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Ron Hiram, Wise Analysis (216 clicks)
Research analyst, dividend investing, oil & gas, mid-cap
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On Nov. 2, 2012, Buckeye Partners L.P. (BPL) reported results of operations for Q3 2012. Revenues, operating income, net income and earnings before interest, depreciation and amortization and income tax expenses (EBITDA) for Q3 2012 and for the trailing 12 months (TTM) are summarized in Table 1:

Click to enlarge images.

Table 1: Figures in $ millions, except units outstanding.

The decrease in Q312 revenues vs. the prior-year period is primarily attributable to a 21.5% decline in sales volume for the Energy Services segment. That was partially offset by an increase in revenues in the Pipelines and Terminals segment and from incremental capacity coming online, combined with higher ancillary revenues, in the International Operations segment.

The favorable comparison of operating income and net income numbers for Q3 2012 and the TTM ended Sept. 30, 2012, primarily as a result from a $170 million goodwill impairment charge for the Lodi acquisition in Q3 2011 and a $21 million equity plan modification expense in Q4 2010. But even absent these writeoffs, Q3 2012 and the TTM ended Sept. 30, 2012, show an improvement in operating income over the corresponding prior year periods. This is due to improved margins on product sales and natural gas storage services, and also because the TTM period ending Sept. 30, 2011, does not include contributions from Perth Amboy (acquired in 2012) and only partial contributions from acquisitions made during 2011.

Adjusted EBITDA improved significantly in Q3 2012 compared to the prior-year period and Q2 2012 ($120 million). Contributions to adjusted EBITDA by segment are presented in Table 2:

Table 2: Figures in $ millions.

Improved Q3 2012 operating performance was primarily driven by increased throughput at the Pipelines and Terminals segment, where volumes increased ~4% compared to the prior-year quarter and ~1% sequentially over Q2 2012. The Energy Services business, a wholesale distributor of refined petroleum products in the Northeastern and Midwestern United States, was adversely impacted by volatility and continued market backwardation (see Glossary of Terms) that reduced sales and inventory value, but recently has been less of a drag on performance. A summary of the prior six quarters is presented in Table 3 below:

Table 3: Figures in $ millions.

Pipelines and Terminals segment performance in Q3 2012 compares favorably with prior quarters also because of a $10.6 million benefit in the third quarter related to the successful resolution of a product settlement allocation matter (the full 2012 impact of this one-time item is $7.8 million).

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. The definition of DCF used by BPL is described in an article titled "Distributable Cash Flow (DCF)." That article also provides, for comparison purposes, definitions used by other master limited partnerships (MLPs). Using BPL's definition, DCF for the TTM ending Sept. 30, 2012, was $340 million, up from $310 million in the TTM ending Sept. 30, 2011, but DCF per unit declined to $3.53 from $3.96.

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 BPL results through Sept. 30, 2012, generates the comparison outlined in Table 4 below:

Table 4: Figures in $ millions.

There are no appreciable differences between reported and sustainable DCF. The risk management item reflects large fluctuations in the value of derivatives used to hedge exposure to commodity prices and interest rates. In certain quarters, BPL's results are significantly impacted by these fluctuations. For example, there was a $79 million loss on derivatives in Q1 2011, a $82 million loss on derivatives in Q3 2011 and an $84 million gain the following quarter. For the most part, these gains and losses are not reflected in BPL's statement of operations. Rather, they increase or reduce total equity through the statement of comprehensive income. Losses on derivatives reported in this manner totaled $29 million in the nine months ending Sept. 30, 2012, and $92 million in the corresponding prior-year period. These losses have a real cash impact and I find their size troubling when considered as a portion of cash generated by operating activities. Coverage ratios for are presented in Table 5 below:

While overall DCF level, both reported and sustainable, increased in the TTM ended Sept. 30, 2012, this was more than offset by a ~19% increase in the number of units outstanding. BPL therefore continues to exhibit low coverage ratios. Management reported 1.19 times distribution coverage for Q3 2012 but in its calculation a ~$135 million outflow used to increase working capital is ignored. I prefer to look at coverage ratios over longer periods and not to add back working capital deployed.

