Author: Ron Hiram
Published: November 23, 2012
On November 1, 2012, Targa Resources Partners LP (NGLS) reported results of operations for 3Q 2012. . Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for 3Q 2012 and for the trailing 12 months (“TTM”) are summarized in Table 1:
|Weighted average units outstanding (million)||89.3||84.8||87.9||81.9|
Table 1: Figures in $ Millions, except units outstanding
NGLS’ revenues are principally derived from percent-of-proceeds (“POP”) contracts under which it receives a portion of the natural gas and/or natural gas liquids as payment for its gathering and processing services. POP contracts share price risk between the producer and processor. Operating income generally increases as natural gas prices and natural gas liquid prices increase, and decreases as they decrease. Regarding Adjusted EBITDA, note that Hurricane Isaac reduced it by approximately $8 million in 3Q12.
The breakdown of revenues between those generated by commodity sales and those by fee revenues is summarized in Table 2:
|Sales of commodities|
|Natural gas sales||252||305||918||1,089|
|Fees from midstream services|
|Fractionating and treating fees||29||26||111||75|
|Storage, terminaling, transportation , export fees||42||28||141||83|
|Gas processing fees||12||8||40||32|
Table 2: Figures in $ Millions
Fees from midstream services increased substantially in the TTM ending 9/30/12 and helped generate an increase in operating income compared to the prior year period.
Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to also review TTM numbers rather than just quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows. In an article titled Distributable Cash Flow (“DCF”) I present the definition of DCF used by NGLS and provide a comparison to definitions used by other master limited partnerships (“MLPs”). Using NGLS’ definition, DCF for the TTM period ending 9/30/12 was $375 million ($4.27 per unit) vs. $303 million in the comparable prior year period ($4.18 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 an MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to NGLS’ results through 9/30/12 generates the comparison outlined in Table 3 below:
|Net cash provided by operating activities||91||-61||525||324|
|Less: Maintenance capital expenditures||-16||-25||-73||-80|
|Less: Working capital (generated)||-38||-|
|Less: Net income attributable to non-controlling interests||-4||-9||-35||-37|
|Working capital used||10||132||-||69|
|Risk management activities||21||3||21|
|Proceeds from sale of assets / disposal of liabilities||-1||0|
|DCF as reported||77||65||375||303|
Table 3: Figures in $ Millions
There are no material differences between reported and sustainable DCF for the TTM ending 9/30/12. The principal differences between sustainable and reported DCF numbers are in the TTM period ending 9/30/11 are attributable to working capital consumed and risk management activities.
Under NGLS’ definition, reported DCF always excludes working capital changes, whether positive or negative. My definition of sustainable DCF only excludes working capital generated (I deduct working capital consumed). 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.
Risk management activities present a more complex issue. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. The NGLS risk management activities seem to be directly related to such hedging, so I could go both ways on this but, in any event, the amounts involved for the periods under review do not materially change the coverage ratios.
Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:
|Distribution per unit||0.6625||0.5825||2.53||2.29|
|Distributions made ($ millions)||73||57||268||212|
|DCF as reported ($ millions)||77||65||375||303|
|Sustainable DCF ($ millions)||70||-95||379||207|
|Coverage ratio based on reported DCF||1.05||1.14||1.4||1.43|
|Coverage ratio based on sustainable DCF||0.96||Negative||1.41||0.98|
Table 4: Figures in $ Millions, except per unit amounts and coverage ratios
While on a TTM basis coverage ratios look robust, on 6/25/12, NGLS announced that due to lower commodity prices it revised its expected distribution coverage for 2012 and 2013 down to 1.00x, assuming $2.50 per MMBtu for natural gas, $80 per barrel for crude oil and $0.75 per gallon for natural gas liquids. The projection also assumes distribution growth for 2012 and beyond. Management’s assessment is that it will increase 2012 distributions by 10%-15% over 2011 while maintaining a coverage ratio of at least 1.0x.
