This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Enterprise Products Partners L.P. (EPD) and looks "under the hood" to properly ascertain sustainability of Distributable Cash Flow ("DCF"). The task is not easy because the definitions of DCF and "Adjusted EBITDA", the primary measures typically used by master limited partnerships ("MLPs") to evaluate their operating results, are complex. In addition, each MLP may define these terms differently, making comparison across MLPs very difficult. Nevertheless, this is an exercise that must be undertaken to ascertain what portions of the distributions being received are really sustainable. For example, MLPs distributions that are funded by issuing debt or through issuance of additional partnership units cannot be considered sustainable. In a downside scenario, MLPs that finance distributions from unsustainable sources or are totally reliant on debt and equity to finance growth capital will suffer significantly greater price deterioration.
Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) 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
Fluctuations in revenues and cost of sales amounts are explained, in part by, changes in energy commodity prices, especially those for natural gas liquids ("NGL"), natural gas and crude oil. Energy commodity prices in 2012 were lower than they were in 2011 (by ~23% for NGLs, by ~31% for natural gas, and by ~1% for crude oil). In 1Q13, NGL prices continued to exhibit sharp drops compared to prior year levels (down ~24% in 1Q13 vs. 1Q12,). That is the main reason for the decline in NGL Pipeline Services revenues in the periods under review. Segment revenues are summarized in Table 2 below:
Table 2: Figures in $ Millions
Lower NGL prices (primarily ethane and propane) drove down NGL Pipelines Services gross margins in 1Q13. However, changes in revenues resulting from lower or higher energy prices may be more than offset by higher or lower, respectively, costs of sales attributable to these changes. For example, natural gas prices were up ~23% in 1Q13 vs. 1Q12, yet Onshore Natural Gas Pipelines Services segment gross margins were down, primarily due to lower gathering volumes as producers curtailed their drilling programs in response to the downward trend in prices of natural gas and NGLs. On the other hand, although oil prices (as measured by Louisiana Light Sweet) were down by ~5% in 1Q13 vs. 1Q12, gross margins improved and volume for the quarter was up ~39% vs. a year ago, benefiting from increased crude oil production volumes from the Eagle Ford Shale, Permian Basin and Rocky Mountains regions The significant and impressive improvement in total gross operating margins reflects primarily higher gross margins generated by crude oil transportation volumes, as shown in Table 3 below:
Table 3: Figures in $ Millions
Total segment gross operating margin in Table 3 above is defined by EPD as operating income before: (1) depreciation, amortization and accretion expenses; (2) non−cash asset impairment charges; (3) operating lease expenses for which it did not have the payment obligation; (4) gains and losses from sales of assets and investments; and (5) general and administrative costs.
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". EPD's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow". Using EPD's definition, DCF for the TTM ended 3/31/13 was $3,402 million ($3.73 per unit), down from $4,692 million ($5.40 per unit) in the prior year period. A comparison between reported and sustainable DCF is presented in Table 4 below:
Table 4: Figures in $ Millions
The principal difference for the decline in reported DCF in the periods under review relates to EPD's proceeds from asset sales. The bulk of the $1,968 million of such proceeds in the TTM ended 3/31/12 is accounted for by the sale of EPD's Crystal ownership interests (natural gas storage facilities in Petal and Hattiesburg, Mississippi) for $547.8 million and the sale of 36 million Energy Transfer Partners, LP (ETE) units for $1,351 million. The ETE units also account for the bulk of the $998 million of sale of assets in 1Q12. Proceeds from asset sales in 1Q13 primarily reflect ~$87 million received from the sale of the Stratton Ridge-to-Mont Belvieu segment of the Seminole Pipeline and ~$30 million received from the sale of chemical trucking assets. As readers of my prior articles are aware, I do not include proceeds from asset sales in my calculation of sustainable DCF. As shown in Table 4, sustainable DCF increased significantly in the periods under review.
The other principal differences between reported DCF and sustainable DCF relate to working capital consumed, proceeds from asset sales, and risk management activities.
Reported DCF for the TTM ending 3/31/13 includes $389 million of cash consumed by working capital needs that management added back. Under EPD'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.
Finally, EPD adds back losses from risk management activities in deriving its reported DCF number. This item relates to interest rate hedging activities and totals $239 million for the TTM ended 3/31/13 and $169 million in 1Q13. I generally ignore cash generated or consumed by interest rate hedging activities in calculating sustainable DCF. EPD accounts for these losses as a component of "accumulated other comprehensive income" and amortizes them to earnings (as an increase in interest expense) over ten years.
TTM numbers tends to be more meaningful than quarterly numbers for the purpose of coverage ratios. However, I present both. As indicated in Table 5 below, sustainable DCF coverage ratios appear strong:
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 EPD:
Simplified Sources and Uses of Funds
Table 6: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-controlling interests exceeded distributions by $718 million in the TTM ending 3/31/13 and by $724 million in the comparable prior year period. EPD is not using cash raised from issuance of debt and equity to fund distributions. On the contrary, the excess cash it generates enables EPD to reduce reliance on the issuance of additional partnership units or debt to fund expansion projects.
Given the significant increase in cash in 1Q13 shown in Table 6, unrestricted cash on hand at March 31, 2013 was $1.28 billion, a much higher than normal level. This is due to proceeds remaining from the March 2013 issuance of senior notes. A portion of the cash on hand was subsequently used to repay $650 million in principal amounts of senior notes due on April 15, 2013. But the remaining balance still seems much higher than normal and may be used for additional repayments or funding of capital expenditures.
Overall, major capital projects in which EPD had invested $2.9 billion were completed and put into service in 2012 (i.e., started generating fee-based cash flows). Management expects to complete another $2.4 billion of project in 2013 and has an additional $4.8 billion of projects under construction that it expects to be completed in 2014 and the first half of 2015. The revenues from these projects will be predominantly fee-based and supported by long-term contracts.
EPD recently announced its 35th consecutive quarterly cash distribution increase to $0.67 per unit ($2.68 per annum), a 6.8% increase over the distribution declared with respect to the first quarter of 2012. EPD's current yield is at the low end of the MLPs I follow:
As of 05/10/13:
Magellan Midstream Partners (MMP)
Plains All American Pipeline (PAA)
Enterprise Products Partners
El Paso Pipeline Partners (EPB)
Targa Resources Partners (NGLS)
Kinder Morgan Energy Partners (KMP)
Buckeye Partners (BPL)
Williams Partners (WPZ)
Regency Energy Partners (RGP)
Boardwalk Pipeline Partners (BWP)
Suburban Propane Partners (SPH)
Energy Transfer Partners (ETP)
I think EPD's premium price is justified on a risk-reward basis given EPD's size, breadth of operations, strong management team, portfolio of growth projects, structure (no general partner incentive distributions), excess cash from operations, history of minimizing limited partner dilution and performance track record. I consider EPD to be a core MLP holding and would continue to accumulate on weakness.