About this website

The website explains how distributable cash flow (DCF) is defined and why it is important to analyze it and derive a sustainable measure of DCF. Results reported by master limited partnerships (MLPs) are analyzed. comparisons of reported DCF to sustainable DCF are generated, and various coverage ratios and reports analyzing performance are generated. Simplified sources and uses of funds statements are presented to focus readers' attention on key cash flow items. The website also features general articles about MLPs and about other topics of interest to yield-focused investors.

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The documents and opinions in this website are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the securities mentioned or to solicit transactions or clients. The information in this website is believed, but not guaranteed, to be accurate. All content on this website is presented as of the date published, is not updated and may be superseded by subsequent market events or for other reasons Under no circumstances should a person act upon the information contained within without first conducting his/her own independent research and consulting with his/her investment advisor and tax professional as to whether such action is suitable based on the investor’s investment objectives, personal and financial situation, and specific legal or tax situation.

Answers to Readers' Questions

 

 

 

 

Outlined below, in date order, are responses to some questions posed by readers:

11/8/16: EPD – management’s cash flow estimates for projects coming on-line

Question: On what do you base your estimate of $125 million of incremental EBITDA per $1 billion of capital deployment? Is that EPD’s number, an industry benchmark, or your calculation?

Answer: My estimate is taken from a management presentation dated January 12, 2016, in which scenarios based on projects producing a 12.5% unlevered return on capital are presented. This is equivalent to an 8x EBITDA multiple and is fairly consistent with what management teams of some other MLPs are projecting for their capital growth projects.

 

8/11/16: ETP – management’s cash flow estimates for projects coming on-line

Question: Do you have an opinion on management’s cash flow estimates for those projects coming on-line over the next 6 quarters?

Answer: I estimate ETP’s investments in projects commencing operations through 2017 total ~$6.2 billion. Management is projecting ~7x EBITDA. That is fairly consistent with what management teams of some other MLPs are projecting for their capital growth projects. My back-of-the-envelope calculation is as follows: ~$890m of EBITDA once the projects are fully operational, less interest payments totaling ~$140m (assuming 50% debt financing at 4.5%), equals ~$750m of additional DCF in 2018. How that translates to additional DCF per unit depends on how the ETP funds the equity portion of the projects.

 

6/3/16: PAA results – why focus exclusively on SDCF and not take price into consideration?

Question: If PAA’s sustainable DCF (SDCF) and distributions remained as they are, but the shares started trading (perhaps due to a flash crash) at $5, I suspect that you would become an aggressive buyer — even though the distributions were still not fully covered by SDCF. In other words, I don’t see why PAA doesn’t look attractive to you at some ratio of price to SDCF (or perhaps at some ratio of EV to EBITDA) rather than when SDCF > the distribution.

Answer: I am not sure I would be a buyer under your scenario. It depends on lots of variables, including where other MLPs would be trading at that point, where alternative yield producing investments would be trading, how the rest of my portfolio has performed, and on a variety of numerical parameters such as price/SDCF, EV/EBITDA. Even if all variables except PAA’s price were static, I would want to look further and try to understand the reason for the price drop. In the unlikely event of a flash crash with no underlying economic reason (e.g., someone entering huge sell orders in error), I may be tempted. But doubtless I could move fast enough to execute a trade. I can tolerate negative SDCF coverage for a short while in the hope for a quick recovery to positive coverage, but not for very long. My principal motivation in holding an MLP is a sustainable current yield. But yields are meaningless if distributions are funded by issuing equity, debt or other non-sustainable sources. So when that happens, I tend to exit regardless of price. As you can see, I give great weight to management that shows concern about diluting its investors and is conservative with respect to DCF coverage.

 

6/3/16: MLP business model – why not use just GAAP measures?

Question: Why not just use the CFFO, CFFI and CFFA ((CF from operations, investments, financing, respectively) values from the company’s consolidated CF statement? These are based on standard GAAP rules. Although consolidation is, at times, a rather blunt instrument, this removes the risk of management manipulation and gives consistency across industries and business forms.

Answer: I don’t accept management’s DCF numbers at face value, although I take a close look at these numbers. I also don’t believe in using only pure GAAP measures, such those you mention. Examples illustrating my problem with pure GAAP: CFFO includes cash generated from liquidating working capital and ignores asset write-offs, even when they occur with unhealthy frequency. But likewise, I take a close look at CFFO, CFFF, CFFI and other GAAP-based measures. I also closely follow the trends in the cash flow numbers.

 

6/1/16: BPL 1Q16 results

Question:  Was the decrease on DCF due to capex and associated financing costs? Will the capex projects come online by Q4 ’16?

Answer: As noted in Table 3, sustainable DCF decreased while reported DCF increased in the periods reviewed. Expansion capex is not part of the DCF calculation and maintenance capex had little to do with the variances. The decline in sustainable DCF is mainly due to reductions in cash generated by operating activities that, in turn, was driven by a requirement to invest more in working capital (vs. the comparable prior year periods).

The Michigan-Ohio pipeline (~$100m) is the main project coming on line in 4Q16, although its financial impact will be felt in 2017.

 

5/16/16: Why is EPD’s sustaining capex so much lower in the latest TTM period

Question:  You show that TTM Sustaining Capex declined by 18%. Does that seem realistic to you? Why would SCE decline when they are adding large new products?

Answer: Management was asked about this and responded that nothing unusual is going – in some periods, maintenance capex spikes up. I would add that a similar spike occurred in 2012 and that there are two major issues around maintenance capex: 1) whether enough is being spent on maintenance; and 2) whether amounts classified expansion capex should really have been classified as maintenance capex. On point 1, more disclosure is needed – i.e., how much is being spent on maintenance in total (expensed + capitalized). On point 2, correct classification can have a huge impact on DCF and on coverage ratios. The problem is that there does not appear to be a reliable, consistent and standard method of determining into which bucket (expansion vs. sustaining) a capital investment should be placed. I don’t see a way of finding out if management inappropriately allocated more than it should have to the expansion bucket, and is thus overstating an MLP’s DCF and its DCF coverage ratio.

 

5/16/16: Why of EPD’s NGL revenues are tied to commodity pricing

Question:  How much of the NGL revenues in Table 2 are tied to commodity prices, how much to volume through put?

Answer: There are various types of contracts ranging from fee-based, which are low risk from the processor’s perspective (fee is fixed per unit of processed natural gas), to keep-whole contracts, which are high risk from the processor’s perspective (the processor retains extracted NGLs as a processing fee). To my knowledge, information about the customer contracts is considered confidential and not even high-level analysis is provided.

 

5/16/16: At what price would you buy?

Question:  At what price, or other metric, would you be a buyer of EPD?

Answer: I don’t think one can give a helpful price-based answer to your question. For example, if I say 15% below the current price and 3 months from now EPD is at $22 instead of $26, you would not automatically buy; and rightfully so, because you would want to evaluate the attractiveness of EPD based on current, not 3 months old, data. As long as I remain comfortable with EPD’s performance and prospects, the metric I use is the percent of my portfolio allocated to MLPs, and within that to EPD. If it deviates too much, I would buy or sell. But the deviation may not be tied to a move in EPD’s unit price. For example, if the rest of the portfolio appreciates, I could sell other appreciated investments and buy EPD even at its current level. The decision process is situation specific, not formula driven.

Question:  What MLPs would you buy at this time and are there any that should be sold?

Answer: I only cover a limited universe of about 12 MLPs, of which I currently own 2 (EPD and MMP). I have been reducing my allocation to the MLP space for quite some time and have done so by eliminating other positions. See also my response to … regarding my approach to buy and sell decisions.

 

8/30/15 Taxation of MLPs

 Question:  I thought that the distributions from MLP’s which issue K1’s are mostly return of capital, and if you take them as cash, they are not taxable.

Answer: Each year you are taxed only on your pro-rata portion of the MLP’s pretax income. Each year your tax basis increases by your pro-rata portion of the MLP’s pretax income and decreases by the amount of distributions you received. Because an MLP’s income is typically less than its distributions, primarily because of depreciation deductions: a) your current taxes are low relative to the cash you receive; and b) your tax basis is reduced. Therefore, when you ultimately dispose of the investment your basis has been lowered and therefore your tax bill will be high relative to the cash you receive. At the end of the day, the tax benefit of owning an MLP is tax deferral, not tax reduction. However, deferred taxes increase your rate of return because you gain the time value of money (cash outflow at a later date is better than the same amount of outflow at an earlier date).

 

8/30/15 Legislative and economic risks facing MLPs

Question:  I have two overriding concerns with MLPs and pipelines in particular. One is the high likelihood they will be required to be taxed as C Corps. The second, the flow of oil/gas mix will significantly change in this very volatile commodity environment. Oil and gas prices are now below the cost of production and many pipelines may stand idle or at reduced flow rates.

Answer: I doubt that there will be a repeal of the legislation granting MLPs their special status. Based on 2Q15 reports, I do not see significant pipeline volume reductions.

 

8/28/15: KMI – should distributions be covered out of FCF or OCF?

 Question: Will KMI be able to pay the dividend as well as 10% increases and will this come from OCF or FCF? Some say that since KMI is now a C Corp they should have FCF to cover the dividends while other say KMI still can operate like an MLP and pay dividends out of OCF. Sure would be nice to hear a nice simple answer to which is correct and why.

Answer: The physical life of a pipeline is considered virtually unlimited given proper maintenance, repair & replacement programs. Pipeline companies and partnerships make dividend or distributions payments to their shareholders or unit holders from “adjusted OCF” (i.e., reduced or increased by various amounts deemed appropriate by management). The rationale is that because the capital investments they make have such long useful lives, it is appropriate to pay for them by issuing long-term debt or equity and that requiring them to cover the payments via FCF as if they had 5 or 10 year lives is too onerous and overly conservative. If you buy into that theory, the simple answer regarding KMI is that it is in the pipeline business and that is what really matters – not whether it is structured as a company or MLP. But it is not really a simple answer because KMI’s dividends are covered by “adjusted OCF”, not OCF. The distinction is important because there is no strict definition of what these “adjustments” should include. That means management has wide latitude to decide and it is exceedingly difficult to make comparisons. Worse, even for items on which there is consensus for inclusion, there is no standard measurement method. For example, one of the two major issues around maintenance capital expenditures is whether amounts classified as expansion cap ex should really have been classified as maintenance cap ex. Correct classification can have a huge impact on DCF and on coverage ratios. But there is no reliable, consistent and standard method of determining into which bucket (expansion vs. sustaining) a capital investment should be placed. I don’t see a way of finding out if management inappropriately allocated more than it should have to the expansion bucket, and is thus overstating an MLP’s DCF and its DCF coverage ratio.

