A Closer Look At Inergy L.P.'s Distributable Cash Flow In Fiscal 2012

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On November 21, 2012, Inergy L.P. (NRGY) reported results of operations for the fiscal year ended 9/30/12. Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for the fourth fiscal quarters and the fiscal years ending September 30 are summarized in Table 1:

Table 1: Figures in $ Millions, except weighted average units outstanding

The numbers for the fourth quarter and year ended 9/30/12 reflect the sale of NRGY's retail propane business to Suburban Propane Partners (NYSE:SPH) in August 2012. Net income and EBITDA for these periods include a ~$590 million gain on disposal of retail propane operations. Offsetting this gain was a ~ $48 million loss on the carrying value of the roughly 14.2 million SPH units held by NRGY from August 1 until they were distributed to the NRGY shareholders on September 14. The sale significantly strengthened NRGY's balance sheet. As of 9/30/12 long term debt was $740 million (NRGM's revolving credit facility accounted for $416 million of that), down from $1,704 million in the previous year. As a multiple of Adjusted EBITDA, long term debt was ~2.3x as of 9/30/12 vs. ~5x as of 9/30/11. In addition to supporting its own debt, NRGY is obligated to provide contingent, residual support of ~$497 million principal amount of SPH's 7.50% senior unsecured notes.

Following the sale to SPH, NRGY has two business segments: (1) NGL marketing, supply and logistics operations; and (2) storage and transportation operations. Operational activities conducted within the first segment include marketing and supply of natural gas liquids ("NGLs"), NGL fractionation (including the West Coast fractionation facility), logistics and transportation of NGLs and the results of the retail propane operations through the date they were contributed to SPH. Operational activities conducted within the second segment include storage and transportation of natural gas and NGLs for third parties and the production and sale of salt products.

NRGY's NGL marketing, supply and logistics operations include assets held through its stake in NRGM: pipelines in New York and Pennsylvania (the North-South Facilities, the 39-mile natural gas interstate MARC I Pipeline, and the 37.5-mile intrastate East Pipeline), and a solution-mining and salt production company in New York (US Salt). Note that Anadarko Petroleum Corporation claims it has an option to acquire 25% of the Marc I Pipeline; the lawsuit it initiated in October 2011 against NRGY is still outstanding.

NRGY's storage and transportation operations include assets held through its stake in Inergy Midstream LP (NRGM): 5 natural gas storage facilities (the Tres Palacios natural gas storage facility in Texas; 4 natural gas storage facilities in New York (Stagecoach, Thomas Corners, Steuben and Seneca Lake); and 1 NGL storage facility in New York (Bath).

NRGY's stake in NRGM is comprised of a ~75% limited partner stake, a non-economic general partner interest and Incentive Distribution Rights ("IDR") entitling it to receive 50% of NRGM's distributions above $0.37 per quarter (the current quarterly distribution is $0.385) .

Segment revenues for the past two fiscal years are broken down in Table 2 below:

Table 2: Figures in $ Millions

For the year ended 9/30/12, "Retail" reflects only ten months of operating activity preceding the August 1, 2012, sale of the retail propane business to SPH vs. twelve months for the prior year.

NGL Marketing's higher revenues reflect a 27.5% increase in gallons delivered, driven primarily by increased production by the Caiman/Williams facility at Fort Beeler, West Virginia, additional third party sales volumes to SPH after the close of the sale, and an increase in sales specific to a location that was only operational for a portion of the prior year period. These increases were partially offset by lower volumes sold to existing customers primarily due to warmer weather conditions vs. the prior year.

"L&L" incorporates the results of Papco/South Jersey Terminal, LLC ("Papco") and Werner Transportation Services, Inc. ("Werner"). Located in Bridgeton, New Jersey, Papco is a rail terminal facility providing NGL transportation services (onsite product storage and truck loading) in the East Coast, Midwest and Southeastern portions of the U.S. Its fleet of specialized transport vehicles and strong presence in the Marcellus shale region increase NRGY's service offerings in the Eastern region of the U.S. Located in Gainesville, Georgia, Werner provides a fleet of NGL transport vehicles to customers east of the Mississippi River. Papco and Werner were acquired during fiscal year ended 9/30/12 and did not contribute to results in the prior year period.

West Coast NGL's higher revenues reflect a 25.8% increase in total NGL gallons sold or processed. The increase was primarily attributable to higher throughput volumes processed as a result of operational expansion of the facility in fiscal 2012.

Storage and Transportation segment revenues were higher in fiscal 2012 vs. the prior year period primarily due to the placement into service of additional facilities.

Until recently, NRGM's NGL activities were centered on the Marcellus Shale. On December 7, 2012, NRGM completed the $425 million acquisition of Rangeland Energy which owns and operates the COLT Hub in the heart of the Bakken and Three Forks shale oil-producing region. The Colt Hub includes a terminal capable of moving more than 120,000 barrels of crude oil per day by rail, and of storing 720,000 barrels of crude oil. It also has a 21-mile bi-directional crude oil pipeline that connects the terminal to crude oil gathering systems and crude oil interstate pipelines.

