Interactive Buyside Equity Research

December 26th, 2013

KINDER MORGAN, INC Thesis Overview

Kinder Morgan, Inc. (KMI) was formed in 1992. It is engaged in energy transportation and storage in North America. They own the general partners of KMP and EPB and approximately 10% of the LP interests of KMP and approximately 41% of the LP interests of EPB. The Company also owns a 20% equity interest in NGPL PipeCo LLC, a major interstate natural gas pipeline and storage system which it operates. Through its subsidiaries, the Company operates or owns an interest in approximately 82,000 miles of pipelines and approximately 180 terminals. These pipelines transport natural gas, gasoline, crude oil, carbon dioxide and other products. The Companys strategy is to focus on fee-based energy transportation and storage assets, increase utilization of its existing assets while controlling costs and leverage economies of scale from incremental acquisitions and expansions of assets. KMI investment highlights include: The shale oil revolution makes KMI a long-term growth opportunity, but investors have lost confidence in the story after a FERC rate revision caused growth to slow in 2014. Typical market myopia! Highly talented and invested ownership team led by Richard Kinder who owns over a billion dollars worth of stock and recently bought $28mm under $34. KMI has increased its cash flow nearly 10x in the last decade. KMI's size as the fourth largest energy company in North America and track record delivering projects on time and on budget gives them a seat at the table for nearly every new expansion project in North America. Over half of EBITDA comes from Nat Gas Pipeline segment, which is stable feebased revenue. Significant, identified growth opportunities over the next 5 years of $14B; 90% of backlog is for fee-based pipelines, terminals and associated facilities.

Stock Rating Catalyst Category Price Target Price (12/26/2013): $35.65 Upside: 18% Ticker: KMI Exchange: NYSE Industry: Energy Trading Stats ($USD millions) Market Cap: $36,930 Price / Book: 2.8x PEG Ratio: 0.75x Dividend Yield: 4.6% Price / FY1 EPS: 34.4x EV / LTM EBITDA: 13.0x Price / LTM Sales: 2.8x
Source: Company filings, Wall Street Consensus

BUY 12 Months $42.00

Price Performance 52 Week range: $32.30 - $41.49 Analyst Details IB Username: Mike Curran Employer: CUSH Capital Job Title: Portfolio Manager Analyst Disclosure KMI Position Held: Yes

Interactive Buyside Equity Research

December 26th, 2013

Company & Investment Highlights Overview

Kinder Morgan (KMI) is the largest pipeline company in the United States. They have a world class management team and a portfolio of irreplaceable assets with monopoly-like market positions. Americas shale oil and gas revolution puts KMI at the center of one of the greatest opportunities this country has had in the last several decades. A recent rate case with the Federal Energy Regulatory Commission (FERC) lowered the toll on one of their big pipeline systems and caused investors to question the growth story.1 We believe this to be a temporary pause in the companys long-term growth which has created an opportunity to buy shares of KMI at very attractive prices.

Investing Highlights/Interesting Data Points:

Recurring revenues are 80% of KMIs top line and should grow to 82% in 2014. ROIC (Return on Invested Capital) for 2012 was 13.6% and has averaged over 13% since 2000. ROE (Return on Equity) for 2012 was 24% and has averaged over 22% since 2000. Complicated ownership structure leads to investor and analyst confusion. A negative analyst report this summer (which has been largely debunked) from Kevin Kaiser, Hedgeye, put pressure on the stock and helped create the present opportunity. 2 Discount to CUSH Net Asset Value (NAV) creates 15-30% total return opportunity over the next 12-18 months; 30% upside if you believe management which thinks they can take the stock to the mid $40s in the next three years. Price/Earnings/Growth (PEG) ratio = .75; EV/EBITDA = 12.9 Net debt/EBITDA consistently @ 3.5x since 19973 Unparalleled asset footprint Significant, identified growth opportunities over the next 5 years of $14B; 90% of backlog is for fee-based pipelines, terminals and associated facilities. KMI expects to declare a total of $1.72 in dividends per share during 2014.4 That's a 7.5% increase from the $1.60 they'll end up declaring for 2013; a nearly 5+% yield with 7+% growth.

A good way to get a feel for Kinder Morgan is to review their fact sheet. You can find it on their website here: http://www.kindermorgan.com/news/factsheet1.pdf.