 

8/28/15: KMI – calculation of DCF and Debt/EBITDA

Question: 1) Have you seen other midstreams where you find that management’s calculation of DCF or DEBT/EBITDA is different than how you might calculate? In other words is KMI alone their in methodology or is this common throughout the industry? 2) When you listed the EBITDA/Debt numbers in the table, did you calculate those numbers for each company using the same method, or is KMI’s the only one you did while the other’s were the management supplied numbers? I’m trying to see if, in your opinion, KMI’s accounting methods are an outlier in the midstream industry or common amongst many companies.

Answer: 1) KMI and other MLPs calculate DCF differently from the way I do, but also differently from each other. I calculate sustainable DCF in the same way for KMI and all the other MLPs I follow. 2) The EBITDA number I use in the comparison table is the number supplied by management (=Adjusted EBITDA). The debt number I use in the comparison table is not supplied by management; it comes directly from the balance sheets. For my own purposes, I also look at the ratio using strict EBITDA (i.e., not Adjusted) in the numerator, but inserting another column would be overkill and explaining the differences could be too time consuming.

 

8/28/15: KMI’s debt load

Question: What is KMI’s plan to deal with the large and increasing debt situation? Isn’t this the real issue here?

Answer: I think your assessment is overly harsh. First, proceeds from the increase in debt of ~$2B and issuance of equity of ~$2.6B were used to fund ~$5B in acquisitions, expansions and contributions to equity investments in 1H15. So the base of EBITDA producing assets has also increased. Second, I calculate sustainable DCF coverage for the 9 months ending 6/30/15 at 0.96, so if business conditions do not deteriorate KMI is close to 1x coverage. Third, additional assets will be placed into service in the remainder of 2015, in 2016 and beyond. I think the real issue is whether business conditions will be sufficiently favorable to meet the projected 10% per annum dividend growth target without blowing through coverage ratios.

 

8/28/15: NGLS vs. SPH

Question: NGLS has been generously increasing its dividend by 12.6% over the past year, however its price has fallen 60% from its peak last September. SPH on the other hand, has fallen 20% from its peak and increased its dividend by 1.4%. Would your analysis suggest that the pattern for dividend increases for both companies would remain the same going forward? The NGLS price has been more sensitive to oil prices than SPH and I suppose that this correlation pattern is likely to continue in consideration of each company’s particular business concentrations.

Answer: I would describe the distributions from MLPs as tax deferred rather than not non-taxable. NGLS and SPH are in totally different businesses and i would not expect their growth patterns to be correlated. Both are sensitive to oil prices, but not in the same way. As I pointed out in the article, SPH benefited from lower prices. Past patterns of distribution increases notwithstanding, further increases may be tougher for NGLS to achieve on a sustainable basis. SPH may be in a better position to maintain its distribution in the face of further sharp declines in oil prices.

 

8/15/15: Treatment of changes in working capital in deriving Sustainable DCF

Question: I just don’t follow your logic on working capital. You reduce DCF by investment in working capital but then don’t add back reductions in working capital because they tend to be needed to be invested back into the business. But you have already deducted those investments in working capital to get DCF so there seems to be double jeopardy there.

Answer: I realize some consider my definition of sustainable DCF overly conservative. It is based on the premise that: a) cash consumed by working capital is not available to be distributed and therefore my calculation, unlike reported DCF, does not add it back; b) cash generated by liquidating working capital is not a sustainable source of DCF (here my treatment does not differ from reported DCF).  In any event, I always look at both reported DCF and what I call sustainable DCF.

 

8/15/15: Changes in unit prices of PAA relative to PAGP

Question: Why was PAGP’s unit price collapse so much greater than PAA?

Answer: Distribution growth is a much bigger factor in GP valuation models than it is for the underlying limited partnerships. The negative effect of slower or zero growth on unit price is therefore much greater at the GP unit level than at the LP unit level.

 

7/18/15: KMI’s ROE, ROIC, ROA

Question: Why are KMI’s ROE, ROIC and ROA so much lower than those of comparable midstream operators? No one has ever responded to my question. Do you have a perspective on the reason for these lower returns?

Answer: It is hard to compare KMI return numbers prior to the merger transactions (when it was primarily an MLP GP) to to those after (beginning 4Q14) and to those of other midstream operators. Comparing KMI numbers for 1Q15 to EPD and MMP in the same period shows that higher interest expenses and provision for taxes explain the bulk of the ROE and ROA differences. Hope the table below appears properly formatted and is helpful (note that ROE and ROA % not annualized).

1Q15 1Q15 1Q15
KMI EPD MMP
Operating Income 1,078 896 220
Interest expense (512) (239) (37)
Other income (expenses) 77 1 2
Provision for income taxes (224) (7) (1)
Less: Net Income Attributable to Noncontrolling 10 (15)
Net income 429 636 184
Equity at period end 35,359 20,058 3,748
Assets at period end 86,164 46,505 5,605
ROE in period (not annualized) 1.21% 3.17% 4.90%
ROA in period (not annualized) 0.50% 1.37% 3.28%

 

6/8/15: Continue holding NGLS and TRGP?

Question: What would you do with units currently owned?

Answer: Hard to answer in a vacuum. Depends on how concentrated you are in this position, your need for current income, the composition of the rest of your portfolio, etc. My MLP holdings are biased towards partnerships with the strongest coverage ratios, but I do have smaller positions in others. I avoided Targa because I thought it was too concentrated in the Bakken, where it is more expensive to extract oil & to transport it to the market. By more expensive I mean relative to, for example, the Texas shale formations (Eagle Ford, Permian) and Marcellus/Utica. My thinking was that the Bakken and, for similar reasons, the Canadian and midcontinent shale formations, are likely to be the first to see production cuts in response to lower oil prices. Having said that, I do I do not believe the dividend is under threat in the short term. Longer term (>1 year), distributions could be adversely impacted.

 

2/28/15: Your calculations vs. MLP Data’s

Question: What factors result in the difference between MLP Data’s calculations and yours?

Answer: MLP Data computes coverage by dividing total DCF by distributions made to LPs. But LPs are not entitled to the entire amount of DCF. ETE (the general partner) gets a substantial portion. DCF coverage should be computed based on distributions made to all the partners. Therefore the denominator should be distributions to LPs + distributions to GP. The result will be a lower number than that shown by MLP Data.

 

1/13/15: PAA’s Supply & Logistics segment.

Question: The transportation revenues equaled $424M, facilities revenues were $281M and supply and logistics revenues were $10,793 for the third quarter 2014 including inter segment amounts. Does this concern you that the S&L revenues were so significant compared to there other segments? Would not take much of a mistake in this sector to wipe out their entire profit 

Answer: Transportation and Facilities are fee-based businesses, while Supply & Logistics are margin-based activities associated with sale of gathered and bulk-purchased crude oil, as well as sales of NGL volumes purchased from suppliers (including the sale of additional barrels exchanged through buy/sell arrangements entered into to supplement the margins of the gathered and bulk-purchased volumes). Therefore it is not surprising that S&L accounts for the bulk of PAA’s revenues and expenses. It makes more sense to look at segment profits than at revenues. For example, in 3Q14 Transportation generated $231m, Facilities $147m and S&L $152m. Margin-based activities are more volatile. Regarding the risk that S&L will wipe out the entire profit I can only point out that PAA’s track record. S&L has made a positive contribution every single quarter, without exception, since at least 1Q10.

 

1/9/15: NGLS and TRGP distribution outlook

Question: How do you feel about Targa now? Should we expect a cut in dividend?

Answer: Targa recently reaffirmed that 2015 distributions will grow by 11-13% for NGLS and by 35% for TRGP. In 2015 it expects to achieve 1x distribution coverage with gas at $3.75 per MMBtu and with oil at $60 per barrel. No mention was made of expectations for 2016 and beyond. Given current prices of ~$2.93 per MMBtu and $48.80 per barrel, coverage may fall below the 1x threshold in 2015. There are numerous examples of MLPs that have not cut distributions despite negative (i.e., below 1x) coverage. I expect Targa will meet its distribution growth targets in 2015 even if coverage falls below 1x. I do not expect distribution cuts, at least not until we have several quarters of negative DCF coverage behind us. How many quarters depends on the magnitude of the drop in DCF coverage. As of now, my best guess is that it will not happen in 2015.

 

12/27/14: PAA

Question: Is PAA positioned to transport imported oil to refineries etc, or is the company largely dependent on US oil?

Answer: PAA’s assets are located throughout North America in major crude oil production & liquids-rich areas, as well as inland and coastal terminal & interchange locations. It is therefore positioned to transport imported as well as domestically produced oil. PAA noted in its 2013 10-K that “While expected to decline, imports of foreign crude oil and other petroleum products are still expected to play a major role in achieving a balanced U.S. market on an aggregate basis. However, because of the substantial number of different grades and varieties of crude oil and their distinguishing physical and economic properties and the distinct configuration of each refinery’s process units, significant logistics infrastructure and services are required to balance the U.S. market on a region by region basis”. PAA’s infrastructure enables such balancing.

 

12/2/14: NGLS and TRGP distribution outlook

Question: How will the recent plummet in commodity prices impact NGLS? Is the dividend now under threat?

