In 1Q 2012, Boardwalk Pipeline Partners, LP (BWP) increased its revenues 5.4% vs. the prior quarter and 0.6% vs. 1Q 2011 (by comparison, revenues in 1Q 2011 increased 3% vs. 4Q 2010 and were up 3.5% over 1Q 2010). Earnings before interest expense, depreciation & amortization and income taxes (EBITDA) increased 15.6% in 1Q 2012 vs. the prior quarter, were up 5.4% over the prior year and were in line with consensus estimates for the quarter. BWP’s definition of Distributable Cash Flow (“DCF”) and a comparison to definitions used by other master limited partnerships (“MLPs”) are described in a prior article. Using that definition, DCF for the trailing 12 months (“TTM”) period ending 3/31/12 was $407 million ($2.31 per unit), down from $437 million in the comparable prior year period ($2.58 per unit).
As always, I first attempt to assess how these DCF figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.
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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 1Q 2012 generates the comparison outlined in the table below:
|12 months ending:||3/31/12||3/31/11|
|Net cash provided by operating activities||468||463|
|Less: Maintenance capital expenditures||(99)||(76)|
|Working capital used||37||48|
|Proceeds from sale of assets / disposal of liabilities||(2)||(1)|
|DCF as reported||407||437|
Table 1: Figures in $ Millions
The principal differences between reported and sustainable DCF in Table 1 is attributable to working capital used. I generally do not include working capital generated in the definition of sustainable DCF but I do deduct working capital used. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the MLP should generate enough capital to cover normal working capital needs. On the other hand, cash generated by the MLP through the liquidation or reduction of 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 used to net cash provided by operating activities in deriving sustainable DCF.
Coverage ratios for 1Q 2012 are indicated in the table below:
|12 months ending:||3/31/12||3/31/11|
|Distributions ($ Millions)||432||403|
|Weighted average units outstanding (millions)||177||170|
|reported DCF per unit ($)||2.31||2.58|
|Sustainable DCF per unit ($)||2.09||2.28|
|Coverage ratio based on reported DCF||0.94||1.09|
|Coverage ratio based on sustainable DCF||0.85||0.96|
These are thin coverage ratios. However, on June 1, 2012, BWP’s distribution yield was ~8.26 % (up from ~7.7% as of my March 14 article ), significantly higher than yields offered as of the same date by some of the other MLPs I have covered. For example: 4.95% for Magellan Midstream Partners (MMP); 5.28% for Enterprise Products Partners (EPD); 5.44% for Plains All American Pipeline (PAA); 5.99% for Williams Partners (WPZ); 6.32% for El Paso Pipeline Partners (EPB); and 6.55% for Targa Resources Partners (NGLS).
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:||3/31/12||3/31/11|
|Net cash from operations, less maintenance capex, less distributions||(63)||(16)|
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||(6)||(100)|
|Acquisitions, investments (net of sale proceeds)||(554)||-|
|Cash contributions/distributions related to affiliates||-||(4)|
|Debt incurred (repaid)||(124)||-|
|Cash contributions/distributions related to affiliates||9||-|
|Debt incurred (repaid)||-||30|
|Partnership units issued||697||-|
|Other CF from investing activities, net||10||-|
|Other CF from financing activities, net||3||-|
|Net change in cash||(28)||(89)|
Table 3: Figures in $ Millions
Net cash from operations less maintenance capital expenditures did not cover distributions in both TTM periods (the shortfall increased to $63 million in the TTM ending 3/31/12 from $16 million in the prior year period). Table 3 therefore shows that distributions in both TTM periods were partially financed by issuing equity and debt. The $63 million shortfall in the TTM ending 3/31/12 can be attributed principally to the fact that a $14 million increase in revenues in that period was accompanied by a $61 million increase in operating costs (of which depreciation accounted for only ~$12 million). The ~$49 million increase in non-depreciation related operating costs can be attributed principally to general operations and maintenance expenses (up $15.3 million) and asset impairment charges (up $28.9 million).
Note that ~ $282 million of the $554 million of equity issuance in the TTM ended 3/31/12 is an adjustment to partners’ capital. In February 2012 BWP acquired from Loews Corporation (L), the parent of BWP’s general partner, the remaining 80% equity interest in Boardwalk HP Storage Company, LLC for $285 million. This drop-down acquisition was accounted for as a transaction between entities under common control. Therefore, the assets and liabilities of HP Storage were recognized at their carrying amounts at the date of transfer and $281.8 million (the carrying amount of the net assets acquired) was treated as an adjustment to partners’ capital. Also, BWP includes HP Storage’s results for the entire quarter, as if the acquisition had occurred on 1/1/2012. Boardwalk HP Storage operates seven high deliverability salt dome natural gas storage caverns in Forrest County, Mississippi, having approximately 29 billion cubic feet (“Bcf”) of total storage capacity, of which approximately 19 Bcf is working gas capacity. It also owns undeveloped land suitable for up to six additional storage caverns, one of which is expected to be placed in service in 2013 at an incremental cost of ~$35 million
I remain concerned about BWP leverage. The partnership is required to maintain a ratio of consolidated debt to EBITDA of no more than 5:1. Excluding the $100 million of affiliated debt, BWP’s total long-term debt stood at $3.4 billion as of 3/31/12. This equates to a multiple of 5.48x EBITDA for the TTM ending 3/31/12. Granted, EBITDA may be defined somewhat differently in the credit agreement (otherwise I do not see how management could have explicitly stated that BWP was in full compliance as of 3/31/12), but this level of debt will constrain BWP’s ability to finance the remaining 2012 capital expenditures, so I would not be surprised to see additional partnership units being issued later this year. Unless results from operations improve significantly, coverage ratios in 2012 may further deteriorate.
Given that distributions have recently been funded, in part, by issuing equity and debt, that coverage ratios are thin, that operating margins have declined, and that leverage is high, I think investors willing to add to their positions on pullbacks such as the one that we are currently seeing should consider other MLPs.