Given that BWP’s current unit price provides a yield of ~7.7%, at the very top end of the large capitalization pipeline MLPs, that the unit price is down ~21% from its 52-week high, and reports in the financial press regarding recent purchases by insiders, an evaluation of the potential risks and rewards of buying BWP should include a review of its cash flows and the sustainability of its distributions.
In an article titled Distributable Cash Flow (“DCF”) I present the definition of DCF used by Boardwalk Pipeline Partners, LP (BWP) and provide a comparison to definitions used by other master limited partnerships. Using BWP’s definition, DCF for the 12 month period ending 12/31/11 was $391 million ($2.26 per unit), down from $454 million in 2010 ($2.68 per unit). As always, I first attempt to assess how these figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units.
The generic reasons why DCF as reported by the MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to BWP results through December 31, 2011 generates the comparison outlined in the table below:
12 months ending:
|Net cash provided by operating activities||453.4||464.7|
|Less: Maintenance capital expenditures||-94.6||-63|
|Less: Working capital (generated)||-||-|
|Working capital used||47.2||39.9|
|Proceeds from sale of assets / disposal of liabilities||1.3||-|
|DCF as reported||390.9||454.3|
Figures in $ Millions
The principal differences vs. the $390.1 million and $454.3 million reported DCF numbers in 2011 and 2010, respectively, are attributable to working capital consumed and other items. As detailed in my prior articles, I generally do not include working capital generated in the definition of sustainable DCF but I do deduct working capital invested. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the master limited partnerships should, on the one hand, generate enough capital to cover normal working capital needs. On the other hand, cash generated from working capital is not a sustainable source and I therefore ignore it. Over reasonably lengthy measurement periods, working capital generated tends to be offset by needs to invest in working capital. I therefore do not add working capital consumed to net cash provided by operating activities in deriving sustainable DCF.
The “other” category includes a variety of items (e.g., asset impairments, cash received for settlements, loss on debt extinguishment adjustments, etc.) that I ignore in calculating sustainable DCF.
Coverage ratios for 2011 are indicated in the table below:
12 months ending:
|Distributions ($ Millions)||419.9||398.1|
|reported DCF per unit||$2.26||$2.68|
|Sustainable DCF per unit||$2.07||$2.37|
|Coverage ratio based on reported DCF||0.93||1.14|
|Coverage ratio based on sustainable DCF||0.85||1.01|
These are thin coverage ratios. However, BWP’s ~7.7% distribution yield is significantly higher than the average of ~5.3% for large capitalization master limited partnerships. For illustration purposes, if we assume 0% per annum growth in BWP distributions per unit, it would take ~6 years for the average large cap MLP growing its per unit distributions at 6% per annum to achieve the same level, never mind catching up on the excess amounts distributed by BWP in the intervening period. Outlined below are several factors to consider when evaluating the risks against the potential reward.
First, the simplified cash flow statement in the table below amplifies the concerns raised by the weak coverage ratios noted above. The table nets certain items (e.g., debt incurred vs. repaid), separates cash generation from cash consumption, and gives a clear picture of how distributions have been funded in the last two years.
Simplified Sources and Uses of Funds
12 months ending:
|Net cash from operations, less maintenance capex, less distributions||-61.1||-|
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||-15.6||-133.4|
|Acquisitions, investments (net of sale proceeds)||-71.2||-|
|Debt incurred (repaid)||-78.4||-|
|Other CF from financing activities, net||-||-10.7|
|Net cash from operations, less maintenance capex, less distributions||-||3.6|
|Cash contributions/distributions related to affiliates||3.6||-|
|Debt incurred (repaid)||-||149.7|
|Partnership units issued||170||-|
|Other CF from investing activities, net||9.6||-|
|Net change in cash||-43.1||9.2|
Figures in $ Millions
While net cash from operations less maintenance capital expenditures just covered distributions in 2010 (excess was $3.6 million), there was a $61.1 million shortfall in 2011, mostly because the $22 million increase in revenue in 2011 was accompanied by a $69 million increase in operating costs. The decrease in BWP’s 2011 operating profitability is attributed by management to asset impairment charges (~$29 million), higher maintenance expenses (~$18 million) and other factors including changes in pricing dynamics and weakening of basis spreads (especially with regard to short-term and interruptible services, as distinguished from revenues derived from capacity reservation charges). The end result is that a significant portion of the 2011 distribution was financed by the $170 million generated via the issuance of additional partnership units in 2Q11 (for a further drill-down that reviews the breakdown by quarter of the 2011numbers in this report, click here).
Another factor to consider relates to potential dilution. BWP spent relatively modest amounts on growth projects during 2011 and 2010 (~$46.6 million and a $160.7 million, respectively). In February 2012 BWP acquired, via a $285 million drop-down transaction from Loews Corporation, the parent of BWP’s general partner, the remaining 80% equity interest in Boardwalk HP Storage Company, LLC. Other significant investments expected in 2012 include the South Texas Eagle Ford Expansion ($173 million on the constructing a gathering pipeline and a cryogenic processing plant in south Texas), and the Marcellus Gathering System ($70 million on the construction of a gathering pipeline in Pennsylvania).
BWP is required to maintain a ratio of consolidated debt to EBITDA of no more than five to one. Assuming the $100 million of affiliated debt is excluded, BWP ended 2011 with $3.1 billion of debt against EBITDA of $618 million, so it seems to me BWP may be constrained in its ability to finance the ~$530 million of 2012 capital expenditures by increasing leverage. However, management explicitly states it does not believe this covenant will have a material impact on BWP’s financing abilities, so perhaps I am missing something. In any event, BWP raised $250 million in February 2012 by issuing 9.2 million common units at a price of $27.55 per unit (less than the $29.33 per unit received in June 2011) and I would not be surprised if additional partnership units will be issued later this year. Unless results from operations improve significantly, coverage ratios in 2012 may further deteriorate.
Finally, there was a report in the financial press in early March of purchases by BWP’s CEO, usually a positive indicator. But it seems to me the recent purchase reported was for just 500 units, prior to which the total of common units beneficially owned (i.e., excluding stock options, stock awards, unit appreciation rights, etc.) was also very small (1,000 units). Also note that these units are owned by the CEO’s spouse.