I find it 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 BPL:

Simplified Sources and Uses of Funds

Table 6: Figures in $ millions.

Table 6 indicates $149 million of net cash from operations remained after deducting maintenance capital expenditures and distributions in the TTM ending Sept. 30, 2012. But as can be seen from Table 4, there would have been a shortfall absent risk management gains of $101 million and $67 million generated by liquidation of working capital.

BPL's current yield is at the high end of the MLP universe and the highest among the MLPs I follow, as shown in Table 7 below:

As of 11/19/12:

Price

Quarterly Distribution

Yield

Magellan Midstream Partners (MMP)

$42.85

$0.48500

4.53%

Plains All American Pipeline (PAA)

$45.73

$0.54250

4.75%

Enterprise Products Partners L.P. (EPD)

$51.36

$0.65000

5.06%

Inergy (NRGY)

$18.87

$0.29000

6.15%

Kinder Morgan Energy Partners (KMP)

$79.87

$1.26000

6.31%

El Paso Pipeline Partners (EPB)

$35.97

$0.58000

6.45%

Williams Partners (WPZ)

$50.95

$0.80750

6.34%

Targa Resources Partners (NGLS)

$36.47

$0.66250

7.27%

Regency Energy Partners (RGP)

$22.41

$0.46000

8.21%

Energy Transfer Partners (ETP)

$42.92

$0.89375

8.33%

Suburban Propane Partners (SPH)

$39.93

$0.85250

8.54%

Boardwalk Pipeline Partners (BWP)

$25.06

$0.53250

8.50%

Buckeye Partners

$48.33

$1.03750

8.59%

BPL expects to spend a total of ~$270 million on expansion and cost reduction projects in 2012, of which $197 million has been spent in the nine months ending Sept. 30, 2012. BPL has not been generating excess cash which could help fund these capital expenditures and must therefore fund them with debt, equity or asset sales. BPL has only $2.9 million cash on the balance sheet and long-term debt that, at $2.7 billion (up from $2.3 billion as of June 30, 2012), is already at 5.3 times adjusted EBITDA on a TTM basis (up from 4.7 times as of June 30, 2012).

I believe it is likely BPL will issue additional equity, further diluting current limited partners (in February 2012, it issued 4.3 million units). Otherwise I don't see how it can fund expansion and cost reduction projects in Q4 2012 and the significant capital expenditures in 2013. Sale of the Natural Gas Storage business will reduce the amount of equity required to be raised but management reports no progress on this front and it is not possible to predict whether, and at what price, a sale will occur.

Also of concern is the Federal Energy Regulatory Commission (FERC) order of March 30, 2012, that disallowed proposed rate increases on the Buckeye System that would have become effective April 1, 2012. The proposed rate increases were expected to increase BPL's annual revenues (and, I presume, EBITDA) by approximately $8 million. But if forced to resort to FERC's generic rate setting mechanism, the adverse impact goes well beyond forgoing this increase and could have a substantial adverse affect on BPL because it would lower tariffs on pipelines that account for ~70% of BPL's revenues. This is a major issue overhanging this MLP.

I held BPL units for many years and eliminated my position in light of the issues highlighted in my prior articles (for example, see article dated Dec. 19, 2011, another article dated Feb. 13, 2012, and a third article dated April 19, 2012). Thirty-two consecutive quarterly increases in distributions per unit ended in Q1 2012 with distribution unchanged at $1.0375 per unit. This is also the amount declared for Q2 2012 and for Q3 2012. Despite positives such as an 8.6% yield and the absence of general partner incentive distribution rights, I am not currently considering reestablishing a position because of concerns discussed in this and prior articles. These include low distribution coverage, expensive acquisitions, past and prospective unitholder dilution, as well as the FERC risk.

Source: A Closer Look At Buckeye Partners' Distributable Cash Flow As Of Q3 2012