Author: Ron Hiram
Published: March 6, 2017
- BPL has substantially underperformed the Alerian MLP index since announcing the VTTI transaction, possibly due to concerns regarding this deal.
- DCF outgrew distributions per unit in 8 of the past 9 quarters; but in 4Q16 DCF per unit decreased due to the VTTI transaction. Special items impacted 4Q16 results.
- In the TTM period ending 12/31/16 BPL funded a small portion its distributions (~$53 million) by issuing debt and limited partnership units.
- Coverage ratios based on reported DCF improved markedly and were above 1x in 2016; coverage based on sustainable DCF in that period was just under 1x
- Distributions are unlikely to increase in 2017, but financial metrics will likely improve; the leverage ratio should come down coverage ratios should improve modestly.
This article analyses some of the key facts and trends revealed by 4Q16 results reported by Buckeye Partners L.P. (BPL), a liquid petroleum products pipeline operator with approximately 6,000 miles of pipeline and a terminal and storage operator with more than 120 liquid petroleum products terminals with aggregate storage capacity of over 115 million barrels.
BPL operates and reports in three business segments:
- Pipelines & Terminals: Transports refined products as well as crude oil, principally in the Northeastern and upper Midwestern states. The refined products include gasoline, jet fuel, diesel fuel, heating oil, kerosene, propane, butane, refinery feedstock and blending components. The pipelines generally operate as a common carrier, providing transportation services at posted tariffs and without long-term contracts. Pipelines and Terminals accounted for ~57% of BPL’s earnings before interest, depreciation & amortization and income tax expenses (EBITDA) in the trailing twelve months (“TTM”) ended 12/31/16.
- Global Marine Terminals: Provides marine accessible bulk storage blending services, rail and truck loading/unloading, and petroleum processing services. The segment includes facilities in the Caribbean (principally the Buckeye Bahamas Hub, one of the largest marine crude oil and petroleum products terminals and storage facilities in the world), in New York Harbor, in Puerto Rico and in St. Lucia. It also includes Buckeye Texas Partners; a joint venture 80% owned by BPL and 20% by Trafigura AG that owns marine terminal facilities in Corpus Christi, Texas, gathering and storage facilities in the Eagle Ford shale formation, and pipelines from the Eagle Ford to Corpus Christi. Global Marine Terminals accounted for ~40% of BPL’s EBITDA in the TTM ended 12/31/16. On January 4, 2017, BPL acquired a 50% interest in VTTI B.V. (“VTTI”) for $1.15 billion in cash. VTTI owns and operates 13 marine terminals with storage capacity of approximately 54 million barrels of refined petroleum products, liquid petroleum gas and crude oil. The terminals are located in key global energy hubs, including Amsterdam, Rotterdam, Antwerp, the United Arab Emirates, Singapore, and Malaysia.
- Merchant Services: Includes the legacy Energy Services segment, the Caribbean fuel oil supply and distribution business and new merchant activities supporting the terminals recently acquired from Hess. Accounted for ~3% of BPL’s EBITDA in the TTM ended 12/31/16.
BPL’s management uses Adjusted EBITDA, a non-GAAP financial metric, to evaluate each business segment’s overall performance and rates of return on proposed projects. Adjusted EBITDA excludes: a) non-cash expenses such as depreciation and amortization; b) unit-based compensation expenses; and c) items that management deems not indicative of core operating performance results and business outlook.
Adjusted EBITDA by segment is presented in Table 1. Losses from natural gas storage operations previously categorized as discontinued operations and disposed of on 12/31/14 are excluded from the table. Also excluded from Adjusted EBIDA is a $40 million reduction in revenue and EBITDA recorded in 4Q14 in the context of a settlement with the Federal Energy Regulatory Commission (FERC) of complaints to FERC by several airlines operating out of airports in the New York area about BPL’s pricing practices.
Table 1: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.
As shown in Table 1, Adjusted EBITDA has been increasing in absolute terms for 9 consecutive quarters vs. the corresponding prior year periods, and for 7 of the 9 recent quarters when the periods are compared on a per unit basis. The per unit decrease in 4Q16 is attributable to a 6.7% increase in the weighted average number of units outstanding due to the 8.9 million units issued to partially fund the acquisition of the 50% equity interest in VTTI.
Performance at the Pipelines and Terminals segment in 4Q16 was essentially unchanged vs. 4Q15. The exercise by a customer in 3Q16 of an early buyout provision of crude-by-rail contract weighed on 4Q16 results, and will continue to do so to the tune of ~$3.75 million per quarter. Compressed butane blending spreads also adversely impacted results in the recent quarter.
Improved performance at the Global Marine Terminals segment in 4Q16 over 4Q15 reflects increased contributions from Buckeye Texas Partners as a result of assets placed in service by this joint venture in 4Q15 (e.g., condensate splitters and refrigerated LPG storage). The segment also benefited from strong customer demand resulting in higher capacity utilization rates and storage rates.
Overall, Adjusted EBITDA in the TTM ended 12/31/16 totaled $1,028 million, up 18.4% on an absolute basis and up 14.6% on a per unit basis vs. the comparable prior year period.