On September 14, 2012, NRGY distributed to its unitholders ~14 million SPH common units received by NRGY as partial consideration for the contribution of its retail propane operations to SPH. Following that, NRGY reduced its annualized distribution from $1.50 to $1.16 to reflect the distribution of the SPH common units to NRGY unitholders. Based on SPH's current annualized distribution of $3.41 per SPH unit, NRGY investors who received and continue to own the SPH units distributed receive total annualized cash distributions of ~$1.53 per NRGY unit ($1.16 from NRGY and ~ $0.368 from SPH).

NRGY'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 year ended 9/30/12 was $208 million ($1.63 per unit), down from $250 million ($2.24 per unit) in the comparable prior year period.

Reported DCF numbers may differ considerably from what I consider to be sustainable. The generic reasons for this are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to NRGY results generates the comparison outlined in Table 3 below:

Table 3: Figures in $ Millions

The principal differences between sustainable and reported DCF numbers for the two periods presented in Table 1 are attributable to cash consumed by working capital and to the disposition of a liability. Both are added back in calculating reported DCF, but are not included in sustainable DCF.

Under NRGY's definition, reported DCF always excludes working capital changes, whether positive or negative. In contrast, 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 (this accounts for $97 million of the variance between reported and sustainable DCF in the fiscal year ended 9/30/11). 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.

In a prior article I did not deduct $39 million of cash outflows relating to disposal of liabilities in my calculation of sustainable DCF for fiscal 2011. This amount represented a cash premium paid to bondholders as inducement to accept early retirement of debt. At the time, I saw it as a genuine one-time, non-operations related, item and therefore ignored this outflow in deriving sustainable DCF. Because this item appeared again in fiscal 2012, this time amounting to $17 million, I no longer consider it "one-time" and, to be conservative, no longer include cash premiums paid to bondholders as inducement to accept early retirement of debt in deriving sustainable DCF, as can be seen in Table 3 above.

Coverage ratios, calculated pro-forma for the reduced level of distributions, are indicated in Table 4 below:

Table 4

Coverage of the current distribution rate of $1.16 per annum appears solid (1.25x) but may be an unreliable indicator. Fiscal 2012 was a transformative year for NRGY and therefore results of operations reflect contributions from assets sold (the retail propane operation generated $138 million or ~43% of total Adjusted EBITDA in fiscal 2012) as well from assets that began making contributions relatively recently and did so for only a portion of the year. Also, COLT Hub which was acquired earlier this month is expected to be 13% accretive for NRGY in fiscal 2013.

The simplified cash flow statement in the table below gives a clear picture of how distributions have been funded in the last two years. The table nets certain items (e.g., debt incurred vs. repaid) and separates cash generation from cash consumption.

Simplified Sources and Uses of Funds

Table 5: Figures in $ Millions

Table 5 indicates that, for the past two years, distributions have been funded through issuance of partnership units, issuance of NRGM units and by debt. But for the same reasons that the solid coverage of the current distribution rate may be an unreliable indicator, one should not conclude that NRGY is unable to generate cash from operations in excess of maintenance capital expenditures sufficient to cover distributions. A back-of-the-envelope analysis provided below indicates NRGY can do so, but just barely absent significant contribution from assets recently placed into service.

A comparison of NRGY's current yield to the other MLPs I follow is presented in Table 6 below:

As of 12/7/12:

Price Quarterly Distribution Yield
Magellan Midstream Partners (NYSE:MMP) $42.96 0.4850 4.52%
Plains All American Pipeline (NYSE:PAA) $45.45 0.5425 4.77%
Enterprise Products Partners (NYSE:EPD) $49.72 0.6500 5.23%
El Paso Pipeline Partners (NYSE:EPB) $37.77 0.5800 6.14%
Kinder Morgan Energy Partners (NYSE:KMP) $79.40 1.2600 6.35%
Inergy $17.98 0.2900 6.45%
Williams Partners (NYSE:WPZ) $47.19 0.8075 6.84%
Targa Resources Partners (NYSE:NGLS) $35.28 0.6625 7.51%
Energy Transfer Partners (NYSE:ETP) $43.31 0.8938 8.25%
Boardwalk Pipeline Partners (NYSE:BWP) $25.79 0.5325 8.26%
Buckeye Partners (NYSE:BPL) $48.52 1.0375 8.55%
Regency Energy Partners (NYSE:RGP) $21.28 0.4600 8.65%
Suburban Propane Partners $38.01 0.8525 8.97%

Table 6

Excluding the retail propane operations, NRGY produced ~$183 million of Adjusted EBITDA of which ~$125 million was contributed by NRGM. At current distribution levels for NRGM, IDRs will not be significant, so for purpose of my back-of-the-envelope basis I ignore them. Also, but with less confidence, I assume these Adjusted EBITDA numbers do not differ significantly from sustainable DCF. Based on these assumptions, NRGY would have generated ~$94 million via its ~75% stake in NRGM plus $58 million (vs. ~$59 million in fiscal 2011) from businesses owned directly by NRGY, for a total Adjusted EBITDA of ~$152 million. This is barely sufficient to cover ~$153 million in distributions (132 million units outstanding at the current rate of $1.16 per unit per annum). Based on this rough analysis, and on the fact that the jury is still out on the enormous transformation undertaken by NRGY in 2012, and on the difficulty in ascertaining sustainable DCF and determining coverage ratios, I would not be a buyer at this time.

Disclosure: I am long EPB, EPD, ETP, PAA, SPH, WPZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.