I find it helpful to look at a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded in the last two years. Here is what I see for NGLS:
Simplified Sources and Uses of Funds
|Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions||-||-143||-||-|
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||-110||-51||-409||-186|
|Acquisitions, investments (net of sale proceeds)||-29||-141||-44||-176|
|Cash contributions/distributions related to affiliates & non-controlling interests||-4||-5||-23||-41|
|Other CF from investing activities, net||-||0||-||-1|
|Other CF from financing activities, net||-1||-||-5||-6|
|Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions||1||-||184||32|
|Debt incurred (repaid)||140||337||145||82|
|Partnership units issued||0||-||168||304|
|Other CF from investing activities, net||3||-||4||1|
|Other CF from financing activities, net||-||-||1||7|
|Net change in cash||-1||-4||20||14|
Table 5: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $184 million in the TTM ended 9/30/12 and by $32 million in the prior year period. However, 4Q11 accounts for $126 million of the $184 million excess in the TTM ended 9/30/12, and 1Q12 accounts for the balance. There was small shortfall in 2Q12 and zero excess in 3Q12. Nevertheless, during these two TTM periods NGLS did no use cash raised from issuance of debt and equity to fund distributions.
NGLS spent $408 million on acquisitions and growth projects in 2011 and estimated it would spend ~$600 million in 2012 (of which ~$352 million was spent through 3Q12). This estimate became outdated upon the November 15, 2012, announcement of the $950 million acquisition of the Williston Basin crude oil pipeline and terminal system and natural gas gathering and processing operations (“Williston Acquisition”) from Saddle Butte Pipeline LLC. The unit price dropped from $39 to $36.18 following this announcement.
NGLS has kept leverage very low with long term debt (net of cash) at ~2.8x EBITDA for the TTM ending 9/30/12. On October 25, 2012, NGLS privately placed $400 million of 5.25% Notes at 99.5% of par value, raising ~$394 million of net proceeds of which ~$218 million will be used to redeem notes bearing interest at 8.25%. This should save ~$6.5 million per year. The remaining amount, post the note redemption, totals ~$176 million.
Concurrently with the Williston Acquisition announcement, NGLS issued 9.5 million units at $36 per unit. Together with the underwriters’ overallotment option of 1.425 million units, I estimate this offering should generate net proceeds of ~$385 million and assume that NGLS will finance the remaining ~$565 million needed for this acquisition by issuing additional debt (of which ~$176 million is available from the October 25 note offering post the note redemption, and a further ~$389 million is yet to be raised).
It appears to me that NGLS is making this purchase at an expensive EBITDA multiple of ~13.5x (NGLS itself traded at ~9.5x Adjusted EBITDA the day prior to the announcement). This assumes, of course, the Williston assets being purchased do not include cash (or that the amount of cash is insignificant). As I calculate it, given the Incentive Distribution Rights (“IDRs”) held by Targa Resources Corp. (TRGP), the general partner of NGLS, $0.8723 of incremental cash flow per unit per quarter is required to maintain the current quarterly distribution rate $0.6625. However, management guiding to 10%-12% distribution growth (I estimate the numbers to be $2.61 for 2012 and $2.93 for 2013). At this level, I calculate $1.0069 of incremental cash flow per unit per quarter is required and that the 10.925 million additional units will therefore require ~$44 million of additional cash. The ~$565 million of additional debt will require $30 million, for a total of ~$74 million by my rough calculation. It seems that management expects the Williston Acquisition to generate approximately cash roughly equal to that total, because the 2013 estimate of Adjustable EBITDA was increased by ~$70 million (a 10%-15% increase from the $555 million midpoint of the prior estimate) to reflect the acquisition.
Table 6 below compares NGLS’ current yield of some of the other MLPs I follow:
|As of 11/22/12:||Price||Distribution||Yield|
|Magellan Midstream Partners (MMP)||$43.30||$0.49||4.48%|
|Plains All American Pipeline (PAA)||$46.24||$0.54||4.69%|
|Enterprise Products Partners L.P. (EPD)||$51.69||$0.65||5.03%|
|Kinder Morgan Energy Partners (KMP)||$81.09||$1.26||6.22%|
|El Paso Pipeline Partners (EPB)||$36.49||$0.58||6.36%|
|Williams Partners (WPZ)||$50.47||$0.81||6.40%|
|Targa Resources Partners (NGLS)||$36.60||$0.66||7.24%|
|Regency Energy Partners (RGP)||$22.31||$0.46||8.25%|
|Boardwalk Pipeline Partners (BWP)||$25.68||$0.53||8.29%|
|Energy Transfer Partners (ETP)||$42.82||$0.89||8.35%|
|Buckeye Partners (BPL)||$49.13||$1.04||8.45%|
|Suburban Propane Partners (SPH)||$39.20||$0.85||8.70%|
Given my concerns regarding the recent acquisition, the low coverage ratio, the high cost of the IDRs and the still significant exposure to commodity prices I am not purchasing NGLS at these levels.