 Answer: Targa is highly concentrated in the Bakken, where it is more expensive to extract oil & to transport it to the market. By more expensive I mean relative to the Texas shale formations (Eagle Ford, Permian) and Marcellus/Utica. So the Bakken, and for similar reasons the Canadian and midcontinent shale formations, are likely to be the first to see production cuts in response to lower oil prices. The larger price drop for NGLS vs. for example EPD, MMP, and ETP reflects this. Having said that, I do not believe the dividend is under threat in the short term. Longer term (>1 year), dividend growth could be adversely impacted.

 

11/21/14: Investing in the general partners of MLPs (PAA vs. PAGP)

Question: Do you have any thoughts on whether PAA or PAGP makes more sense going forward?

Answer: Hard to answer this in a vacuum – the answer requires understanding how your entire portfolio is allocated to assets of different risk classes, the composition and volatility of your income-producing assets, how sensitive you are to a current yield reduction (from PAA’s 4.86% to PAGP’s 2.85%), whether/how you plan to make up for the foregone yield, your ability to absorb additional risk that come with the GP’s prospects for faster distribution growth and capital appreciation. Other factor to consider: a) the lower level of liquidity in the GP units than in the underlying MLPs; b) while PAGP should provide superior growth, less dilution and better alignment of your interests with management’s, you may be too concentrated in MLPs for your yield producing investments. If that’s the case, there are more non-MLP alternatives to PAGP’s 2.86% yield than to PAA’s 4.86% yield.

 

11/21/14: Keystone Pipeline

Question: Any comments on the Keystone Pipeline as it relates to PAA and, further, the energy distribution business in general?

Answer: The major competitor to the proposed Keystone XL pipeline intended to transport Canadian oil to the Gulf Coast via Cushing is KMI’s Trans Mountain pipeline. PAA said it was evaluating the opportunity to connect to the Keystone XL and the TransCanada East systems.

 

11/21/14: Energy Transfer’s Bakken Pipeline

Question: If Phillips 66 is 25% owner, with ETP and ETE, of Bakken Pipeline, where does SXL fit in?

Answer: ETE will, at some point, drop down its interest in the Bakken Pipeline to ETP (which is already a partner and will see its stake increase) and/or SXL (which currently has no interest in this pipeline).  

 

11/21/14: Likelihood of an Energy Transfer rollup

Question: How likely is it that ETE will follow what KMI has done in rolling up the companies?

Answer: KMI-type rollup is highly unlikely for Energy Transfer based on Kelcy Warren’s response to a similar question. Seehttp://seekingalpha.co…

 

8/18/14: Investing in the general partners of MLPs (ETE vs. ETP)

Question: would you still be overweight ETE if you were a retired investor who relied on his investments for his living expenses?

Answer: Hard to answer this in a vacuum – the answer requires understanding how your entire portfolio is allocated to assets of different risk classes, the composition and volatility of your income-producing assets, your ability to absorb losses, how sensitive you are to a 4% yield reduction (from ETP’s 6.6% to ETE’s 2.6%), whether/how you plan to make up for the foregone yield, etc. Another factor to consider is that while ETE should provide superior growth, less dilution and better alignment of your interests with management’s, you may be too concentrated in MLPs for your yield producing investments. If that’s the case, there are more non-MLP alternatives to ETE’s 2.6% yield than to ETP’s 6.6% yield.

 

8/17/14: Investing in the general partners of MLPs

Question: MMP and EPD are my two largest MLP positions. I like that they do not have GPs. I am in the process of building a position in PAA. Would investing in both PAA and PAGP be equivalent to investing in a MLP that owns it’s GP? If that makes sense what % allocation to each would be wise? I have been thinking about 60% PAA and 40% PAGP.

Answer: It’s a reasonable approximation, but not quite the same for a variety of reasons (e.g., unit liquidity, cost of capital, cost of maintaining 2 public entities, etc.) MLP GPs such as PAGP yield less than their underlying MLPs. On the other hand they should provide better growth, less dilution and better alignment of your interests with management’s. The ratio depends your willingness to absorb lower current yields and additional risk that come with the GP’s prospects for faster distribution growth and capital appreciation.

 

8/17/14: PAA – calculations of sustainable DCF

 Question: DCF “available to the limited partners” in 2Q14 was not $1.00 – it was around $0.62, and that was the number most analysts from the brokerages reported in their Q2-14 write-ups. When you adjust for the payments to the GP, PAA sent $94 million to “AAP” and $25 million to PAGP. 94 + 25 = 119. $367 million – $119 million = $248 in DCF after the IDR adjustment248 / 367 units = $0.6757 per unit of Q2 DCF At this point in time, I lack certainty on what the brokerage analysts also subtracted to get to their $0.62/unit numbers. The IDR charges went up (comparing Q2-14 to Q2-13) – so the DCF available to the limited partners went down when comparing Q2-14 to Q2-13.

Answer: DCF per unit is a measure I use to evaluate whether total DCF generated is growing or contracting, not to calculate DCF coverage. In the case of PAA’s 2Q14 results, DCF per LP unit was $1.00 and distributions per unit were $0.65. But, as my article points out, DCF coverage was 1.07 (i.e., not 1/0.65). This reflects $344 million in total distributions (of which $110 million in GP IDRs, not $119 as you calculate) vs. $367 million of total DCF. So 367/344 = 1.07x

MLPs’ methods of determining DCF and DCF coverage differ. KMP, for example, deducts the general partner’s portion of net income in deriving DCF. It thus adopts a narrow definition, one that includes only that portion of DCF that is attributable to limited partners. This is the approach you seem to prefer. The more common and broader definition of coverage (e.g., PAA) is one whose numerator is total DCF (available to both LPs and GP) and whose denominator is the total of all distributions made to all the stakeholders, including the general partner. DCF, DCF growth and DCF coverage as computed using the narrow approach are not consistently lesser or greater than they would have been had the broader definition been used. They are just different.

The brokerage analysts’ calculation you refer to is as follows: $344m total distributions, less $110m IDRs, less $5m GP’s 2% stake = $229m distributed to LPs. Divide $229m by the average 367m units outstanding = $0.62.

 

5/24/14: Comparing MLPs that own their GPs to those that don’t

 Question: IDRs are not typically 48%. Not even ETP or KMP pay at a 48% rate on all of their DCF. IDRs (which I agree can be onerous) begin at 2% and typically are stepped up as distributions increase so that even well after getting to an incremental 48% rate the blended rate is significantly lower.

Answer: You are correct that the marginal (vs. average) rate is 48%. However, the break points typically start at 13% (not 2%) and the step-up thresholds for increases were reached years ago, so the bulk of the IDR payments are at 48%. Using ETP as an example: for each current quarterly LP distribution of $0.935, ETE (as general partner) receives $0.558, of which  $0.517 is at the 48% rate. Overall, the distribution split is 62.6% to LPs and 37.4% to the GP.

 

5/24/14: Investing in the general partners of MLPs

Question: An article I read stated that several GPs were a better value than the underlying MLPs because their shareholder distributions were increasing faster than the MLP. Also I have read that it makes sense to hold both the MLP and the GP in equal weighting. Can you offer any comments about this?

Answer: MLP GPs such as PAGP, KMI and ETE yield less than their underlying MLPs. On the other hand they should provide better growth, less dilution and better alignment of your interests with management’s. But, relatively speaking, it is easier to find non-MLP alternatives to the lower-current-yields / faster-growth combination offered by the GPs than it is to find non-MLP alternatives to the higher current yields offered by the underlying MLPs. So if you are concerned about being too concentrated in MLPs for your yield producing investments, you should choose non-MLP alternatives for that portion of your portfolio designed to generate faster capital appreciation, albeit provide less current income.

 

4/24/14: EPD plan to build ethane export terminals 

Question: Enterprise Products (EPD) announced it would build ethane export terminal to cut glut.

How is ethane used or is it used in other end products? Does EPD’s plan make sense given that ethane supply is currently 3x greater than demand?

Answer: Ethane is one of the six marketable products (excluding condensate and sulfur) produced from the NGL stream. Ethane (also known as C2) is typically the second-largest component of natural gas (methane is the largest). It is primarily used as a feedstock for ethylene production by the petrochemical industry. Thus, the demand for ethane is tied closely to ethylene production, which, in turn, is tied to demand for plastics, or more broadly speaking, the health of the overall economy. Methane and ethane are sometimes referred to as “dry gas” or “natural gas” because these two hydrocarbons make up over 95% of the gas that is delivered to city gates for use as fuel.

Excess ethane supply in the U.S. has driven down price and has given the U.S. petrochemical industry an enormous advantage over petrochemical plants in Europe (where some have had to shut down) and elsewhere. There should be a lot of foreign demand for cheap US ethane, even after factoring in EPD’s margins and transportation costs.  As I see it, this is the bet EPD is making.

 

3/27/14: Comparing MLPs that own their GPs to those that don’t 

Question: In order to make an apples-to-apples comparison of MLPs that own their GPs versus those that have freestanding GPs, shouldn’t the EBIDTA be reduced by the percentage of the IDR siphon? For instance, shouldn’t the PAA EBIDTA be reduced by 48% since that portion of earnings is siphoned by the GP to pay IDRs? The other option would be to add in the EV of the GP…which would also result in an increased ratio.

Answer: Creating an “apples-to-apples” comparison for MLPs is difficult. Adopting a narrow definition of coverage, one that includes only that portion of DCF that is attributable to limited partners, requires reducing EBITDA by the total of IDR payments (rather than the 48% of EBITDA as you suggest). This will not neutralize the “noise” created by temporary waivers that GPs frequently grant, but may still be preferable to no adjustment at all. I will try to incorporate a comparison of this kind in a future article.

 

2/24/14: Maintenance capital expenditures

Question: Do you agree that the difference between capitalizing or expensing maintenance outlays is meaningless since both are reflected in the calculation of distributable cash flow)?