KMI Investment Framework

We mention KMIs complicated ownership structure as one of the factors that creates some confusion around the stock and periodically leads to undervaluation. KMI is basically the parent company to three other publically traded entities. We found this article http://seekingalpha.com/article/1668882-kindermorgan-all-5-tickers-explained from Adam Jones did a good job of laying out all the moving pieces.

Interactive Buyside Equity Research

December 26th, 2013

The predecessor to KMI was Kinder Morgan Energy Partners, L.P. (NYSE: KMP) which was founded in February of 1997 when a group of investors led by current Chairman and CEO Richard D. Kinder and former Vice Chairman William Morgan acquired the general partner of a small, publicly traded pipeline limited partnership. This pipeline partnership came about as part of the Enron collapse. This was a set of pipelines that Richard Kinder knew well since he had been the President at Enron just five years before it went down. It was called Enron Liquids Pipeline, L.P. Based in Houston, TX, KMP began with relatively few assets, 175 employees and an enterprise value of around $325 million. Richard Kinder and Bill Morgan had a vision to build a different type of energy company and they wanted to utilize the master limited partnership (MLP) financial structure as the growth vehicle for their new company. Their purpose was to raise capital from smaller investors by offering them a partnership investment in an affordable and liquid security. This strategy has worked, as KMP has become one of the largest publicly traded pipeline limited partnerships in America. In the early years KMP grew mostly through acquisitions, purchasing such assets as refined petroleum pipelines, carbon dioxide (CO2) production fields and transportation pipelines, intrastate natural gas pipelines and bulk and liquids terminals. In recent years, most of KMP's growth has come through expansions and new build projects. During the past 15 years, KMP has invested over $20 billion to grow the company through joint ventures, expansions and acquisitions. In 1999, Mr. Kinder and his management team took over KN Energy, an integrated natural gas pipeline company based in Lakewood, Colo. KN's roots dated back to 1936 when, as a local distribution company, it provided natural gas service to small communities and rural areas in Kansas and Nebraska. One of the main assets that came from this deal was Natural Gas Pipeline Company of America (NGPL), which continues to serve the Chicago market. Following the transaction, KN became Kinder Morgan, Inc. (NYSE: KMI), Kinder Morgan's second publicly traded company. On Oct. 16, 2011, KMI announced it would acquire El Paso Corporation (NYSE: EP) for approximately $38 billion. The transaction, which closed on May 24, 2012, made Kinder Morgan the largest midstream and the fourth largest energy company (based on combined enterprise value) in North America. As part of the transaction, Kinder Morgan added a fourth publicly traded entity to its family of companies El Paso Pipeline Partners, L.P. (NYSE:EPB). Today, Kinder Morgan is a Houston, TX-based holding company that enables the movement of natural gas in the US, as well as oil and petrochemicals. They have ownership interests in over 82,000 miles of pipeline with over 70,000 miles of that pipe carrying natural gas, the rest oil and CO2. Pipelines are approximately 40% of their revenue; 60% of that is regulated. They have a terminal storage business which includes 180 storage terminals which handle 2.5 million barrels of oil per day and 55 billion cubic feet of gas per day.

Interactive Buyside Equity Research

December 26th, 2013

KMI owns the general partner, incentive distribution rights, and roughly 10% of the outstanding limited partner units of KMP, which together account for more than 95% of KMI's cash flow. It also owns the general partner, incentive distribution rights, and roughly 41% of the outstanding limited partner units of EPB. It also owns a 20% stake in a major interstate natural gas pipeline system, NGPL, which it operates on behalf of its partners. We will take a step back here as this is as good a place to try to explain briefly what an MLP is and a little more about the intricacies of a somewhat complex ownership structure of KMI. Most MLPs can be defined as publicly traded partnerships. MLPs consist of a General Partner (GP) and Limited Partners (LPs). GPs typically hold a 2% ownership and are responsible for managing the operations of the MLP. The GP runs the companys operations and holds all of the voting power, while the LPs provide the capital and realize the benefits of the distribution package; these benefits primarily lie in favorable tax treatment. We first wrote about this in September of 2011, see our newsletter here5 for more information on MLPs and our original discussion of EPB. The partnership is obligated by law to distribute profits to the partners accordingly, making up a majority of KMI s earnings. The GP is paid via a management fee. The MLP shares, called units, make up the majority of the partnership and represent the LPs stake in the partnership. KMP, an MLP, trades just like a common stock. An MLP must earn 90% of its income from activities related to natural resources, commodities or real estate; KMP fits easily into the definition of an MLP. MLPs allow energy companies to structure themselves in a way that attracts conservative, long-term investors rather than speculators; more income investments rather than capital-gains plays leveraged on commodity prices.

