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Author: igodard Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 27  
Subject: KAB: Reposts from 11Wall (part 4) Date: 12/15/1999 9:41 AM
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The message below and the following discussion was posted at http://www.11wall.com and might be of interest here.

11Wall is a moderated discussion board. As such it has no spam or flame wars and is generally civil and thoughtful. You might visit if postings like this interest you, whether you agree with them or not. I don't read here, so please post any responses at 11Wall.
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LHO39: KAB Debt/equity...

The Wall Board: Stocks (Misc): STOCKS NOT OTHERWISE LISTED: LHO39: KAB
Debt/equity...

By Igodard on Sunday, December 5, 1999 - 05:54 pm:

[ I was looking at the Yahoo profile. They list the Long Term Debt/Equity as 2.79 and the
Current Ratio as 1.59. Is
the first one not a bit high and the CR just all right?]

As TC points out, they have the proceeds of the KPP units offering in the bank, most of
which went to pay down a lot of the debt. However, I expect that they will bring the debt
back up with additional acquisitions in short order, returning the balance sheet to a more
heavily leveraged position.

However, I am not concerned by a high D/E here, and in fact see the current balance sheet
as more a negative than the positive light that TC sees it in.

The reason why I like them leveraged is that the underlying business is essentially a utility,
with almost constand demand and near monopoly pricing. Sure, there's another pipeline
east of their's, so there is some competition, but from the Rockies well out into the grain belt
they are pretty much the only game in town, and will have a 10-15% cost edge over
anybody who tries to supply liquids over a more circuitous route. Likewise the tank farms
have competition, but the location and access factors ensure that they will stay pretty full,
even in a major recession. Trucking stuff in is doable, but again they will always have a cost
edge.

Utility-like businesses can and do use a much higher leverage structure - read the sheets for
your local power or water companies for examples. So long as the returns reliably exceed
the cost of capital the bottom line benefits. Utility investments are essentially an interest
arbitrage play, not a business play like a manufacturing corporation. That's why they are
interest rate sensitive.

In KAB's case they stand to drop $400k net in earnings for each point rise in rates. This is low
for a utility of their size, and reflects the fact that they have lain off most of the interest rate
risk onto the KPP partners - which is in part why KPP has the high coupon. In any case, the
number is low enough that even a 70s style rate spike still leaves them profitable.

I'm hoping that they will use the cash and new debt to fill in their infrastructure where their
wholesale fuel business is located, and pick up a few more tank farms internationally to
spread their regional economic risk. They already have an international presence in the
industrial services division (the best in the business apparently), so adding more simply drops
them into the existing structure without any great integration costs. The IS business has
almost no need for cash other than acquisitions, but they should be buying there as fast as
they can integrate the pieces. Most deals offered to an IS house are stock or earnout, and
with an all-cash offer the buyer can get a much sweeter deal. Their history shows that they
can absorb fairly substantial acquisitions without a hiccup in the numbers, which is hard to
do and part of why I like the management.

Disclosure: accumulating

Ivan
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