Seeking Alpha
Value, dividend investing, growth at reasonable price, contrarian
Profile| Send Message|
( followers)  

Energy Transfer Partners (NYSE:ETP) has been telling a pretty complicated story for a while and Wall Street doesn't like complex stories. This fact, coupled with the stagnant unitholder quarterly cash distributions, have caused the natives to rumble a bit.

However, upon the first quarter conference call held last week on Thursday morning, company management reported some very positive developments. In this article, I will share with you my views on what I consider the key takeaway items.

Before I go into the details, let's begin with a chart highlighting price action: Energy Transfer units showed a nice pop leading into and immediately after the first quarter update. This has continued what's been a very solid YTD performance trend.

Energy Transfer Partners -- YTD Price, Volume and Studies

(click to enlarge)

ETP units have outpaced the S&P 500, increasing 16 percent since January, without considering two ex-distribution dates that subtracted $1.79 from the underlying unit price. While I am not a big chartist, I did notice the MACD has recently turned positive once again and the RSI is above the 50-yard line, but not overbought. I also like the fact that the unit price keeps bobbing above the 50-day SMA.

What are the First Quarter Takeaways?

I believe the key items reported in the first quarter are as follows:

  • DCF (Distributable Cash Flow) has turned decidedly positive over the past four quarters
  • The Cash Distribution Coverage Ratio was comfortably above 1.0x
  • Major capital projects promise significant future growth
  • The organizational structure has been simplified. Even I can understand it now!
  • Credit metrics remain acceptable

There are also a couple of concerns I will discuss towards the end of the article.

Distributable Cash Flow

DCF is on a roll. This was to be expected, as hyperbolic M&A activity is now coming home to roost. The extra kicker is that first quarter revenues and cash exceeded Wall Street analyst expectations. That's always a good thing.

Here's a quick chart highlighting Distributable Cash Flow over the past four quarters:

Energy Transfer Partners -- Distributable Cash Flow $M

(click to enlarge)

Quite encouraging. Please note that ETP has diluted the number of units significantly over this period of time; a result of financing the various mergers and acquisitions. Nonetheless, even as a function of the higher unit count, DCF is up. This news is positive.

Cash Distribution Coverage Ratio

Energy Transfer management cannot increase the distribution if the company doesn't make enough cash to cover the current payout. This has been an on-and-off problem for a few years. However, the first quarter coverage ratio was 1.18x, coming off the heels of a 0.94x fourth quarter figure. The 1Q ratio was strongest I've seen of late, and well within management's target of 1.05x or greater.

While one good period doesn't seal the deal, management started really prepping the Street for an upcoming boost in the distribution. Here are three excerpts from CEO Kelcy Warren, offering his remarks on Thursday's conference call after being asked directly about future distributions:

…Absolutely, there is commitment to raise the distribution as fast as we can raise it, that is our absolute commitment here. We are pleased that we've simplified our structure again. We put assets in the place they belong.....

….We are also committed to issue as little equity as ETP, as we can to maintain the credit metrics that we must maintain and to run our business correctly. But I will tell you, trust me. Nothing gets talk about more in the halls around here than getting ETP to a point where it can resume distribution growth....

….We are committed to getting ETP consistently above the one coverage ratio in a healthy way and to resume distribution growth. At ETP, we are committed....

I see an increase in the distribution as a catalyst for driving the underlying unit price higher, too. I submit even a small increase in the 2013 payout will generate renewed interest in the units and propel them forward. I suspect it will be a kind of a double-whammy.

Major Capital Projects

What I find most interesting about Energy Transfer Partners is the enormous change in the business over a relatively short period of time. Senior leadership has completely re-arranged the face of the company. While management has stated clearly that additional M&A activity is over for awhile, there remains considerable capital project work centered around the new assets under the fold.

It was reported that the Trunkline conversion project is expected to sign a foundation shipper and begin an "open season" for additional shippers no later than June of this year. This project is big; it entails converting and reversing the Trunkline gas pipeline to deliver liquid hydrocarbons to the Texas / Louisiana Gulf Coast refinery complex. The refinery complex consumes over 5.5 million bbls/day of crude oil.

Two other major projects, one in the Midstream segment and the other in the NGL business, were reported to likely come in ahead of schedule and on-budget. These include the Rich Eagle Ford mainline expansion project, and the completion of a second NGL fractionation unit in partnership with the Lone Star NGL LLC joint venture. Energy Transfer owns a 70 / 30 percent majority interest in that JV with Regency Energy Partners (NYSE:RGP). The latter project is expected to come online one quarter earlier than originally planned: the third quarter 2013. The Rich Eagle Ford project is also slated for accelerated completion sometime in the first quarter of next year.