The above explanation is helpful for understanding KMIs investments and assets. The primary cash inflows for KMI are from its general and limited partner stakes in KMP and EPB. KMI directly and indirectly owns approximately 10% of KMP, including ownership of the GP, while also owning 41% LP interest and ownership of the GP interest in EPB. If we fill in the above chart concerning KMI, they are the GP for both KMP and EPB, with Rich Kinder, other management and original stockholders owning about 28% of the stock, the Public owns about 65% of the stock and sponsors own around 7% of KMI stock.

Interactive Buyside Equity Research

December 26th, 2013

While for accounting purposes KMI consolidates KMP into its financial results, creating complex accounting to track cash flows, if you look at what KMI does it's easier to understand the company. It collects cash distributions from its ownership stakes in KMP, EPB and NGPL, pays modest general and administrative expenses, pays interest on KMI-level debt, pays income taxes, and distributes the remaining cash to its shareholders as dividends. Owning shares of KMI gives investors a claim on the general partner stake of Kinder Morgan Energy Partners. The difference between limited and general partner distribution growth comes down to incentive distributions rights (IDRs). IDRs allow the holder to collect incentive payments that increase as the MLP's per-unit distribution to limited partners increases based on defined distribution levels, which top out in the high splits, where the general partner is entitled to receive fully half of every incremental dollar paid out as distributions. KMP has been in the high splits for a decade, and currently KMI's general partner stake collects roughly 45% of total cash distributions paid out by KMP. This is the primary mechanism used throughout the industry to incentivize the GP to grow the distribution payments of the LP, and historically it has worked very well. The following table details IDRs due to KMI from KMP at various distribution levels:

Similarly the following table details the IDRs due to KMI from EPB at various distribution levels:

We are not new to the KMI story; this is a stock that we have owned for a while. A look at their stock chart for 2013 shows us that KMI is actually down a couple of percent in a year when the overall market moved ahead by over 20%. Its this experience that creates an opportunity worthy of an outsized position in our portfolio, and thats why we bring it to your attention now.

Interactive Buyside Equity Research

December 26th, 2013

Even before we owned KMI, we were long time owners of EPB stock and were forced to do our due diligence on Kinder Morgan when they announced in October of 2011 that they were going to acquire EPBs parent company, El Paso Corporation. As a research firm, we have known of Richard Kinder and his Kinder Morgan companies over the years. It did not take us a lot of research time to get on board with Kinder Morgan owning El Paso. Also, at CUSH, we host a monthly investors club for area executives and other successful investors. Several times over the years we have talked about this company. We welcome anyone interested in joining our investors club to Contact CUSH Capital.

Management Team
We, at CUSH, are very impressed with the executive management team of Kinder Morgan. We could write an entire research report on Richard Kinder and his accomplishments. We found the following article from Forbes very illuminating: Far from the oil patch, Kinder grew up in the land of Mark Twain, paper route and all. He was born in Cape Girardeau, Mo., on the banks of the Mississippi. His dad was an insurance salesman and his mother a schoolteacher. He served in Vietnam as an Army captain, attended the University of Missouri and got a law degree. The 1970s were rocky. He filed for bankruptcy in 1980 after a bad investment in a Howard Johnsons (though he later repaid his debts in full). Married, with a daughter, and scrambling to keep financially afloat, he talked to a college friend, Bill Morgan, who was working with another Missouri buddy of theirs, Ken Lay, at Houston Natural Gas. Morgan suggested that Kinder get a job at Florida Gas to learn the pipeline business. He did, and when Houston Natural Gas acquired Florida Gas in 1984, Kinder and Lay were reunited. By 1990 Kinder had risen to president of the newly christened Enron, with Lay as chairman and CEO. The two were a powerful team, growing the company from revenues of $5.7 billion in 1991 to $13.3 billion in 1996. Kinder expected Lay to hand him the Enron CEO mantle and move upstairs to the chairmans office, but the board blindsided him. Thinking Kinder was too much of a fuddy-duddy, too wedded to the fading pipeline business and lacking the swashbuckling style needed to run a company so clearly destined to remake the worlds of deal making and energy trading, they withheld the top job. Kinder left at the end of 1996; Lay replaced him with Jeffrey Skilling and held on to the CEO office. If Kinder had stayed on as president, Enron would still be here, says Richard Smead, a veteran industry executive now a consultant at Navigant. Others find it hard to believe that Kinder didnt know anything about the fishy financial engineering that eventually killed the company in late 2001. Kinder dismisses that idea. I left Enron five years before it imploded and was j ust as surprised as everyone else at the companys demise, he says.

