As an investor seeking the high yields being offered by master limited partnerships ("MLPs"), my first question is what portion, if any, of the distributions I am receiving are really "earned." I am leery of investing in MLPs that fund distributions with debt or through issuance of equity (i.e., sale of additional partnership units). Since money is fungible and the MLP financial statements are voluminous and not always easy to read, ascertaining whether you are genuinely receiving a yield on your money (rather than a return of your money) can be a complicated endeavor. This is an exercise that must be undertaken in addition to evaluating MLP's growth prospects. Sustainable distributions coverage provides some protection in a downside scenario. Those MLPs that, when faced with such a scenario, cannot maintain their distributions or are totally reliant on debt and equity to finance growth capital, are likely to suffer significantly greater price deterioration.
This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of El Paso Pipeline Partners, L.P. (EPB) and looks "under the hood" to properly ascertain sustainability of DCF. The task is not easy because the definitions of "Adjusted EBITDA" and Distributable Cash Flow ("DCF"), terms typically used by MLPs to denote the primary measures to evaluate their operating results, are complex. In addition, each MLP may define these terms differently which makes comparison across MLPs very difficult.
EPB owns Wyoming Interstate Company, L.L.C. ("WIC"), Southern LNG Company, L.L.C. ("SLNG"), Elba Express Company, L.L.C. ("Elba Express"), Southern Natural Gas Company, L.L.C. ("SNG"), Colorado Interstate Gas Company, L.L.C. ("CIG") and Cheyenne Plains Investment Company, L.L.C. ("CPI"), which owns Cheyenne Plains Gas Pipeline Company, L.L.C. ("CPG").
On May 24, 2012 EPB and EPB's parent, El Paso Corporation, were acquired by Kinder Morgan, Inc. (KMI). As part of that transaction, EPB acquired the remaining 14% interest in CIG that it did not previously own, and all of CPI and CPG. EPB's financial statements now fully consolidate CPG. Retrospective adjustments were made to prior periods to reflect this CPG consolidation.
Revenues, operating income, net income and other key metrics for the periods under review are presented in Table 1 below. Given quarterly fluctuations in revenues, working capital needs and other items, a review of TTM numbers tends to be more meaningful than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows. However, I present both:
Table 1: Figures in $ Millions, except weighted average units outstanding and margins
The lack of revenue growth is troubling. In fact, revenues contracted despite full period contributions by CIG and CPG. Results for 1Q12 exclude contributions from CIG and CPG operations and results for the TTM ending 3/31/12 exclude ~2 months of contributions from CIG and CPG.
Net income improved on reduced operations and maintenance costs. Maintenance capital expenditures continue to be much lower than they were when EPB was part of El Paso Corp. Hopefully the lower levels reflect careful pruning of maintenance expenditures and corners are not being cut.
Management assesses segment performance based on "EBDA", a metric defined as earnings before depreciation and amortization, certain general and administrative ("G&A") expenses and interest expense. These certain G&A expenses include employee benefits, legal, information technology and other costs that are not deemed controllable by operating management and thus are not included in the measure of performance for which each segment is accountable.
While EBDA improved by 12% in 1Q13 and by 9% in the TTM ending 3/31/13 compared to the prior year periods, this is in large part due to the full period contributions by CIG and CPG noted above.
The generic reasons why DCF as reported by an MLP may differ from what I call sustainable DCF are reviewed in an article titled "Estimating sustainable DCF-why and how." EPB adopted a new definition of DCF following its acquisition by KMI and its reported DCF numbers are now based on this new definition. In an article titled "Distributable Cash Flow," I present this new definition and provide a comparison to definitions used by other MLPs. After restating the numbers to conform to this new format, the comparison between reported and sustainable DCF is presented in Table 2 below:
Table 2: Figures in $ Millions
In 1Q13, EPB reported a $26 million increase in DCF over the prior year period. This was primarily driven by the 2012 acquisitions (CPG and the increased ownership interest in CIG), by higher revenue at Southern Natural Gas Company LLC ("SNG") due to expansions placed in service in June 2012, and due to decreases in sustaining capital expenditures.