Answer: You may be right in the sense that whether a maintenance expense is capitalized or expensed, it is deducted in deriving DCF.  I don’t think it’s a meaningless distinction because, as I understand it, if management classifies it as an expense it can be added to the cost base for purposes of setting tariffs. That is an advantage. But you are missing the main point. The two major issues around maintenance cap ex are: 1) whether enough is being spent on maintenance; and 2) whether amounts classified expansion cap ex should really have been classified as maintenance cap ex. On point 1, more disclosure is needed – i.e., how much is being spent on maintenance in total (expensed + capitalized). On point 2, correct classification can have a huge impact on DCF and on coverage ratios. The problem is that there does not appear to be a reliable, consistent and standard method of determining into which bucket (expansion vs. sustaining) a capital investment should be placed. I don’t see a way of finding out if management inappropriately allocated more than it should have to the expansion bucket, and is thus overstating an MLP’s DCF and its DCF coverage ratio.

 

1/23/14: Potential acquisition of EBP by KMP

Question: if this were to happen, what happens to the EPB unit holders? Do they wind up with units of KMP? Would it be better, at the present time, to buy EPB or KMP? Which would be the better investment – again assuming that it takes place with 100% certainty?

Answer: If it happens, EBP unit holders will exchange their units for KMP units. My guess is that EPB holders will receive the smallest number of KMP units per EPB unit that a fairness opinion will allow KMI to get away with.This is based on  my guess that Rich Kinder’s loyalties are in the following order: KMI, KMP, KMR, EPB. But there is no way for you to reliably estimate today what the exchange ratio would be, and how fair the market is likely to judge it. If I were to increase my investment in Kinder Morgan it would be via KMI.

 

12/8/13: General partners (GPs) of MLPs

Question: I am looking to MLPs with a stock counterpart (i.e. KMI) due to the burden of Schedule K tax filing headache. Are any on your list offering a non-partnership stock similar to KMI, LINCO?

Answer: Look at TRGP, WMB, PAGP, OKE

 

12/8/13: Which MLPs to buy

Question: do you see BPL as a buy, sell or hold? I got in at 52. It seems there are more then one MLP that can’t afford their distributions and depend on new money or borrowed money. What to do?

Answer: The answer to your question requires analyzing your own specific portfolio. For example, what is the percent invested in MLPs? How much of that is BPL? What does the rest of the portfolio look like, how correlated are its returns to MLPs and the energy sector? The answers should give you an indication of what you should do, regardless of your entry point. My articles indicate which MLPs I regard as having solid, sustainable, or improving coverage ratios. Assuming you decide to diversify, I would begin the selection process with those. But bear in mind there are many additional factors to take into consideration.

 

11/27/13: Bakken vs. Marcellus and Texas shale plays

Question:  why you believe developing infrastructure for Bakken is more risky than for Marcellus and Texas shale plays.

Answer: Terrain is rough and remote, distance to processing plants and markets is greater, there are boom-town type problems (e.g., more difficult to get people). All these factors drive up expenses for drillers. On the revenue side, I crude produced at Bakken fetches lower prices than that produced in Texas. I have also seen articles saying that by 2017 the amount of Bakken acreage available for new wells will have fallen substantially.

 

11/18/13: Taxation of MLPs

Question: When you “reduce positions” or sell for any reason how do you handle the recapture taxes? How does this affect the returns on investments?

Answer: Each year you were taxed only on your pro-rata portion of this MLP’s pretax income. An MLP’s income is typically less than its distributions, primarily because of depreciation deductions; so in effect the distributions you received were tax deferred. But when you ultimately dispose of the investment your tax basis will be lower and, consequently, your tax bill will higher. Deferred taxes increase your rate of return, all else being equal.

 

11/18/13: EPB vs. KMP

Question: I am long EPB and KMP. Do you have a preference between the two?

Answer:  EPB does not have the i-shares that distort, in my view, the coverage ratios. On the other hand, I am beginning to suspect KMI favors KMP over EPB. On balance, as between the two, I prefer EPB.

11/18/13: EPB, KMP – potential merger

Question: I have wondered for a while why EPB and KMP don’t merge. It makes a lot of sense, given the conflict issues you have pointed out, as well as operational efficiencies they would gain. Do you know if there is any reason why they don’t?

Answer: I agree that it makes sense. There may be tax considerations that make it disadvantageous, but I don’t have specific data on this. Also, the conflicts involved in executing such a merger, and the cost of the inevitable lawsuits, are also a factor.

 

11/16/13: KMP vs. KMI

Question 1: How can you suggest that KMP’s dividend is not well covered, and then recommend KMI? If KMP’s dividend goes down, as the author implies it might, the KMI dividend will go down as well, by twice the percentage. I think KMI is a better long-term investment than KMP/KMR, but only because it is a better way to play KMP. You can’t like one without the other.

Answer 1:  KMI’s results spell out the various sources of cash used to make distributions. You are correct that the influence is large. See KMI’s press release dated 10/16/13.  In any event, my point was not to recommend KMI but to say that for those who like the Kinder Morgan story, KMI may be a better way to play it.

Question 2:  I’m a little confused. You caution about the sustainable DCF of KMP but then in the last sentence you sort of recommend KMI that relies on this exact same sustainable DCF to grow it’s own distribution.

Answer 2: I think you are oversimplifying. KMI relies in only in part on KMP’s DCF. It has other assets and its economics are different. An example of the conflicting interests is given in my recent article on EPB. See http://www.wiseanalysis.com/category/by-company/epb/

 

11/15/13: EPD- impact of the Panama Canal expansion

Question: Do you have any thoughts on how expanding the Panama Canal could affect the future of EPD?

Answer: The 2015 Panama Canal expansion is expected to enable EPD to substantially increase propane exports to Asia. First because the Asian market is currently being supplied exclusively from the Middle East, enabling EPD and other US exporters to offer a second source. Second, because in addition to being able to provide a second source of propane to destinations in the Far East, EPD will be also able to offer faster deliveries because large vessels departing from the US Gulf Coast will require a ~25 day journey vs. the ~41 days it currently takes.

 

9/21/13: Investing in the general partners of MLPs (ETE, KMI)

Question: How do you feel about the GP ? KMI and ETE are core positions for my portfolio. GP is the place where the insiders always have the largest stake.

Answer: KMI and ETE yield less than their underlying MLPs. On the other hand they should provide better growth, less dilution and better alignment of your interests with management’s. But if you are concerned about being too concentrated in MLPs for your yield producing investments, there are more non-MLP alternatives to the lower returns offered by the GPs than to the higher current yields offered by the underlying MLPs.

 

9/21/13: EPB and KMP  – maintenance capital expenditures

Question: The Kinder Morgan’s 9/19 conference call preceded your article — and yet you haven’t responded. IMO, Rich Kinder and his CFO effectively answered all of your concerns. If you missed that, I suggest you review the transcript and then respond, perhaps revising/restating your concerns. I look forward to your comments.

Answer: I submitted the article for publication before the transcript of the conference call was made available. The additional level of detail provided re the maintenance cap ex issue was very helpful in mitigating my concern on this issue. My other concerns (relating to the way coverage is calculated and KMR’s impact on coverage) were not the subject of this call and were therefore not addressed.

 

9/9/13: Which MLPs to buy

Question: You do some very helpful work and its appreciated by many of us. In looking at your articles re DCF coverage, I read summaries that are balanced – and particularly focused on safety. But I was wondering which MLPs you think may have good DCF growth prospects over the next 12 – 18 months. As you rightly point out in many of your articles, once the IDRs hit high break points, the LPs don’t get a declining proportional benefit of the MLP’s growth. Thanks for your insights.

Answer: The MLP GP’s probably offer the greatest DCF growth prospects. Take a look at ETE, TRGP and WMB. Other than that, look at EPD, PAA, MMP and WPZ. Of the MLPs I cover, these probably provide the best DCF growth prospects.

 

9/7/13: Targa Resources partners (NGLS) –sustainability of distributions

Question: do you think they will be able to continue to pay the same dividend and make enough DCF? You seem to be saying they will not.

Answer: I am saying they are more reliant on raising cash via debt and equity issuance than other MLPs (i.e., NGLS is not generating excess cash); an LP’s exposure to dilution risk is therefore greater.

 

9/5/13: Suburban Propane Partners (SPH) – reasons for purchase 

Question: Why are you long SPH over APU?

Answer: I bought when it yielded >9%. This was after SPH acquired the propane operations from NRGY. The reasons for initiating the position were outlined in http://www.wiseanalysis.com/sph-a-closer-look-at-suburban-propane-partners-fy-2012-distributable-cash-flow/

 

8/4/13: Investing in the general partners of MLPs

Question: As a rule of thumb, do you feel that it is best to own a piece of both the GP and LP?

Answer: I view the GP as a higher risk asset, but expect it to produce higher returns. What is “best” for you, may not be so for me. I have done well with my GP investments, but this has been a rising market for MLPs for quite a while. I expect the GPs to underperform if MLP prices suffer sustained declines.

 

7/13/13: Taxation of MLPs

Question: what would be my tax exposure if I started an MLP in which I have a significant gain? I have thought about selling in the money calls as a way to protect any decrease in the current price. From your article, it seems as though the next six months may be difficult for this MLP. I look forward to hearing from you

Answer: Bear in mind that you were not taxed on the distributions you received from this MLP; rather, they decreased your basis. Each year you were taxed only on your pro-rata portion of this MLP’s pretax income. An MLP’s income is typically less than its distributions, primarily because of depreciation deductions, so in effect the distributions you received were tax deferred. But when you ultimately dispose of the investment your tax basis will be lower and, consequently, your tax bill will higher. Selling in the money calls to lock in your gains, or at least a portion, seems to make sense. Let me know if you find an options exchange that trades puts and calls on this MLP.

 

5/22/13: GP IDRs

Question: Does the short history of MLP’s show that once the MLP payment to the GP gets to 50% there is a big slow down in the growth of the distribution to unit owners? Would you expect CLMT’s distribution growth to be much lower? Does the GP payments off set other management or operational expenses of the MLP? Or is the GP incentive just dollars off the top?

Answer: IDR payments do not offset any other expenses. It just divides the pie so that the GP gets more and the LPs get less, all else being equal. Distributions are more a function of underlying performance than GP IDR ratchet points. Moving from 13% to 48% IDR participation increases cost of capital and could slow down distribution growth. But my guess is that quantifying the correlation between distribution growth and IDR % will be difficult because  there are so many other variables at play.