Interactive Buyside Equity Research

December 26th, 2013

No matter. Soon after leaving Enron, Kinder heard from Bill Morgan again, who was angling to acquire some tired old pipelines and a terminal that Enron wasnt using anymore. For an equity investment of $40 million Morgan and Kinder took co ntrol of assets worth $325 million. Kinder Morgan was born.6 We include this story here because, although it is anecdotal, we like the story of his life and how it has unfolded. In our due diligence, we have heard from more than one person that says best in the business when we ask about their thoughts on Rich Kinder. A few other points that caught our attention: Past Morningstar CEO of the Year Kinder Morgan is one of Fortune magazines Most Admired Companies Buffett-like salary of $1 with no bonuses, stock options, etc. Personally owns ~24% of KMI has never sold a single share Incredible Track Record of compounding returns for shareholders Kinder Morgan has average annual growth rate of over 20% since its founding in 1997! Insider Buying: Rich Kinger recently bought $28mm at prices under $34.

The return on shareholders equity, their expanding profit margin s and growth rates generated by Kinder Morgan speak to the job that management is doing. In this report we only mentioned Rich Kinder when speaking about management but if you spend much time researching the rest of the management team, you find them a very qualified compliment to his leadership. They also own about 6% of the stock. Kinder Morgan is one of the only companies we know in the energy space that publishes both their annual budget and their enviromental and safety performance records on their web site.

Moat
Kinder Morgans moat is pretty self-explanatory. The assets are regulated and monopoly-like in nature. Once a pipeline is built there is no incentive for competition to try to replicate these assets. All-in-all we find that Kinder Morgan has one of the higher quality moats of any investment in our portfolio. Kinder Morgans size and historical success are hallmarks of a company with a strong moat: Nearly impossible-to-replicate assets. Pipelines are considered toll-road like assets: Over 82% of 2014 cash flow is fee-based and almost 94% of 2014 cash flow is fee-based or hedged.7 CO2 business consistently generates ROIC north of 22% Connected to every important US natural gas resource play, including Eagle Ford, Marcellus, Utica, Uinta, Haynesville, Fayetteville and Barnett in US. Largest independent transporter of petroleum products in US. Largest transporter of CO2 in US. Largest independent terminal operator in US. They have the only oil sands pipe serving the West Coast of US. ROIC consistently in the 11-14% range since 2000. ROE consistently in the 17-25% range since 2000. Tax-favored status helps ensure steady investment (drop downs, IDRs). Majority of new investment is deployed in projects backed by long-term fixed contracts. The company's beta currently stands at 0.77, reflecting a more stable investment when compared to the overall market.

Interactive Buyside Equity Research

December 26th, 2013

Mis-pricing / Valuation
We grade KMIs valuation at B+. The price ran up a little bit on us while we were trying to get this report completed. Under $34 where Rich Kinder recently bought another $28mm worth would be somewhere in the A range. Notwithstanding, the current price represents a sound bargain on a stock with a wide moat and great management team that could very reasonably occupy a spot in our portfolio for a decade or more as the United States capitalizes on its wealth of natural gas reserves. We expect Kinder Morgan to benefit from that. The recent drop in prices would suggest that investors are extrapolating the 2014 pause in distribution growth out forever. We dont think thats realistic as KMIs size and experience gives them a seat at the table for every major energy deal in North America. If we assume only a 4% growth rate in distributions we can very easily make the case that the stock is worth $40. We mentioned these points in the above section titled: Investing Highlights/Interesting Data Points but most apply as the reasons for their mispricing: Complicated ownership structure. Much of the value to KMI is tied up in the IDRs due to the parent company. These are unusual and difficult to value. See page 4 of this report to get more detail. FERC case cited in intro: KMI has estimated its exposure is between $0 and $50MM.8 FERC rat cases are ongoing in nature and KMI will always be exposed to this risk. We have spoken with the management team and believe that the current market price has pessimistically assumed that any such headwinds as these will virtually cancel all future growth for KMI. This is too bearish and creates opportunity. Negative press from Hedgeye analyst. Links to the actual story have all been taken down but you can find a good summary of the report from Barrons here.9 You can find a rebuttal from Hedgeye here.10 Management thinks they can take the stock to the mid $40s in the next three years. This conviction is evidenced by recent insider buys totaling nearly $28 million by Rich Kinder under $34. PEG ratio = .75; EV/EBITDA = 12.9 Net debt/EBITDA consistently @ 3.5xs since 1997. Discount to Net Asset Value (NAV) creates 15-30% total return opportunity over the next 12-18 months.