Sustainable DCF in the TTM ending 3/31/13 exceeded the prior year level mainly due to reduced distributions to minority interests and due to maintenance capital expenditures being much lower. Management projected maintenance capital expenditures to total $55-60 million in 2012. The actual number was much lower ($46 million) compared to ~$100 million actually spent in 2011. Management expects to spend an even lower amount ($40 million) in 2013. Whether the lower levels of maintenance capital expenditure level are sufficient is an open question.
The major differences between reported and sustainable DCF are attributable to working capital and various items grouped under "Other."
In deriving reported DCF for the TTM ending 3/31/13, management added back to net cash from operations $86 million of working capital used. Under EPB's definition, reported DCF always excludes working capital changes, whether positive or negative. In contrast, as detailed in my prior articles, in deriving sustainable DCF, I generally do not add back working capital used but, on the other hand, I exclude working capital generated. 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.
Items in the "Other" category include numerous adjustments. These adjustments further illustrate the complexity and subjectivity surrounding DCF calculations and highlight the difficulty of comparing MLPs based on their reported DCF numbers. For example, items included in the TTM ending 3/31/13 include non-cash severance costs, pre-acquisition costs, and loss on write-off of assets. I exclude these adjustments from my definition of sustainable DCF.
Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are shown in Table 3 below. Note that the coverage ratio I calculate compares total DCF to total distributions to all unitholders (including the general partner). DCF as reported by EPB consists of cash it calculates as being available for distribution to limited partners only (i.e., after distributions made to the general partner are deducted). The comparison of reported vs. sustainable coverage shown below therefore includes the reported number had it been calculated pre-distribution to the general partner.
EPB is unlikely to be able to continue growing distributions at the recently experienced rates. It increased its quarterly distribution by 20% in the TTM period ending 3/31/13. During that period, DCF per unit grew 21%. However, the 22% increase in distributions from 1Q12 to 1Q13 was accompanied by an increase in DCF of only 13%. From 4Q12 to 1Q13, DCF per unit growth slowed further, to just 3.7% (from $163 million to $169 million).
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 EPB:
Simplified Sources and Uses of Funds
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 $103 million in the TTM ending 3/31/13 and by $264 million in the prior year period. EPB is not using cash raised from issuance of debt and equity to fund distributions.
Table 5 below compares KMP's current yield to some of the other MLPs I follow:
As of 5/7/13:
Magellan Midstream Partners (MMP)
Plains All American Pipeline (PAA)
Enterprise Products Partners (EPD)
El Paso Pipeline Partners
Targa Resources Partners (NGLS)
Kinder Morgan Energy Partners (KMP)
Buckeye Partners (BPL)
Williams Partners (WPZ)
Boardwalk Pipeline Partners (BWP)
Regency Energy Partners (RGP)
Suburban Propane Partners (SPH)
Energy Transfer Partners (ETP)
In 3Q13, EPB is expected to purchase KMI's 50% interest in Gulf LNG. There is always a concern regarding these related-party transactions but the concern that EPB will be treated as a stepchild by KMI has, in my view, dissipated and I expect management will deal with this prudently and structure an accretive deal for the limited partners. Analysts have estimated a $750 million purchase price for this asset. The long-term debt-to-EBITDA as of 3/31/13 was at a very manageable 3.8x level, so the balance sheet can absorb additional debt to fund the acquisition; but I expect EPB will issue additional equity to pay for a portion of that dropdown.
Coverage ratios appear solid, debt is not excessive, and although the pace of distribution growth will be reduced, it is still quite substantial. Management projects distributions in 2013 will total $2.55 per unit, up 13% from the $2.25 per unit in 2012, and that EPB will end the year with excess coverage of $25 million. By comparison, Kinder Morgan Energy Partners LP projects 2013 distribution growth of 6% (despite accounting for the bulk of the $11 billion of expansion projects underway at the Kinder Morgan entities).