 

5/14/13: ETP – cash contributions from affiliates and non-controlling interests and non

Question: Could you expand the ground why exclude net interest from non-controlled parties. To me it seems the same thing as all other ETP business segments operations> there is no guarantee that non-controlled parties continue to perform in the future but the same may be said about the ETP itself – business is business. To me it sounds a bit unfair from the sustainability point of view, however I agree with you on the working capital aspects and other one-off events.

 Answer: In the case of ETP, the bulk of the amount seems to be related to affiliate contributions. Specifically, RGP reimburses ETP for 30% of the capital expenditures related RGP’s share of the Lone Star venture. The far larger portion of capital expenditures on Lone Star has been growth, rather than maintenance. I therefore regard the reimbursement as an offset to ETP’s capital expenditures rather than an addition to cash flow from operations.  Theoretically I should add back the portion related to Lone Star maintenance capital, but I don’t think that number is provided and, in any case, the amount would not be material.

 

4/25/13: Kinder Morgan Energy Partners (KMP) – calculations of sustainable DCF

Question: Just using back of the envelope stuff, it appears that when you do your sustainable DCF coverage calculation thru Q1 ’13 for KMP, it will be somewhere around .80 for the trailing twelve months. It almost can’t turn out any other way given: 1) the distribution for Q1 ’13 is about the same proportion to reported DCF as Q1 ’12, and 2) your quarterly sustainable DCF coverage calculations for Q4 and Q3 and Q2 of 2012 were .60 and .80 and .78, respectively. With that in mind, if you agree, several questions: First, respectfully, do you think your sustainable calculation assumptions can be too conservative in some cases? Second, in situations where there has been acquisition activity and maybe a company is in the midst of drop downs, do you think that looking at trailing twelve months data tells us much about how things are going to wind up? Finally, with an (assumed) coverage ratio of .80, how come Kinder Morgan does so well and is so highly regarded and how do they deliver on their targeted distributions so consistently?

Answer:

1. Of course it is possible my analysis is too conservative in some cases. In the case of KMP, outflows from risk management activities totaled $157 million in 2012 reflecting termination of interest rate swap agreements. I ignored this outflow while management deducted it in calculating DCF. So for this item I was less conservative. On the other hand, I deducted $367 million of inflows in the “Other” category, while management included these in the DCF calculation. So here I was more conservative. The breakdown of items included in “Other” is provided in http://www.wiseanalysis.com/kmp-a-closer-look-at-kinder-morgan-energy-partners-distributable-cash-flow-as-of-4q-12/. Readers can decide for themselves which items are appropriate. As an aside, I could go either way on $171 million of that $367 million. It represents KMP’s share of depreciation in various joint ventures. The way I look at cash from joint ventures that appears in DCF numbers but not in an MLP’s cash flow statements our outlined in prior articles. For example, see the RGP analysis in http://www.wiseanalysis.com/rgp-a-closer-look-at-regency-energy-partners-distributable-cash-flow-as-of-4q-2012/.

2. I always look at quarterly and TTM numbers but recognize that both are rear view mirror numbers. They are helpful but not sufficient in trying to assess future performance. Many other factors should also be taken into account.

3. The article on KMP referenced above takes a crack at answering your 3rd question. In the discussion of Table 6 I noted that KMR owns approximately 31% of KMP in the form of i-units that receive distributions in kind. Not having to pay cash for such a significant portion of distributions makes a big difference. I think it causes KMP’s coverage ratios to appear higher than what I believe they really are. 

 

3/28/13: Which MLPs to buy

Question: At the prices of today, where in the MLP arena with almost everyone hitting new all time highs would you put new $$ to work?

Answer: At this point I am not increasing my exposure to MLPs.

 

3/20/13: Retail Marketing segment (ETP);

Question: Do you think all those snack foods and sugary drinks will hit the UBTI line?

Answer:  Yes, as well as pretax income generated by sale of gasoline and middle distillates. But beyond the tax problem, I don’t see a strategic fit for the Retail Marketing segment and neither did ETP’s GP at the time of the acquisition. Seems to me they tried to sell the retail operation but couldn’t get the price they wanted. Perhaps the asking price was more than what they paid, but I don’t think it likely (given there was little opportunity to enhance value in the short intervening period); hence, I believe, the decision to keep the asset.

 

3/5/13: LNG export opportunities and potential (EPB)

Question: how do you think the announcement of the EPB/KMI export of LNG will effect EPBs share price long term?

Answer: Capital expenditures for Phase 1 of the plant to be built by Elba Liquefaction Company are estimated at ~$1 billion. I doubt EPB’s 50% share will all be spent this year. In 2013 EPB expects to spend $4 billion for growth capital. So this project is not very significant as a percent of total capital spending and I see no reason that its results would have a greater effect on EPB’s long term share price than other projects. There are at least 10 LNG export terminals in various stages of planning in the U.S. The process of getting DOE permission to export LNG (especially to non-FTA countries) and getting FERC combined operating licenses and approval to construct or modify facilities is very lengthy. While Phase 1 of this project has received DOE approval, and while it is smaller than most of the others and utilizes Shell’s capabilities for rapid design, construction and implementation, I still cannot hazard guesses as to whether it will receive all the required approvals or when it will commence operations. No timeline was provided by Shell or EPB.

 

3/4/13: Which MLPs to buy

Question: I’m currently long KMP and will look at some of the others in your table. If you had to force-rank them, with the “best” at the top, what would be your order?

Answer: The answer to your question depends on your risk tolerance, what is currently in your portfolio and a lot of other factors. “Best” may differ for each investor. Most recently, on Jan 9, I recommended to a reader to start buying EPD, MMP, PAA, WPZ and EPB, allocating more to the first 3 than the last 3, despite their lower yields. I said I would split the 6th investment between KMI (GP of EPB, KMP, KMR) and WMB (GP of WPZ). With the exception of WPZ/WMB, they have all done well, but their prices have increased substantially. Despite that, if your decision is to buy MLPs at this point, I would repeat the recommendation. 

 

1/26/13: DCF per unit calculation for Boardwalk Partners (BWP)

Question: In the 2011 Annual Report the Distributable Cash Flow is reported at 391M. As far as I could tell in the entire report there is not ‘per unit’ number reported. My second question is do the Class B units get factored in when computing the per unit DCF?

Answer: DCF per unit is a measure I use. This metric is not provided by BWP. Re your second question, I factor in the Class B by dividing total DCF by the sum of common plus Class B units outstanding on a weighted average basis. I realize this is not 100% accurate because the class B unitholder (Loews) participates in distributions on a pari passu basis with the common units up to $0.30 per quarter (i.e., no participation in quarterly distributions above $0.30 per unit), but I do not view the inaccuracy as being material.

 

1/26/13: Investing in the general partners of MLPs (KMI); Boardwalk Partners (BWP)

Question: what are your thoughts on the likes of leader KMI and niche player BWP?

Answer: KMI yields 3.97% vs. 5.8% for KMP, but KMI should give you better distribution growth, better capital appreciation potential (MLP GPs should be candidates for acquisition by the underlying MLPs because of the burden they create in terms of cost of capital), and less dilution. If you are concerned about being too concentrated in MLPs for your yield producing investments, there are more non-MLP alternatives to the 3-4% current returns offered by the MLP GPs than for the 5-6% current returns offered by the underlying MLPs. 

 

1/9/13: Which MLPs to buy

Question: I am I am looking to buy 5 or 6 MLP’s to spread my money out a little.I am more looking for income and safety. What do you think would be 5 or 6 for me to buy? I intend about 35 to 40 thousand each.

Answer: I would start buying EPD, MMP, PAA, WPZ and EPB. I would allocate more to the first 3 than the last 3, despite their lower yields. I would split the 6th investment between KMI (GP of EPB, KMP, KMR) and WMB (GP of WPZ). Safety is, of course, relative.

 

1/8/13: Risks facing a long-term MLP investor

Question: I am long CLMT, EPB, ETP, EPD, LINE, MMP, OKS, PAA, NGLS and WPZ and am committed to MLPs as a retirement growth and income strategy. I would like your opinion on what you see as the greatest risk(s) to this strategy over a 15-20 yr timeframe.

Answer: 1. Environmental. To quote an International Energy Agency (IEA) official: “If the social and environmental impacts aren’t addressed properly, there is a very real possibility that public opposition…will halt the unconventional gas revolution in its tracks”. See also a documentary titled “Gaslands” by Josh Fox. 2. Falling afoul of the regulators. For example, ETP fell >12% when FERC announced that it is seeking civil penalties and the disgorgement of profits totaling $167 million for allegedly manipulating the wholesale natural gas markets in Texas. 3. Too much money. MLPs have become increasingly popular. The ease with which they can raise equity and debt creates a risk of too much money investment opportunities and lowering the returns. 4. Tax code changes that would eliminate the advantages inherent in the MLP structure.

 

12/22/12: Assessing reasonableness of maintenance capital expenditures

Question: Do you believe there is a way to determine with some confidence the maintenance capex required over time by these MLPs?

Answer: I don’t know of such a way. The only thing I can suggest is to look across a large number of MLPs and see what they mean and median numbers of maintenance capital expenditures as a percent of revenues. Then look more closely at those that deviate significantly.

 

12/20/12: Borrowing in order to increase distributions and maintain higher per unit prices

Question: Does lowering distributions cause the price of the units to fall far lower? If so, they should borrow to increase the distribution rate artificially, so that when they sell new units they can get a higher price than they would otherwise. Do you also believe that stocks paying higher dividends, all else being equal, trade at higher prices? Do you believe they should?

