On August 6, 2012, Targa Resources Partners LP (NGLS) reported results of operations for 2Q 2012. Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) were as follows:
|Weighted average units outstanding (million)||89||85||89||84|
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Table 1: Figures in $ Millions, except units outstanding
In 2Q 2012, lower operating income resulted from decreases in gross margins and increases in operating expenses. The increase in operating expenses primarily reflects increased compensation and benefits and contractor costs related to expanded business operations and acquisitions.
Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review trailing 12 months (“TTM”) numbers rather than 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 trailing twelve month (“TTM”) period ending 6/30/12 was $363 million ($4.18 per unit) vs. $295 million in the comparable prior year period ($4.30 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 6/30/12 generates the comparison outlined in the table below:
|12 months ending:||6/30/12||6/30/11|
|Net cash provided by operating activities||449||349|
|Net cash provided by operating activities||373||445|
|Less: Maintenance capital expenditures||(81)||(68)|
|Less: Working capital (generated)||-||(45)|
|Less: Net income attributable to noncontrolling interests||(40)||(32)|
|Working capital used||83||-|
|Risk management activities||24||(4)|
|DCF as reported||363||295|
Table 2: Figures in $ Millions
The principal differences of between sustainable and reported DCF numbers in the two TTM periods are attributable to working capital consumed and risk management activities. 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.
Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:
|12 months ending:||6/30/12||6/30/11|
|Distributions ($ millions)||252||195|
|DCF as reported ($ millions)||363||295|
|Sustainable DCF ($ millions)||252||301|
|Coverage ratio based on reported DCF||1.44||1.51|
|Coverage ratio based on sustainable DCF (including risk management)||1.09||1.52|
|Coverage ratio based on sustainable DCF||1.00||1.54|
Coverage ratios have declined sharply and, on 6/25/12, NGLS announced that due to lower commodity prices it revised its expected distribution coverage for 2012 and 2013 to 1.00, assuming $2.50 per MMBtu for natural gas, $80 per barrel for crude oil and $0.75 per gallon for natural gas liquids (“NGLs”). The projection also assumes distribution growth for 2012 and beyond. Management’s assessment that it will increase 2012 distributions by 10%-15% over 2011 while maintaining a coverage ratio of at least 1.0 confirms the view I expressed in a prior article dated 4/9/12 that a 10+% growth in distributions in 2012 is sustainable even absent EBITDA growth.
Note that NGLS’s coverage figures in Table 3 are calculated based on distributions actually made during the relevant period, so the coverage ratios do not incorporate the ~3.2% distribution increase announced by NGLS for 2Q12 and are therefore somewhat overstated.
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
|12 months ending:||6/30/12||6/30/11|
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||(350.1)||(159.1)|
|Acquisitions, investments (net of sale proceeds)||(156.4)||(35.2)|
|Cash contributions/distributions related to affiliates & noncontrolling interests||(24.3)||(72.4)|
|Debt incurred (repaid)||-||(389.4)|
|Other CF from investing activities, net||(0.3)||(1.1)|
|Other CF from financing activities, net||(4.4)||(26.4)|
|Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions||39.7||182.5|
|Cash contributions/distributions related to affiliates & noncontrolling interests||-||-|
|Debt incurred (repaid)||342.0||-|
|Partnership units issued||168.2||479.4|
|Other CF from investing activities, net||1.3||1.7|
|Other CF from financing activities, net||0.7||6.8|
|Net change in cash||16.4||(13.2)|
Table 4: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $40 million in the TTM ended 6/30/12 and by $183 million in the prior year period. NGLS is, thus far, not using cash raised from issuance of debt and equity to fund distributions.
NGLS spent $408 million on acquisitions and growth projects in 2011 and expects to spend ~$650 million in 2012. The three major capital projects extending through 2013 are:
- The $360 million Cedar Bayou Fractionator expansion project at Mont Belvieu (adding a fourth fractionation train and related infrastructure enhancements);
- The $250 million expansion of the Mont Belvieu complex and the existing import/export marine terminal at Galena Park to export international grade propane; and
- The $150 million North Texas Longhorn project for a new cryogenic processing plant with associated projects.
On January 23, 2012, NGLS completed a public offering of 4 million units at a price of $38.30, raising approximately $150 million. The numbers indicate additional offerings (equity and/or debt) will be required during 2012 even absent a major business acquisition. However, NGLS has kept leverage very low with long term debt ~2.7x EBITDA for the TTM ending 6/30/12. If management were to increase borrowings to the mid-point of its target multiple of 3-4x EBITDA, I estimate it could raise $500 million and perhaps avoid diluting the limited partners.
NGLS’ current yield of 6.50% (as of 8/10/12) compares favorably with many of the MLPs I cover. For example: 4.78% for Magellan Midstream Partners (MMP); 4.81% for Enterprise Products Partners (EPD); 4.99% for Plains All American Pipeline (PAA); 6.01% for Kinder Morgan Energy Partners (KMP); 6.19% for Williams Partners (WPZ); 6.46% for El Paso Pipeline Partners (EPB). I prefer it so some of the higher yielding partnerships such as Buckeye Partners (BPL) (7.75%); Boardwalk Pipeline Partners (BWP) (7.85%); and Energy Transfer Partners (ETP) (8.05%). In my reports dealing with those higher yielding partnerships I highlighted my specific concerns with each. Compared to them I believe NGLS is a better choice and offers a more compelling risk-reward tradeoff.