By Jason Born, CFA
It seems that the desire among investors to bring in a high current yield will persist for quite some time due to the demographics in developed economies around the world. As a result, we continue to beat the bushes for companies or partnerships that have delivered in this regard in the past and which ought to continue in a similar fashion. The commentary below is a short summary review of one of our holdings.
Boardwalk Pipeline Partners LP (BWP) is one such entity. The company transports natural gas over three interstate pipeline systems it owns from the Gulf Coast region, Oklahoma, and Arkansas to Tennessee, Kentucky, Illinois, Indiana, and Ohio. Natural gas producers make up 54% of BWP's revenues, while local distribution companies and marketers make up 22%, and 18%, respectively. Most of its customers pay a monthly charge for capacity reservation regardless of actual utilization. The average life of their contracts currently stands around six years, with some expiring each year, obliging a renegotiation.
In recent years, new methods of producing natural gas greatly increased supply. This fact caused pipeline companies to form and / or expand. Subsequently, over the calendar years 2011 and 2012, the increased supply of natural gas pushed down its price. Producers of gas curtailed production, which led to a highly competitive environment for pipelines. However, even though the transport of a commodity would itself seem to be a commodity, there exists differentiating elements such as access to supply, flexibility, terms of service, and reliability. Each of these areas is a strength found in BWP.
The company's balance sheet is solid with approximately 50% of its capital in the form of long term debt. After peaking over the last two years, we expect this number to moderate moving forward. Like all limited partnerships, they are often seen issuing new debt and partnership units and so this number will be in constant flux. Investors should always keep this fact in mind. Another compliment regarding their balance sheet is that it is not clogged with large amounts of intangibles such as goodwill, a sign that in the absence of impairment write-downs, past acquisitions have been made at reasonable prices.
BWP has produced an average distributable cash flow [DCF] of approximately $2.60 per unit in the recent past. Due to the long term nature of its contracts with customers, we believe it is appropriate to smooth out the annual vagaries in the distributable cash flow by utilizing the average (trailing twelve months [TTM] is closer to $2.13). We expect growth of their long-haul business to lag the overall growth in the pipeline sector due to the shale gas boom. Therefore, we project a growth in DCF of only 3%. The actual distribution ought to grow at approximately the same rate since the coverage is currently at 1x. If coverage was considerably higher, we would be more comfortable forecasting a higher growth rate for the actual distribution than for DCF.
Our target over the coming 12 to 18 months on BWP is $30. This result is the simple average of two intrinsic value calculations. First, we took $2.60 and used a multiple of 11 to get about $29. Second, we used the TTM distributable cash flow in the Gordon growth model, [2.13*1.03]/[0.10-0.03] to get $31.