Answer: Retail investors form a large part of the MLP investor base.I argue in my articles that it is quite difficult to determine whether an MLP’s distributions constitute a return on the investment or are sourced via issuance of debt and/or equity. Many investors do not make the distinction and hold the MLP for its current yield and expect future increases in distributions and unit prices. Therefore an announcement by an MLP that distributions are being cut or no longer growing frequently triggers a sell-off. BPL and NRGY are cases in point. Lenders frequently limit an MLP’s borrowing capacity, so when LT debt to EBITDA exceeds ~5:1 (e.g., BPL currently and NRGY prior to selling its retail propane business) propping up distributions by raising additional debt becomes problematic for an MLP. Your last two questions deal with stocks, not MLP units. My response is that all else is never equal. But if you found a situation where all things were equal, and if current tax regulations remain unchanged, I would rather receive $1 of dividends than $1 of short or long-term capital appreciation. So I would pay more.

 

12/20/12: MLPs with no IDRs

Question: Can you share which MLPs do not have Incentive Distribution Rights (IDRs)?

Answer: Of the ones I follow-BPL, EPD, MMP, NRGY. Other include GEL, CPNO, MWE, PVR, LGCY, LINE, PSE, QRE, VNR

 

12/17/12: Which MLPs offer compelling valuations?

Question: Can you suggest 4 or 5 off the cuff, which you think are compelling valuations now and also likely to be good long term holds? I certainly will investigate any suggestions further but want to be positioned to buy if we get a larger pull back as we likely go over the fiscal cliff. I see the MLP’s you are holding now on your articles, but what was a compelling investment when you made it may not be a great buy now, or in the near future.

Answer: I have been adding to my EPD position on dips and would also feel comfortable with MMP and PAA. Their valuations are high, but they were also high a year ago when I compared them to other MLPs. Despite the much higher valuation, they generated superior performance over the past year. No one knows whether this will be repeated. I give great weight to management that shows concern about diluting its investors and is conservative with respect to DCF coverage. WPZ used to fit the bill until they began a string of large acquisitions. It has since been issuing units in large amounts, and the coverage ratios dropped sharply. I believe WPZ is building great presence in the Marcellus shale. It is riskier, but may offer capital appreciation upside. So I have also been adding to WPZ on dips – but it seems like every time I do that, it falls further. Still, I think it is attractive from a risk-reward standpoint. SPH is my most speculative and smallest MLP position. Again a case of very careful, conservative, non-diluting management that made a large acquisition and consequently issued units in large amounts and suffered significant drops in coverage ratios and took on a lot of debt.

 

12/16/12: Kinder Morgan Energy Partners (KMP) – calculations of sustainable DCF

Question: I am Japanese individual investor. I hold KMI instead of KMP, because of tax proceeding. You analyzed KMP in a Nov 3 2012 article “A Closer Look at Kinder Morgan Energy Partners’ Distributable Cash Flow as of 3Q12″. In this article, you calculated TTM Sustainable DCF coverage ratio of KMP was 0.96.But in today’s article table 5 said only 0.66.There is quite a difference between 0.96 and 0.66. What is the difference?

Answer: In cases such as KMP, where an MLP distributes significant amounts to the general partner in the form of Incentive Distribution Rights (“IDR”), coverage ratios diverge significantly depending on whether one is referring to coverage of the LPs distributions or coverage of total distributions. In the TTM ending 9/30/11, KMP generated sustainable DCF of $1,599 million. Dividing that by ~343 million LP units outstanding gives $4.67 sustainable DCF per unit. Distributions declared in that period amounted to$4.85, hence the ratio of 0.96. However, distributions actually made per the cash flow statements also include significant amounts distributed to the general partner. Including the IDRs, KMP distributed a total of $2,413 million in the TTM ending 9/30/11 against sustainable DCF of $1,599 million, hence the ratio of 0.66. Your question is a good one and I will highlight and explain these differences in future articles.

 

12/15/12: Energy Transfer Partners (ETP); Regency Energy Partners (RGP); Energy Transfer Equity (ETE)

Question: what would an ETP/RGP merger mean for unit holders? Since ETP has 4x the market cap, I assume it would be acquiring entity. Would RGP holders be bought out at a premium?

Answer: Not necessarily. ETE is the GP of both and would likely have the most influence on the transaction price. Investment bankers will be retained by ETP and RGP to provide a “fairness opinion” to each side of this non-arms length transaction. If there is a premium, I doubt it will be much. Also, rather than ETP acquiring RGP, you may see a 3-way merger between ETE, ETP and RGP accompanied by elimination of the GP IDRs. This seems to me a more likely path. The premium is likely to be paid to ETE unitholders.

 

11/14/12: MLP valuation parameters

Question: my 2 cents on the last table in your recent article on EPD, which is great, is that it would be even more useful at my level, if the table included a few other columns: namely distribution growth over last 3 years, distribution/cash flow and perhaps price to book.
Would you comment on the value of using these metrics for choosing MLP’s to buy for long term income and income growth.
thanks again, excellent analysis.

Answer: I will shortly summarize key parameters for the MLPs I follow along the lines you suggest (I did that ~3 months ago once I completed my analysis of all the 10-Qs). I don’t think price-to-book is not a key metric for MLPs.

 

11/12/12: Energy Transfer Partners (ETP); Regency Energy Partners (RGP); Energy Transfer Equity (ETE)

Question: what is the relationship between ETE, RGP and ETP?

Answer: ETE is GP of both ETP and RGP.RGP owns 30% of Lonestar (ETP owns 70%). ETP sells natural gas and NGLs to RGP. It also provides transportation services and compression equipment to RGP and receives certain contract compression services from RGP. ETE pays ETP to provide various general and administrative services on its behalf to RGP.

 

11/6/12: Taxation of master limited partnerships

Question: please comment on what happens now if the government’s efforts to raise revenue without a rate increase could impact all the MLP’s and REITS with issues such as deductions, depreciation, loopholes etc.

Answer: I assume you are refering to possible tax reform proposals that would deny MLPs their tax-advantaged (pass-through) structure. Current legislation (the Revenue Act of 1987) required MLPs to receive 90% of their income from qualified sources. Qualifying sources include natural resource activities such as exploration, development, production, mining, refining, and transportation (including pipelines) of oil, natural gas, minerals, geothermal energy, and/or timber. Given that these incentives have worked well for many years and that additional investments are required to increase domestic oil and gas production and reduce U.S. dependence on oil imports, I doubt that there will be a repeal of the legislation granting MLPs their special status. Of course, if I am wrong, I will suffer significant declines in the value of my MLPs.

 

11/6/12: Depreciation with respect to pipeline assets

Question: dodepreciation schedule for these assets tend to understate their useful lives?

Answer: the physical life of a pipeline is considered virtually unlimited given proper maintenance, repair & replacement programs (http://www.hawkpros.com/download/). I haven’t seen any studies that indicate maintenance cap ex per pipeline mile must rise substantially over time.

 

11/2/12: Federal Energy Regulatory Commission (FERC); Buckeye Partners

Question: how big of a risk factor FERC rate decisions are more generally for MLPs? With most MLPs seeming to earn superior returns on capital for many years (especially vs. utilities), is there a risk that FERC decides to get tougher on the MLPs? This seems to be an under-discussed risk factor for mid-stream MLPs — was wondering if you could share any thoughts on this issue.

Answer: FERC regulates the interstate transmission rates. On the one hand it limits the returns pipeline operators can earn and on the other hand it stabilizes their earnings. FERC, like other government agencies, may be influenced by politics and the policies of, the current administration. From 1992 to 2006 the pipeline inflation indexing methodology there has been only one substantive change to the indexing method, and it was a positive for the pipeline owners. Prior to July 2003, the FERC capped tariff increases at PPI minus 1%. In 2003, the FERC raised this to PPI + 0%. In 2006, this again was raised to PPI +1.3%. Future regulatory changes could, theoretically, be detrimental. The FERC issue with respect to Buckeye Pipelines (BPL) is specific to that MLP and I don’t a see it affecting others.

 

8/17/12: LNG export opportunities and potential

Question: I would greatly appreciate your comments on the LNG export & transport sector. I feel this sector will blossom in the last half of this decade with Sabine Pass & Kitmat terminals now under construction with 3 or more export sites seeking Government approval.

Answer: there are at least 10 export terminals are in various stages of planning. But, as I understand it, the process of getting DOE permission to export LNG (especially to non-FTA countries) and getting FERC combined operating licenses and approval to construct or modify facilities is very lengthy. I cannot hazard guesses as to who does and who does not get all the approvals and how significant LNG exports can become. For time constraint reasons I am not sure I will be able to do kind of research you are requesting, but I agree with you that there could be significant opportunities in LNG exports.

 

6/19/2012: Taxation of MLPs

Question: As these pipeline companies operate multiple States is there a personal income tax liability to these multiple locations? Or are the distributions covered at the corporate level?

Answer: See http://www.investingdaily.com/13535/mlps-and-taxation-a-quick-refresher-for-tax-season: “It is true that when you own an MLP you are considered to be earning income in every state in which that MLP operates. However, in most cases unless you own a large position in the MLP it’s likely you will not have to file a return in every state or pay any state taxes outside your home state. There are two main reasons for this. First, many key states in which MLPs operate don’t have state income taxes at all. Examples include Texas and Wyoming, both states where MLPs are extremely active. Most others have minimum income limits; unless you have income from the MLP above that limit you’re not required to file state taxes. Second, as most MLPs operate in multiple states, the share of income allocable to each individual state is quite small; typically only investors with large holdings will need to file. The exact amount of income allocable to each individual State is included in your K-1 form.The benefits of tax deferral coupled with high current income outweigh these complications. And many find it easier to simply consult a tax professional; any good accountant can easily handle MLPs.”

 

6/18/2012: Taxation of MLPs

Question: If an MLP is held in an IRA, and state income tax is due, does the IRA status mean that the tax is not payable?

Answer: MLPs invested within tax-exempt accounts could potentially generate unrelated business taxable income (UBTI). Should one place a MLP in an IRA and its allocated taxable net income exceeds $1,000, then it may trigger UBTI that would be subject to tax at the Federal level. Not sure about state level, but would not be surprised if this were the case at the state level too. You will need to check with an accountant or tax lawyer.

