billion of incremental Natural Gas Pipelines EBDA.
Net income attributable to KMI fell to $315 million from $594 million, due to a $937 million loss on the FTC divestiture (discontinued operations), $310 million in after-tax EP acquisition costs, and a $200 million NGPL Holdco impairment.
Cash available to pay dividends was $1.41 billion ($1.55 per share) versus $866 million in 2011; 2012 dividends declared were $1.40 per share, and 2013 dividends are guided to $1.57 per share (+12%).
Approximately 81% of KMI's 2012 dividend-supporting cash came from KMP and EPB distributions, which concentrates risk in the two MLPs.
Total consolidated debt rose to about $32 billion (roughly $30.2 billion excluding fair value adjustments) from $16.2 billion, with about 35% at variable rates; Moody's cut senior secured debt to Ba2 in July 2012, later revised to positive outlook in February 2013.
Pending KMP acquisition of Copano Energy (~$5 billion including debt, 0.4563 KMP units per Copano unit) is expected to close in Q3 2013 and be accretive, with KMI's general partner agreeing to forgo incentive distributions of $120 million in 2014 and 2015.
Goodwill climbed to $23.6 billion (from $5.1 billion) and total assets reached $68.2 billion, so future impairment testing and integration performance are important to monitor.

03—Questions

Frequently Asked Questions

Why did KMI's net income decline in 2012 even though operating income increased sharply?
Operating income rose to $2.59 billion from $1.42 billion, but net income attributable to KMI fell to $315 million from $594 million. The main drivers were a $937 million loss from remeasuring and selling KMP's FTC Natural Gas Pipelines disposal group (reported in discontinued operations), $310 million after-tax of El Paso acquisition-related expenses, a $200 million pre-tax impairment of the NGPL Holdco investment, and higher interest expense of $1.43 billion versus $703 million in 2011 due to acquisition debt.
How secure is KMI's dividend, given its reliance on KMP and EPB?
Distributions from KMP and EPB represented about 81% of the cash generated for KMI's dividends in 2012, so a decline in MLP cash flows, higher MLP debt costs, or changes in incentive distribution rights would directly affect KMI's dividend capacity. The company covered its 2012 declared dividend of $1.40 with cash available to pay dividends of $1.55 per share, but the dividend policy is discretionary and the board may amend it. KMP's general partner has also waived incentive distributions to support acquisitions, which reduces KMI's near-term cash flow.
What is the status of the El Paso acquisition and its expected benefits?
The El Paso acquisition closed May 25, 2012, for approximately $23.0 billion in total consideration. KMI implemented more than $400 million of year-one cost savings and dropped down Tennessee Gas Pipeline and 50% of El Paso Natural Gas to KMP for about $6.2 billion to de-lever acquisition debt. The purchase price allocation remains preliminary and is expected to be finalized in the second quarter of 2013. The EP operations were excluded from management's internal control assessment for 2012, as they represented 56% of total assets and 19% of revenues.
What are the main litigation and regulatory risks disclosed?
KMP's most significant exposures involve SFPP's West Coast products pipeline rates at FERC and the CPUC, where shippers seek roughly $100 million in FERC refunds and $375 million in CPUC reparations, though KMP believes the amounts would be substantially lower. Other notable matters include the Union Pacific easement dispute, a $30 million+ Severstal crane claim, a City of San Diego MTBE/Mission Valley suit (dismissed by the court in January 2013 with an appeal filed), and environmental reserves of $397 million. Total legal and rate-case reserves were $423 million at year-end 2012. The company also faces climate-change and pipeline-integrity regulatory costs that could be material.

04—Continue

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