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Kinder Morgan Energy Partners L.P.’s (KMP - Analyst Report) fourth quarter 2011 earnings of 55 cents per limited partner unit (excluding certain items) were considerably short of the Zacks Consensus Estimate of 61 cents. However, the quarterly results were almost 20% above the year-ago profit of 46 cents.

Revenue increased 4% to $2,004.0 million in the reported quarter from $1,926.6 million in the year-ago quarter. In 2011, total revenue increased to $8,211.2 million versus $8,077.7 million reported in 2010..

Importantly, quarterly cash distribution per common unit was raised to $1.16 ($4.64 annualized) during the quarter, representing a 3% year-over-year growth. The partnership has now increased the quarterly distribution 42 times since its current management took over in February 1997.

Kinder Morgan’s annual distribution of $4.61 per unit exceeded the previously announced level of $4.60 per unit, fueled by outstanding growth opportunities in the midstream energy sector, with more emphasis in the natural gas shale plays as well as in the coal export business.

The partnership’s distributable cash flow –– a measure of its ability to make unitholders’ payments –– before certain items was $424.9 million versus $366.2 million in the comparable quarter last year. Additionally, distributable cash flow per unit before certain items was $1.27, up 8.5% year over year.

Segmental Highlights

Products Pipelines: The business segment experienced a 5.6% year-over-year decline in earnings before DD&A and certain items to $161.4 million. The FERC rate case ruling as well as the unfavorable decision in a court case pertaining to annual rights-of-way lease payments for certain West Coast operations led to increased expenses, which in turn weighed down revenues. Total refined products volume stood at 166.6 million barrels, down 2.6% from the prior-year period.

For 2011, segment earnings before DD&A and certain items crept up 1% to $694.4 million from $687.5 million last year, significantly below its published annual budget of 6% growth.

Natural Gas Pipelines: Earnings before DD&A and certain items from the business grew an impressive 19.3% annually to $289.5 million. Performance was aided by the KinderHawk acquisition and contributions from the commencement of operations of Fayetteville Express Pipeline, along with improved results from the Rockies Express Pipeline and robust results from EagleHawk Field Services joint ventures. Further, Kinder Morgan Treating benefited from the SouthTex and Gas Chill acquisitions.

Overall, transport volumes moved up 11% from the year-ago quarter, mainly attributable to the start-up of the Fayetteville Express Pipeline system and solid transport volumes on the Texas intrastate pipeline system, partly due to Eagle Ford Gathering volumes being transported on the intrastates.

The segment earnings before DD&A and certain items climbed 14% to $951.1 million in 2011 from $835.9 million in 2010. This segment’s earnings substantially exceeded its published annual budget of 8% growth mainly on the back of the Petrohawk acquisition.

CO2: The segment’s earnings before DD&A and certain items were $280.6 million, up 16.2% year over year on higher oil and natural gas liquid prices, increased production at the Katz Field and reduced costs.

In 2011, CO2 segment earnings before DD&A and certain items were $1.09 billion, up from $0.96 billion, and in line with the published annual budget of 14% growth.

Terminals: The business segment earned $184.4 million before DD&A and certain items in the fourth quarter, up nearly 7% year over year. The segment reported earnings before DD&A and certain items of $701.1 million in 2011, up 8% from $646.5 million a year ago. This was slightly below the published annual growth rate of 10%.

Kinder Morgan Canada: The segment reported fourth-quarter earnings of $50.7 million before DD&A and certain items compared with $48.7 million in the year-ago quarter. The income growth was supported by a new toll agreement on the Trans Mountain pipeline and appreciation of the Canadian dollar.

The partnership’s segment earnings before DD&A and certain items were $198.5 million in 2011, up 9% from $181.6 million for 2010 and the growth rate was significantly above the budgeted 6% for 2011.

Financials

As of December 31, 2011, Kinder Morgan had cash and cash equivalents of $409 million and long-term debt (including current maturities) of $12,798 million. Debt-to-capitalization ratio stood at 62.7% (versus 61.8% in the last quarter).

Our Take

Kinder Morgan is one of the largest publicly traded master limited partnerships (MLP) and generally serves as a benchmark for the pipeline MLP group. A focus on fee-based and diversified businesses has enabled the partnership to dilute its business risks.

Recently, Kinder Morgan increased its holding in Battleground Oil Specialty Terminal Company, LLC (BOSTCO) project to 98% following the purchase of an additional 50% stake from TransMontaigne Partners L.P. (TLP - Snapshot Report). Kinder Morgan, which currently holds an ownership interest in the BOSTCO project, started construction of the first phase in December 2011. Kinder Morgan has executed terminal service agreements and/or letters of intent for the majority of capacity.

The project positions Kinder Morgan favorably to take advantage of the trend to export petroleum-related products overseas. The completion of the project is scheduled for first quarter 2014.

Kinder Morgan also acquired SouthTex Treaters, a leading manufacturer, designer and fabricator of natural gas treating, for approximately $155 million. The acquisition will help Kinder Morgan Treating to build amine plants and provide customers the option to own or lease the equipment.

The partnership’s parent company Kinder Morgan Inc. (KMI - Analyst Report) in its attempt to expand its resource base, earlier, announced plans to acquire El Paso Corp. to create the largest natural gas pipeline system in North America. With a large trail of assets in North America, the partnership remains well positioned for future growth.

The Kinder Morgan-El Paso deal will enhance steady cash flow generation and promise growth for Kinder Morgan Energy Partners, which plans to acquire a significant portion of EL Paso’s natural gas pipeline assets over the next few years at attractive prices. For some several years to come, the average annual growth rate in KMP distributions per unit is expected at around 7%, up 5% annually from the prior estimate on the back of likely dropdowns from this transaction. The deal is also expected to dilute the impact of the partnership’s CO2 oil business and offset a potential slowdown in demand of the refined products.

However, Kinder Morgan remains vulnerable to volatile crude oil and natural gas prices, imbalance between supply and demand for its products, and rising interest rates. As such, we expect the partnership to perform in line with the broader industry and rate it Neutral on a long-term basis. Kinder Morgan currently holds a Zacks #3 Rank (short-term ‘Hold’ rating).

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