April 3, 2012

Kinder Morgan has a pipeline of stronger earnings in the offing

by Sridharan Raman

Higher oil prices are creating winners and losers across the energy complex, with exploration and production companies, refining businesses and oil services companies all grappling with different consequences. At one end of the spectrum are the obvious winners: the companies whose production is made up of low-cost sources of crude oil. At the other are those who aren’t benefitting, such as natural gas producers (the price of natural gas has plunged amidst a supply glut) and refiners, whose profit margins are being eroded by the high price of crude oil, their raw material. Among the biggest winners as long as oil remains above the $100 per barrel level (in both Brent and West Texas Intermediate, or WTI) are the infrastructure players, who will benefit as oil producers respond to those high prices by increasing exploration, production and transportation.

Kinder Morgan (KMI.N) falls into that category. Its core business is the transportation of crude oil, natural gas and other petroleum products; the company’s pipelines operate like toll roads for oil and natural gas. Kinder Morgan collects a fee (approved by regulators) for each barrel of oil or thousand cubic feet of gas that is transported via their network of pipelines. While the company doesn’t benefit directly from higher commodity prices, to the extent that demand for any of the fuels it transports rises as the economy shows signs of strength, the volumes it transports from wellheads to utilities and refineries also will increase. That translates into the prospect of higher earnings at Kinder Morgan in the coming months. Thus, the company is the next that the StarMine research team has picked as being among those most likely to beat or miss estimates when reporting their first-quarter results. With a positive Predicted Surprise of 4.8%, the Kinder Morgan clearly falls into the former category, poised to give investors an upside surprise when it unveils its profits for the first quarter on April 23, 2012.

As can be seen in the chart below, oil prices have soared since 2009. The blue line represents North Sea Brent, while the gold line reflects the price of West Texas Intermediate (WTI) at the Cushing delivery point. Historically, WTI and Brent have traded in within a tight range of each other’s price, but over the last two years, WTI prices have remained relatively low when compared to the surge in Brent crude’s price, which now trades for $15 per barrel above the WTI price of about $107 a barrel. Industry analysts attribute that pricing anomaly to the fact that Cushing has reached capacity; pipeline capacity is restricted, meaning that crude oil can’t be readily transported to the Gulf Coast for export, or to other regions of the country, where producers can then collect on higher prices; there is no ability to arbitrage away the price differential.

Not surprisingly, therefore, the ability to improve distribution by making more pipeline capacity available will be a key driver of demand. In turn, that is good news for local pipeline operators, such as Kinder Morgan, as the demand for WTI crude increases within the US market. Kinder Morgan has invested in the Kinder Morgan Pony Express Oil Pipeline, a 710-mile project that will involve converting an existing 500-mile long natural gas pipeline to enable it to transport oil instead, as well as a 210-mile extension that will enable producers in Wyoming to transport more crude oil to Cushing, a project that is expected to go live in 2014. That won’t solve the Cushing bottleneck problem, of course, but the odds are good that whatever solution is devised, Kinder Morgan, as a major industry player, will be eager to be part of the action.

Analysts already are recognizing Kinder Morgan’s importance in both the transportation and storage business. Since the company reported its fourth-quarter results in January, analysts have raised their estimates for its first-quarter earnings, as the chart below illustrates. The blue line that represents the SmartEstimate (now at 32 cents a share) is above the I/B/E/S consensus estimate of 31 cents per share. The SmartEstimate is driven higher by a “Bold Estimate” of 38 cents a share. (Bold Estimates are particularly aggressive calls by top analysts that differ significantly from the consensus; these analysts have been given a five-star rating by StarMine to reflect their track record of timeliness and accuracy.) When one of these star analysts sticks his or her neck out and issues a Bold Estimate, we believe it’s worth taking a fresh look at the company and its prospects.

With oil exploration companies subscribing to a “drill, baby, drill” philosophy, pipeline companies like Kinder Morgan will be a major beneficiary as they seek to get any increased production to end users. The instability in the Middle East has only increased calls within the United States to reduce the country’s dependence on imported oil; by extension, that implies that there will be more domestic demand for WTI output, and thus a growing need for pipeline infrastructure. Kinder Morgan – which expects to complete its merger with El Paso (EP.N) in May, nearly doubling its natural gas pipeline capacity to 67,000 miles of pipe – is likely to be an integral part of that infrastructure solution. Even in an environment where natural gas demand is low and prices are falling, there is still a need to store the existing supplies, and here Kinder Morgan’s storage depots will come in handy. As exploratory drilling on the Bakken Shale increases, more pipelines will follow, but those projects will take some time to materialize. With oil prices consistently above $100 and transportation capacity remaining constrained, and natural gas storage in high demand, Kinder Morgan is in place to profit today and the positive Predicted Surprise signals that beginning with the current quarter that is likely to start showing up soon, in the form of a positive earnings surprise later this month.

SmartEstimates: Thomson Reuters StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary SmartEstimates®. SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.

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