I am encouraged by the Energy Transfer project engineering team. The organization has consistently brought home big projects on-time, on-the-money, or better. The staff shows no signs of letting up.

Finally, I was especially impressed with the project update on the LNG import/export terminal to be constructed / expanded in Nederland, Texas. A combination of Sunoco Logistics (NYSE:SXL), a wholly-owned ETP subsidiary, and Lone Star LLC have signed a deal with Shell Oil Company (NYSE:RDS.A) for a long-term, fee-based to become the anchor customer. I encourage you to review the entire press release here.

Readers, I point out these projects because they are large, integrated hydrocarbon transportation plays that will "move the needle" for ETP unitholders. Looking forward, I am actually more enthusiastic about future prospects for the company due to these developments as much as any other activity.

Organization Structure is Simplified -- A Lot

The recent divestitures, dropdowns, and rationalizations have greatly simplified the Energy Transfer structure. While the work is not complete, it is clearly on the downhill side. Essentially, Energy Transfer management plans to move operating assets into Energy Transfer Partners and partnership interests into Energy Transfer Equity (NYSE:ETE). They are well on the way.

While quite pleased with the overall progress, I see at least two loose ends remaining on the asset rationalization front.

First, the Louis-Dryfus spinoff to the Laclede Group must be completed. This looks tracked, as it's scheduled to close in the third quarter of this year. Second, ETP must offload their equity interest in AmeriGas Partners, LP. Valuation estimates of $1.3 billion were pegged upon acquisition of the units. The equity provides no strategic value to Energy Transfer, and whatever proceeds are recovered would be better used to bolster the balance sheet. The challenge is to sell the shares without disrupting the somewhat thinly-traded AmeriGas unit market; a promise that Energy Transfer made to AmeriGas when it acquired the unit to begin with.

Credit Metrics Look OK

It's important to pay attention to the balance sheet with all this activity ongoing. I follow three metrics to help me follow along:

Debt-to-Adjusted EBITDA

This measure is tracked closely by company management, too. The 2013 1Q annualized rate is 4.3x with a corporate objective of 4.00 to 4.25x. I don't believe a cash distribution increase will be forthcoming until this number comes within the range.

Interest Coverage Ratio

This is a standard debt metric I like to watch. ETP currently has a 2.9x ratio. Anything above 1.5x is acceptable. Above 2.0x is good.

Long-Term Debt-to-Equity Ratio

This ratio is derived from the balance sheet. Energy Transfer clocks in with 93%. This is a bit high for my liking and slightly above the 89% mark from year-end 2012.

Concerns

Virtually all enterprises have issues, and virtually all investors will find some on top of it. Frankly, my concerns are not overwhelming. The news from Dallas has been generally pretty positive.

Nevertheless, there were two things that bugged me:

  • The Midstream business segment EBITDA margin fell significantly in the first quarter. The tumble was reported to be a function of corporate re-shuffling and segment SG&A expenses. I'd watch that going forward. This business segment only contributed about 8 percent of total EBITDA last quarter.
  • The Retail Marketing business is a puzzlement to me. It does not appear core to what Energy Transfer does. Regular industry margins in that business are low. ETP's Sunoco stations are no exception. The segment EBITDA margin dropped from 1.8 percent in the fourth quarter 2012 to 0.7 percent (yes, that's not a typo) in the first quarter of this year. While the cash contribution is relatively stable, I worry about Energy Transfer's long-term management expertise in this area, and if the "climb is worth the view," when factoring in tiny margins and significant exposure to the public. If the company could fetch an indifference point price, I wish they would jettison this business.

Conclusion

Indeed, the pieces appear to be falling into place for Energy Transfer Partners. Cash is way up. The organization structure has been greatly simplified. Major capex is being spent on projects that have significant potential to really grow the business and impact cash generation. Furthermore, these projects are coming in on-time and on-budget, or better. Credit metrics are decent. The rating agencies are at bay.

Finally, and most importantly for investors, I believe management and business performance are aligning towards an increase in the cash distribution. My view is any 2013 increase will be modest, but I think it's more likely to come now than anytime since I've been following the company.

As always, please do your own homework and proper due diligence before making any investment. Good luck with all your 2013 investments.

Source: Energy Transfer Partners: The Pieces Are Falling Into Place