 

6/4/12: Boardwalk Partners (BWP)

Question: what are BWP’s capital investment plans?

Answer: BWP’s capital program consists primarily of:

(1)   The just completed HP Storage transaction

(2)   South Texas Eagle Ford Expansion: BWP expects to spend approximately $180.0 million (of which $173.0 million in 2012) to construct a gathering pipeline and a cryogenic processing plant in south Texas, which it expects to be operational in early 2013

(3)   Marcellus Gathering System: BWP expects to spend approximately $90.0 million (of which $70 million in 2012) to construct a gathering pipeline system in Pennsylvania. The first portion of the system is presumably already in service.

Compared to some other MLPs, this is relatively little by way of a new projects pipeline.

 

6/4/12: Treatment of maintenance capital expenditures; Boardwalk Partners (BWP)

Question: isn’t maintenance capex expensed? Accordingly wouldn’t it already be reflected in net cash generated from operating activities? Same thing for working capital changes, those too are reflected in cash flow from operating activities. Accordingly, I am not following you when it comes to the adjustments for maintenance cap ex and working capital used.

Answer: Capital expenditures, both expansion and maintenance, are capitalized and appear as cash outflows from investing activities. See for example EPB Form 10-K. Working capital changes on the other hand are reflected in net cash from operations. I don’t count cash generated by reducing working capital in the sustainable category and therefore adjust down net cash from operations.

 

5/26/12: Yield vs. yield growth; Magellan Midstream Partners (MMP)

Question: MMP has a 5% yield with 9% projected yield growth. KMR has a 7% current yield and 7% projected yield growth. In both cases you get a 14% projected total return?

Answer: I would do the math differently. To illustrate, compare ETP which yields ~8.3% and where I expect no distribution growth to MMP which yields ~4.9% and where investors expect 9% distribution growth. If you invest $100 in each MLP today and after 5 years, your $100 MMP investment would be yielding $7.54, still less than the $8.30 you would be getting from your $100 ETP investment. Cumulatively over that period, your $100 ETP investment would generate ~$9.50 more than your $100 MMP investment (assuming expectations are met, and no difference between them in terms of unit price appreciation or depreciation during that period).

 

5/25/12: Investing in the general partners of MLPs; Kinder Morgan (KMP, KMI)

Question: is KMI or KMP the better long term investment?

Answer: KMI yields 3.95% vs. 6% for KMP, but KMI should give you better growth and perhaps less dilution. If you are concerned about being too concentrated in MLPs for your yield producing investments, there are more non-MLP alternatives to the 3-4% current returns offered by the MLP GPs than for the 5-6% current returns offered by the underlying MLPs.

 

5/25/12: Kinder Morgan (KMP, KMI)

Question: are both KMP and KMI in the same position or does the general partner KMI have an upper hand and priority standing in distributions, as is usually the case? If so, does your pro forma analysis support a conclusion that KMI will cut its dividend? Will any cuts be restored after El Paso accretes, if it indeed does?

Answer: they are definitely not in the same position. Because EP was purchased by KMI rather than KMP, KMI and KMP must now “negotiate” the prices at which assets will be sold by KMI to KMP. As GP of KMP, KMI is on both sides of this transaction. I think that in order to fulfill its fiduciary duty as GP, KMI will have to drop down assets that, at least based on reasonable projections, will be accretive to KMP (immediately or in very short order). The questions are how aggressive those projections will be, how accurate they will turn out to be, what proceeds can KMP generate from the divested assets. I did not conclude that KMP or KMI will cut their distributions.

 

5/24/12: Investing in the general partners of MLPs; Williams Pipeline Partners (WPZ)

Question: Why would you bother owning WPZ when you can own WMB? WMB is the prime beneficiary of all WPZ’s equity issuance and will grow faster.

Answer: WMB yields 3.9% vs. 5.66% for WPZ. Perhaps WMB will grow faster but I am concerned about being too concentrated in MLPs for my yield producing investments. There are more non-MLP alternatives to the 3-4% current returns offered by the MLP GPs than for the 5-6% current returns offered by the underlying MLPs.

 

5/21/12: Buckeye Partners (BPL)

Question: Wow…you sure nailed that one! Based on your ratios, it would seem that BPL is going to have a difficult time sustaining its current distribution rate. Would you agree?

Answer: I agree. The shortfall between DCF and distributions was about $12m in the last quarter. BPL could, of course, issue additional units and use a portion of the proceeds to maintain its distributions until investments such as BORCO and Perth Amboy start generating cash to cover the shortfall.

 

5/14/12: Energy Transfer Partners (ETP)

Question: (1) at what price do you think the falling PPS justifies the risk of entry given your DCF concerns, (2) how do you see the Sunoco deal playing out in terms of DCF, particularly given ETE’s agreement to not collect IDRs for 3 years, (3) how many new issues are likely going to get issued to pay for the Sunoco deal, when they might be issued given the representations that the “deal will close in 4-6 months,” and (4) the price range you would expect to see for those units when priced? I know, big questions for a crystal ball, but I am trying to learn various peoples’ perspectives and you are clearly one of the most knowledgeable around on ETP given your article.

Answer: I don’t think one can give a helpful answer to your first question. For example, if I say 15% below the current price and 3 months from now ETP is at $38 instead of $44.74, you would not automatically buy; and rightfully so, because you would want to evaluate the attractiveness of ETP based on current, not 3 months old, data. So there’s not much value you can attach to the answer. Regarding your 2nd question, I noted in the article that I cannot understand how the SUN acquisition could be immediately accretive to ETP. This is after taking into consideration ETE’s relinquishment of $210m in IDRs over 3 yrs. The only answer I can provide to your 3rd question is that given the amount that needs to be raised, there may be several unit offerings and there could be substantial downward price pressure.

 

5/13/12: MLP candidates to acquire or be acquired; outlook for natural gas prices

Question: I own a number of MLPs and anticipate more consolidation in the space. Do you have particular thoughts about candidates to conglomerate or, conversely, ripe for acquisition. Also, nat gas is so low, and will be for the next few years (in my estimation), I expect opportunistic buys to arise in the near future. Do you agree?

Answer: I follow a limited subset of the MLP universe, about 15 in all. Within that universe, the GPs should be candidates for acquisition by the underlying MLPs because of the burden they create in terms of cost of capital. ETE is a good example. KMI is another. On natural gas, I agree. EIA’s new estimates are for natural gas production to be up 4.47% in 2013 vs. 2011, while consumption if forecasted to increase 6.63% in that period

 

5/11/12: Enterprise Products Partners (EPD)

Question: Impressive analysis. Yet, a little niggling thought makes me wonder how truly deep we need to go with such analysis. Analysts do the same job (Schwab, Ned Davis, S&P, etc), look at the same company, and come up with opposed conclusions about the worth (rating). Then, when I look at stocks that are rated A by most analysts, and compare the price performance of the “A”s to the “C” stocks, I don’t see a measurable advantage for the “A” stocks. So, perhaps the benefit of such fundamental analysis is just to make sure the stock is not a dog about to die, do no further analysis, then use other types of analysis (technical mainly) to determine whether and when to buy? I’d enjoy your comments on this point.

Answer: The overwhelming majority of Buy side analyst recommendations are positive, so your point re worrying about the downside is well taken. Indeed, you should worry about the downside of every material stock position. But worrying is useless if not accompanied by analysis, so you need to analyze all your positions. I eliminated my positions in NRGY and BPL following such analysis. Take a look at my Jan 3 2012 article on NRGY and Feb 14 2012 article re BPL. For me, the return on the time and effort I put into the analytical effort was definitely worthwhile.  I don’t think technical analysis will help too much in deciding whether and when to buy. There is no algorithm that I know of that will do this for you. Although the decision process involves integrating data from many sources, at the end of the day the number of variables that can impact the outcome is too large to list, let alone integrate and understand. I try to make a decision if after the fundamental analysis I develop a strong sense, either positive or negative, and develop a gut feel that the timing is right. Wish I could be more precise.

 

5/11/12: Enterprise Products Partners (EPD)

Question: What impact do you see from the adverse ruling by FERC on the Seaway rates?

Answer: EPD says the order affects about one-third of the initial capacity of 150,000 bpd (12.5% of the planned 400,000 bpd capacity) and further says the effect would be minimal. I have no basis for disagreeing.

 

5/11/12: El Paso Pipeline Partners (EPB)

Question:  I have not been able to figure out the new IDR’S for Kinder, have you?

Answer: In 2011 quarterly distributions for the first time exceeded the $0.43125 threshold beyond which the general partner’s incentive distribution rights reach 50%. KMI purchased EP, so I think KMI will now receive 50% of any excess beyond the threshold. That is one of my main concerns with EPB.

 

4/9/12: Buckeye Partners (BPL)

Question: HI Ron, I know you are trying to do a good job and be objective, but what are you saying Ron? Did you reach a conclusion with BPL? I am not sure I see a conclusion in your article. You don’t mention anything about the company’s strategy? Do you like it? Or do you hate it? When you write “fairly highly levered” what are saying? Is it over levered or not? My understanding is that anything over five times is highly levered, but what does “fairly highly” mean? Given the change in the company’s strategy, what do you think EBITDA will be in 2012 and 2013? Do you think there will be improvement? What about the company’s purchase of the New Jersey terminal for $260 million cash?

Answer: BPL’s $260m purchase of the liquids terminal in New York Harbor is the latest in what has been a string of acquisitions. You ask whether I like this strategy. My answer is that external acquisitions generally require paying top dollar and are thus less accretive than internal growth projects. So I prefer MLPs that are not taking on significant price and execution risks by going on a buying spree. I noted in my article that BPL’s LT debt is at 4.9x EBITDA. You seem to agree this is quite high.  I no longer own BPL because I am uncomfortable with: 1) the strategy; 2) the execution (writeoffs and missing projections); 3) the debt level; 4) the likelihood more equity being issued.