CUSH models that KMI is worth between $35 and $45. We use several valuation methods to define this range. Our dividend discount model produces a price target of $35 using an 8% discount rate and a very conservative 3% growth rate. Peer group analysis would suggest an EV/EBITDA multiple of 13.4 and implies a price target of $36. Our Sum-of-the-Parts model takes a closer look at the value of KMIs Incentive Distribution Rights under various scenarios and produces a range of values from $35 - $45.

IDR Valuation assumes 4% growth rate until EPB splits equal approximately 50% to GP, then a terminal value based on a 7% yield; 8% discount rate; 35% tax rate.

Risks
As with any investment there are risks. For Kinder Morgan these include: Declines in the price of crude oil, nat gas and nat gas liquids; economic downturn Tax or regulatory changes that could affect KMPs MLP status Changes in regulated pipeline tariffs

Interactive Buyside Equity Research

December 26th, 2013

o They have an inflation-adjusted tariff structure in place. Capital investment risks Pipeline spills, explosions, ruptures; terrorism o Safety statistics are updated for the public every month. Interest rates increasing o This is a concern and something we watch closely as a full-year impact of 100-basis point increase in floating rates equates to ~$48 million increase in interest expense at KMP (this number was ~$54 million as of 6/30/2013). o As of 9/30/2013 approximately $4.8 billion of KMPs total $19.1 billion in net debt was floating rate.7 Can be more hedged if need be. o Fixed rate debt at KMP-70%; EPB 100% and KMI 60%. To counter the Hedgeye analyst referenced above we feel confident looking at a few key metrics, EV/EBITDA and ROIC have remained consistent over the years. Also, if you have a spare hour-and-a-half you can listen to a special conference call that Rich Kinder and his management team held special on September 18, 2013, just to refute the charges, one-by-one, that that analyst leveled against Kinder Morgan.

Conclusion
The shale gas revolution is not a new story. KMIs recent decline provides a great entry price to participate in one of the least risky ways to benefit from this trend. Growth opportunities have not dried up. As the company executes in coming quarters investors will realize this and the stock will re-price itself. We expect a total return of 15-30% in the next 12-18 months and see a high likelihood that KMI could be a core holding for many years.

Interactive Buyside Equity Research

December 26th, 2013

Financial Snapshot

Interactive Buyside Equity Research

December 26th, 2013

References & Disclosures

1 https://www.ferc.gov/whats-new/comm-meet/2013/101713/G-2.pdf,

Oct 17, 2013, page 204 slide 6

2 http://blogs.barrons.com/stockstowatchtoday/2013/09/10/hedgeye-details-short-case-on-kinder-morgan/ 3 http://www.kindermorgan.com/investor/presentations/1211_Wells_Fargo_(SK).pdf, 4 http://bitylink.info/2014-Financial-Expectations 5 http://www.cushcapital.com/wp-content/uploads/CUSH-September-2011.pdf 6 http://www.forbes.com/sites/christopherhelman/2012/11/21/rich-kinders-energy-kingdom/ 7 http://www.kindermorgan.com/investor/presentations/1211_Wells_Fargo_(SK).pdf, 8 http://www.kindermorgan.com/investor/KMI_3Q_Rpt_2013.pdf,

slide 10 pg. 42 9 http://blogs.barrons.com/stockstowatchtoday/2013/09/10/hedgeye-details-short-case-on-kinder-morgan/ 10 http://app.hedgeye.com/m/KVs/a'm2Y2/kinder-morgan-s-rebuttals-don-t-hold-up

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