But in 4Q16 management increased Adjusted EBITDA by reversing (i.e., adding back) $16.8 million of expenses related Hurricane Matthew which struck the Bahamas facility in October 2016 and resulted in $11.0 million of additional operating expenses and a $5.8 million write-off due to damaged assets. On the other hand, a $5.3 million gain on sale of an ammonia pipeline is excluded from this quarter’s Adjusted EBITDA.
To derive Distributable Cash Flow (“DCF”), BPL deducts from Adjusted EBITDA cash interest payments, taxes and maintenance capital expenditures. Table 2 shows DCF, distributions and reported coverage ratios:
Table 2: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.
Table 2 shows that DCF per unit has been increasing at a faster pace than distributions per unit in 8 of the past 9 quarters. The most recent quarter is the exception, mostly due to the 8.9 million units issued to partially fund the acquisition of the 50% equity interest in VTTI.
In addition to the Hurricane Matthew EBITDA adjustments previously noted, management also increased DCF by reversing (i.e., adding back) $6 million of maintenance capital expenditures associated with the hurricane.
DCF is one of the primary measures typically used by a midstream energy master limited partnership (“MLP”) to evaluate its operating results. Because there is no standard definition of DCF, each MLP can derive this metric as it sees fit; and because the definitions used vary considerably, it is exceedingly difficult to compare across entities using this metric. Additionally, because the DCF definitions are usually complex, and because some of the items they typically include are non-sustainable, it is important (albeit quite difficult) to qualitatively assess DCF numbers reported by MLPs.
Reported DCF may differ from sustainable DCF for a variety of reasons. These are reviewed in an article titled “Estimating sustainable DCF-why and how”. Applying the method described there to BPL’s results generates the following comparison between reported and sustainable DCF:
Table 3: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
The variance between reported and sustainable DCF results, in part, from differing treatments of working capital cash flows. DCF numbers reported by BPL ignores all such cash flows, while my sustainable DCF calculation deducts cash used for working capital because cash consumed is not available to be distributed. However, despite the apparent contradiction in the methodology, I ignore cash generated by liquidating working capital because I do not consider it a sustainable source. Over reasonably lengthy measurement periods, working capital is typically not a huge consumer of funds for MLPs.
The variance between reported and sustainable DCF also results from risk management activities. These reflect fluctuations in the value of derivatives used to hedge exposure to commodity prices and interest rates. On a quarter-to-quarter basis, BPL’s results can be significantly impacted by these fluctuations. On a TTM basis the impact is typically more muted. Some of the gains and losses related to these cash flows are not reflected in BPL’s statement of operations. Rather, they increase or reduce total equity through the statement of comprehensive income. I do not take these into account when calculating sustainable DCF.
BPL’s business is seasonal. The second and third calendar quarters typically generate lower coverage ratios. Stronger performance is typical of the first and fourth calendar quarters due to the seasonal rebound in heating oil margins and butane blending opportunities. It therefore makes sense to focus more on TTM coverage ratios because the seasonal fluctuations are neutralized:
Table 4: Figures in $ Millions (except Coverage Ratios). Source: company 10-Q, 10-K, 8-K filings and author estimates.
Coverage ratios based on reported DCF improved markedly and were above 1x in the latest TTM period. Coverage based on sustainable DCF in that period is just under 1x in the TTM period ending 12/31/16. BPL funded a small portion its distributions (~$53 million) by issuing debt and limited partnership units. The simplified cash flow statement in Table 5 shows this:
Table 5: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
BPL held ~$640 million in cash and cash equivalents as of the end of the year in anticipation of closing on the VTTI transaction.
Since announcing this transaction, BPL has substantially underperformed the Alerian MLP index (-4.0% vs. +5.3% from October 24, 2016, through March 6, 2017). Concerns surrounding this deal include price (over 10x EBITDA), lack of synergies (because VTTI will continue to operate as a standalone entity), foreign currency exposure (principally to the euro), operations in areas unfamiliar to BPL, and geopolitical exposure. In addition, the structure is complicated. BPL will be fairly far removed from the operating assets. It will be involved at a board level, but not in the day-to-day management. BPL will include its portion of the EBITDA and DCF generated by the VTTI terminals (i.e., the equity method of accounting) and anticipates the transaction to be immediately accretive. But the actual amount of cash that will flow to BPL from VTTI may differ substantially from BPL’s portion of the DCF. In my view, this compromises the quality of the reported DCF number. The current quarter (1Q17) will provide a first glimpse of the order of magnitude of the delta.
Distributions have been increasing at the modest rate of $0.0125 per quarter since 1Q13. In the conference call discussing 4Q16 results, management indicated distributions will not increase in the near term: “we expect to grow our quarterly distribution by $0.0125 throughout 2017”. It also indicated that in 2017 it expects to see “significant year-over-year financial improvement”. This will be driven partly contributions from VTTI, absence (hopefully) of hurricane-related losses, and continued investments in organic growth capital projects (between $280 million to $330 million) per annum. I expect the leverage ratio (total debt to adjusted EBITDA) to come down from its 4.1x level as of 12/31/16 and a modest improvement in coverage ratios.
Investors wishing to broaden their exposure to midstream energy MLPs, or replace one MLP investment with another that exhibits better operational results, better prospects and lower leverage, should consider BPL.