Published: May 24, 2012
In a report dated March 19, 2012, I noted that Williams Partners, L.P. (WPZ) expects capital expenditures to total ~$2.9 billion in 2012 but that a large acquisition could dwarf these numbers, and that Williams Companies, Inc. (WMB), which holds ~ 69% of WPZ limited partnership interests and the 2% general partner interest, has been on the prowl for acquisitions as indicated by its ~$5.5 billion bid for Southern Union Gas (SUG) which was rejected in favor of a competing bid by Energy Transfer Equity, Inc. (ETE), the general partner of Energy Transfer Partners, L.P. (ETP). The following day (March 20), WPZ announced the Caiman acquisition, upping its estimate of 2012 capital expenditures by $3 billion to $6 billion. The price per unit immediately dropped from $61 to $56 on investor concerns regarding dilution. WPZ closed at $53.63 on 5/23/12 and currently yields 5.73%. To evaluate whether to increase or initiate an investment in WPZ, I will briefly review results of the most recent quarter, look at how sustainable are the distributions and address the dilution concerns.
Revenues in 1Q 2012 decreased 6.7% vs. the prior quarter and were up 6,7% vs. 1Q 2011 (by comparison, revenues in 1Q 2011 increased 5.4% vs. 4Q 2010 and were up 6% over 1Q 2010). Earnings before interest expense, depreciation & amortization and income taxes (EBITDA) met 1Q 2012 consensus estimates. They decreased 5.4% vs. the prior quarter and were up 8.5% over the prior year period. The Partnership’s first-quarter operating results were not impacted by the $2.5 billion Caiman Midstream Eastern acquisition announced March 20 which will significantly enlarge WPZ’s footprint in the Marcellus shale.
For the purpose of analyzing changes in reported and sustainable distributable cash flows, it makes sense to review trailing 12 months (“TTM”) numbers rather than quarterly numbers given quarterly fluctuations in revenues, working capital needs and other items. For example, due to the unusually mild weather in 1Q 2012, WPZ was able to schedule more of its maintenance work in that period and consequently its spending doubled vs. the prior year period, but this is not at all indicative of what WPZ’s maintenance capital expenditures on a full year basis.
The definition of DCF used by WPZ is described in an article titled Distributable Cash Flow (“DCF”). That article also provides, for comparison purposes, definitions used by other master limited partnerships. Using WPZ’s definition, DCF for the TTM period ending 3/31/12 was $1,684 million ($5.76 per unit), up from $1,332 million ($4.90 per unit) in the TTM period ending 3/31/11.
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 WPZ results through March 31, 2012 generates the comparison outlined in the table below:
12 months ending:
|Net cash provided by operating activities||2,168||1,731|
|Less: Maintenance capital expenditures||-441||-303|
|Less: Working capital (generated)||-132||-67|
|Less: Net income attributable to noncontrolling interests||-||-10|
|Add: Net income attributable to noncontrolling interests||-||10|
|DCF as reported||1,684||1,332|
Table 1: Figures in $ Millions
The gap between reported DCF and sustainable DCF for both TTM periods relates mostly to adjustments for earnings from unconsolidated subsidiaries and, in any event, does not seem to be material. Coverage ratios are indicated in the table below:
12 months ending:
|Distributions (to LPs and GP; $ Millions)||1,167||894|
|Weighted average units outstanding (millions)||293||272|
|Reported DCF per unit||$5.76||$4.90|
|Sustainable DCF per unit (ex $204m in 2010)||$5.45||$4.97|
|Coverage ratio based on reported DCF||1.44||1.8|
|Coverage ratio based on sustainable DCF||1.37||1.82|
Distributions actually made (vs. declared) averaged approximately $0.75 per unit for the TTM ending 3/31/12, so the $0.7775 distribution declared for 1Q12 should not significantly reduce the strong coverage ratios. What is more likely to lower distribution coverage is the rapid growth in the number of units outstanding as a result of issuing equity to partially finance large acquisitions. Before examining this further, it will be helpful to look at a simplified cash flow statement by netting certain items (e.g., acquisitions against dispositions) and by separating cash generation from cash consumption.
Here is what I see for WPZ:
Simplified Sources and Uses of Funds
12 months ending:
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||-628||-520|
|Acquisitions, investments (net of sale proceeds)||-847||-1,377|
|Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions||560||687|
|Cash contributions/distributions related to affiliates & noncontrolling interests||56||16|
|Debt incurred (repaid)||396||478|
|Partnership units issued||490||806|
|Other CF from investing activities, net||2||1|
|Other CF from financing activities, net||2||13|
|Net change in cash||31||104|
Table 3: Figures in $ Millions
In both TTM periods, net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests, more than covered distributions. The excess was $560 million for the TTM ending 3/31/12 and $687 million for the TTM ending 3/31/11. These excess amounts help fund expansion projects (acquisitions & investments), reducing the reliance on issuance of additional debt and equity.
So far in 2012, WPZ has issued or announced issuance of units as follows:
- A public offering of 8.05 million units priced at $62.81 per unit was completed on January 25, 2012, raising ~$505 million;
- A public offering of 7.5 million of units priced at $59.75 was completed on February 17, 2012, raising ~$465 million in connection with the, $750 million, Delphi Midstream Partners acquisition ($325 million was paid in cash);
- A public offering of 11.5 million units priced at $54.56 was completed on April 4, 2012, raising ~ $627 million;
- WPZ will issue 11.8 million units in connection with the non-cash portion of the Caiman acquisition (there will be a 1.5 year lockup on these units)
- WPZ needs to raise $1.78 billion for the cash portion of the Caiman acquisition. Of that amount, ~18.5 million units (assuming $54 per unit) worth $1 billion will be issued to WMB and $780 million will be debt financed.
The number of units outstanding as of 4/23/12 is ~316 million. By my calculation it will increase by ~42 million following consummation of the Caiman transaction. On the balance sheet, equity will increase by ~$2.2 billion and debt will increase by ~$3 billion ($2.25 billion of capital expenditures unrelated to Caiman and $780 million for the cash portion of Caiman). From a total leverage perspective, WPZ’s balance sheet can absorb this (long term debt was only 2.95x EBITDA as of 3/31/12). From a dilution perspective, Tables 1and 3 indicate there should not be a problem. Table 3 shows that for the TTM ending 3/31/12 WPZ generated $560 million excess net cash from operations (i.e., after maintenance capital expenditures and after paying distributions). We need to reduce that by $132 million which is the non-sustainable portion of that amount generated by reducing working capital, as shown in Table 1. This leaves an excess of ~$430 million which can easily cover the ~$310 million of additional outflows ($130 million per annum of additional distributions from issuing 42 million units and $180 million of interest on $3 billion in debt, assuming a 6% interest rate).
Of course, we must now add the contribution to cash flow expected from Caiman amounting to $200 million in 2013 and $400 million by 2014. Therefore, management’s assertion that it can grow distributions by 8%-10% in the next 2 years seems reasonable to me, even after taking the general partner’s incentive distribution rights into consideration. I am considering adding to my WPZ position on pullbacks such as the one that we are currently seeing.