 

3/18/12: Inergy, L.P. (NRGY)

Question: I read your older article on NRGY. Are you relying just on the company’s disclosures to determine the distributable cash flow (DCF)? I assume this is defined as the operating cash flow minus just the maintenance capex? NRGY appears to be spending a lot on capex, and I assume that must be to fund growth for their midstream assets inside the NRGM MLP structure? In a situation that is so capex intensive, wouldn’t it make more sense for them to just stop the distributions entirely and wait for that new capex to start generating sustainable cash flows? Otherwise I assume that the distribution will end up getting matched by additional debt or equity raises to fund future capex? Have you studied the MLP NRGM much? It looks highly valued against the current cash flows, so I assume it must actually be getting valued against future cash flows from all the capex they are doing? What do you think fair value for NRGM is? Do you think much of the quality of the assets inside NRGM, and are they really fee-producing assets that won’t suffer from the drop in natural gas prices?

Answer: DCF as reported is per NRGY’s SEC filings. Sustainable DCF is my own definition. Reported DCF is not as per your assumption. See NRGY under www.wiseanalysis.com/definition-of-distr…/ I don’t know whether, theoretically, NRGY could do as you suggest and stop distributions altogether. It may violate the LP agreement. But in any event, practical considerations make it impossible. They would decimate their base of unitholders. I have not taken a close look at NRGM, so cannot as yet answer your questions on it.

 

3/6/12: El Paso Pipeline Partners (EPB)

Question: Point #5 in the article A Closer Look At El Paso Pipeline Partners’ 2011 Distributable Cash Flowis interesting – “Post the EP acquisition, it will make sense for KMI to simplify its structure in order to avoid the complication, expense and potential conflict of interest inherent in being the general partner of three distinct MLPs.” I am curious as to what you think may occur, KMI bought by the MLP’s, KMP merge with EPB, or something else.

Answer: My best guess is a merger of KMI with the underlying MLPs (KMP, KMR, EPB) in which incentive distribution rights are eliminated and a single EPD-like entity remains.

 

3/6/12: Enterprise Products Partners (EPD)

Question: As I read through your article, I am not sure I see your conclusion,” Is DCF sustainable or not?” It looks like they come up short based on your calculations? Is that what you are saying that DCF is not sustainable from operating performance?

Answer: Although the reported DCF number is higher than what I consider sustainable, principally because reported DCF includes over $1 billion of proceeds from asset sales, EPD does not “come up short” because in 2011 sustainable DCF = 134% of distributions. See the 2nd table in the article “A Closer Look At Enterprise Products Partners’ 2011 Distributable Cash Flow”. This is a very strong coverage ratio.

 

2/17/12: Buckeye Partners (BPL)

Question: My question on BPL is how do you look at their future? 2011 was an obvious tough year for BPL in terms of properly covering their distributions, but at the same time, they have several new projects that should come online during 2012, and should impact their DCF. I bought BPL some time ago ($60.xx = 4.5% allocation). They historically have had good management with good follow through. Since I already own them, my inclination is to stick. But, I do worry about sticking with a potentially high risk situation. So, when you go through your MLP analysis – how much does the “potential future DCF” play into your risk analysis? I like owning good management but I also like preserving my capital much more. Thanks!

Answer: In terms of my analysis, there is no precise weight for future DCF. Trying to distinguish between master limited partnerships based on an assessment of which of their projects will come in on time, on budget and deliver the expected throughput is a task I don’t try to undertake. It is too complex and there are too many uncertainties involved. Since virtually all the energy MLPs have new projects coming on line that they expect will positively impact DCF, I try to distinguish them based on other factors. For example, whether the yield is real and whether it is sustainable.

Regarding BLP, I summarized my concerns for another reader as follows:

  1. BPL has not met expectations for at least 4 consecutive quarters;
  2. The trend in BPL’s reported DCF per unit does not seem positive: $1.03 in 1Q11, $0.83 in 2Q11, $0.87 in 3Q11 and $0.77 in 4Q11;
  3. Reported DCF includes items I do not consider sustainable (such as reductions in working capital, certain risk management activities);
  4. BPL has been aggressively buying assets and projects these purchases will significantly drive performance. But for that to happen, it must price them correctly and sucessfully integrate them into its operations. That has not always happened, as witnessed by the ~$170m (38%) 3Q11 write down of the Natural Gas Storage business unit (acquired in 2008 for ~$440 million). Hopefully they will fare better with the BORCO acquisition.

My analysis of sustainable DCF for the 9 months ended 9/30/11 caused me concern regarding BPL’s ability to make distributions that are financed by operations rather than by borrowings or sale of additional partnership units. I will update the analysis once the 10-K is issued and additional cash flow information becomes available. In the meantime, I think a note of caution is in order. Investors who don’t want their current distributions to be dependent on an MLP’s future growth and/or ability to raise capital should consider alternatives to BPL.

Bottom line – although BPL is the first MLP I owned and the one I have held longest I began reducing my position and recently sold the last batch.

 

2/14/12: Taxation of master limited partnerships

Question: Have you considered the potential impact of the Obama 2013 budget proposal, released 2/13/2012, on all MLPs? I read through the relevant sections (a not-so-fun read) and did not think that any of the energy-related tax proposals would have a direct affect on midstream MLPs. The proposed change in the treatment of all dividends, however, is a concern. Obama is recommending to take the dividend tax rate from the current 15% to a top rate of 39.6%. And remember, ObamaCare will raise both of these by another 3.8% for upper income earners. This could dampen interest in MLPs, depressing not only their after-tax attractiveness, but their stock prices as well.

Answer: Bear in mind that the distributions made by MLPs are not dividends. You get taxed on your pro-rata portion of the MLP’s income, not on the distributions. An MLP’s income is typically less than its distributions, primarily because of depreciation deductions, so in effect the distributions are tax deferred. Distributions decrease your basis so when you ultimately dispose of the investment your tax bill is higher. What MLP investors need to watch for on the tax front are proposals to tax MLPs as corporations. This would reduce the tax benefit of owning them.

 

2/9/12: Investing in the general partners of MLPs

Question: I am currently investigating an investment in ETE and trying to answer the question about whether it is better to invest in GP or the MLP. I started to explore this issue when I started to look at Williams and its MLP’s. I have WMB for long term capital appreciation and WPZ for income and tax reasons. The Williams group appears to me to have been designed by tax masters. I also have looked at MLP subsector performance for 2011. At this point I do not have multi-year data. Performance of the GP subsector was 23.9% for 2011 followed by Nat Gas Gathers and Processors (14.5%), Ref Prod Pipelines & Terminals (13.3%), Nat Gas Transportation (10.3%), Alerian MLP Index (7.3%), Crude Oil Transportation ( 6.9%) and Upstream (4.4%). The other 4 subsectors were negative with Nat Gas Storage at the tail end with a negative 40.1 percent. I would like to find out the correlation between incentive distribution fees to GP’s and their performance to limited MLP partners. Unfortunately, I don’t have the time and expertise to develop this hypothesis.

Answer: I have not done the kind of correlation study you mention, but the length of time an MLP has been in existence is a key factor. The longer the period, the greater the likelihood that the GP has supassed the trigger points for the higher incentives to kick in. A number of MLPs have merged with their GPs (generating nice profits for the GP’s investors) because the GP’s IDR’s were weighing down the LP returns. In any event, if you are investing out of a retirement account, an investment in an MLP’s GP makes more sense (provided it is structured as a C-Corp.) because there is no UBTI issue. For non retirement accounts, you should look not just at returns but also at the composition of returns (capital appreciation vs. distributions) and at volatility.

 

1/25/12: Williams Pipeline Partners (WPZ)

Question: I’m wondering if yesterday’s announcement of the offering of additional units and today’s >3% drop might change the analysis, especially in light of your observation that “These excess amounts help fund expansion projects (acquisitions & investments), reducing the reliance on issuance of additional debt and equity.”

Answer:  I did a quick look-back and unless I missed something WPZ has not issued additional LP units since 2008. So perhaps they surprised investors. Seems to me they decided to take advantage of the ~30% runup in unit price from last August. In any event, it doesn’t really change the analysis. Although, by definition, the excess reduces reliance on issuance of additional debt or equity, this does not mean the MLP will not tap the markets for additional capital.

 

12/27/11: Energy Transfer Partners (ETP) and Energy Transfer Equity (ETE)

Question: So, you own both ETP and ETE, and you have concerns about the sustainability of the distribution.  Does this mean you are going to sell, hold and watch, or ignore the analysis you just published?

Answer:  My analysis is not meant to produce a buy, hold or sell recommendation. It provides a tool which supplements additional analysis. There are reasons to be positive on ETP, including the expected drop-downs from the acquisition of Southern Union Gas by ETE, the $1.25 billion of investments to expand ETP’s Eagle Ford footprint, the Woodford Shale project, the NGL storage and pipeline assets (Lone Star JV, 70% ETP, 30% RGP) acquired with from LDH, as well as other NGL pipelines that recently have, or shortly will have, commenced operations. I reduced my exposure to ETP and ETE, but remain invested.

 

12/22/11: Risk management activities

Question: I am curious as to why you exclude risk management activities from your analysis of sustainability. There are many MLPs that use hedges for three or so years out as a regular part of their ordinary course operations on a perennial basis. It seems to me that if hedges are a part of normal course operations they should be included in your analysis of sustainability.

Answer: The problem I run into is that risk management activities encompass many kinds of items, including:

  1. Net changes in fair value of derivatives;
  2. Amortization of net losses related to monetization of derivative instruments;
  3. Currency hedges and valuations;
  4. Unrealized gains on non-hedged interest rate derivatives;
  5. Unrealized (gains) losses on commodity risk management activities;
  6. (Gains) losses on non-hedged interest rate derivatives;
  7. Proceeds from termination of interest rate derivatives

For example, gains or losses on non-hedged interest rate derivatives could reflect floating-to-fixed swaps used to hedge interest rates associated with anticipated note issuances. I would not consider this a sustainable item and have not yet developed a methodology for reliably differentiating between the various risk management items. Therefore I exclude the from my analysis at this point. An investor adopting a different approach can easily use my tables to incorporate risk management activities into the definition of sustainable DCF.