This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Energy Transfer Partners, L.P. (NYSE:ETP) 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 and each MLP may define the terms differently, making comparison across MLPs very difficult.
In the case of ETP, the level of complexity is particularly high for several reasons. One is that in 4Q12 management changed its definition of Segment Adjusted EBITDA to reflect amounts for less than wholly owned subsidiaries based on 100% of the subsidiaries' results of operations. In prior periods, amounts for less than wholly owned subsidiaries were reflected in Segment Adjusted EBITDA based on ETP's proportionate ownership, such that the measure was reduced for amounts attributable to non-controlling interests. In periods prior to 4Q12, NGL Transportation and Services was the only segment that included a less than wholly owned subsidiary - the Lone Star joint venture. Lone Star is 70% owned by ETP and 30% by Regency Energy Partners, L.P. (NYSE:RGP). It operates natural gas liquids storage, fractionation and transportation assets in Texas, Louisiana and Mississippi. In 1Q13, Segment Adjusted EBITDA includes not only 100% of Lone Star but also 100% of the Florida Gas Transmission Pipeline ("FGT") and 100% of the Fayetteville Express Pipeline ("FEP"), even though ETP owns 50% of these latter two ventures and previously accounted for them using the equity method.
The structural changes ETP is undergoing adds another level of complexity and makes is exceedingly difficult to compare across periods, to say nothing of trying to draw forward looking conclusions based on ETP's past performance. For example, ETP's consolidated financial statements have been retrospectively adjusted to reflect consolidation of the Southern Union Company ("Southern Union") into ETP beginning March 26, 2012 (the date ETE acquired Southern Union) and the consolidation of Sunoco, Inc. ("Sunoco") beginning October 5, 2012 (the date ETP acquired it). These consolidations were enabled by the formation of a company called ETP Holdco ("Holdco"), an entity that was owned 40% by ETP and 60% by its general partner, Energy Transfer Equity L.P. ("ETE"). Subsequent to 1Q13 (on April 30, 2013), ETP acquired ETE's 60% stake in Holdco for $3.75 billion (consisting of 2.35 billion newly issued ETP common units and $1.4 billion in cash). Also on that date, Holdco spun out to RGP its interest in Southern Union Gathering Company ("SUGS"), one of Southern Union's subsidiaries, for $1.5 billion (consisting of $750 million of newly issued RGP units, $150 million of new RGP Class F units, and $600 million in cash). Net of closing adjustments for these two transactions, ETP paid ~$800 million using its revolving credit facility.
Revenues, operating income and net income data are provided in Table 1 below. I generally review TTM numbers, but in ETP's case a TTM comparison of these parameters is not really useful given the changes in the businesses owned by ETP and the manner in which it accounts for them. In order to enable more meaningful comparisons I included in this Table 4Q12 data and pro-forma 1Q12 data. This pro-forma data incorporates Sunoco and Southern Union historical results, as well as the deconsolidation of the propane business following its contribution by ETP to AmeriGas Partners, L.P. (NYSE:APU) in January 2012 in return for ~$1.46 billion in cash and ~29.6 million APU units:
Table 1: Figures in $ Million except units outstanding
Table 1 shows operating income and net income improved in 1Q13 compared to 4Q12. Operating income was also higher compared the 1Q12 pro-forma results but I don't know what portion of that would have been attributable to non-controlling interests.
Segment Adjusted EBITDA is a metric developed by ETP management to measure the core profitability of its operations. Segment Adjusted EBITDA forms the basis of ETP's internal financial reporting and is one of the performance measures used by senior management in deciding how to allocate capital resources among business segments. The data is summarized in Table 2 below:
Table 2: Figures in $ Millions
Interstate transportation and storage revenues increased primarily due to the consolidation of Southern Union's transportation and storage operations beginning March 26, 2012. The main asset purchased via the $2 billion Southern Union acquisition was a 50% joint venture interest in Citrus Corp., an entity that owns 100% of the FGT pipeline system (a 5,400 mile pipeline system that extends from south Texas through the Gulf Coast to south Florida). The other 50% of FGT is owned by Kinder Morgan, Inc. (NYSE:KMI).
Segment Adjusted EBITDA contributed via the $5.3 billion Sunoco acquisition (consisting of 55 million ETP Common Units and $2.6 billion in cash and completed October 5, 2012) is split in two: "Investment in Sunoco Logistics" and "Retail Marketing". The former includes the operations of Sunoco Logistics Partners L.P. ("SXL"). The latter includes the Sunoco retail operations (gas stations and convenience stores in 25 states). ETP's interests in SXL consist of a 2% general partner interest, 100% of the incentive distribution rights ("IDR") and 33.53 million SXL units representing ~32% of the limited partner interests as of December 31, 2012.
The "All other" segment includes ETP's compression operations, its equity method investment in APU, Southern Union's distribution operations, a ~30% non-operating interest in PES, a joint venture that owns a refinery in Philadelphia, and the wholesale propane businesses. In 1Q12 and the TTM ending 3/31/12 this segment consisted primarily of: 1) the natural gas compression operations; 2) Southern Union's local distribution operations beginning March 26, 2012; 3) Sunoco's ~30% non-operating interest in PES; and 4) the retail propane operations prior to its contribution to APU in January 2012 and the investment in APU for the balance of the period.
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". ETP's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow". Using ETP's definition, DCF for the TTM ended 3/31/13 was $1,839 million ($6.80 per unit), up from $1,092 million ($5.05 per unit) in the prior year period.
Table 3 below shows sustainable DCF increased substantially in 1Q13 and the TTM ended 3/31/13 compared to the prior year periods. It also provides a comparison between sustainable DCF and the DCF number reported by management:
Table 3: Figures in $ Millions
The principal differences between reported DCF and sustainable DCF relate to working capital and to risk management activities.
Under ETP's definition, reported DCF always excludes working capital changes, whether positive or negative. My definition of sustainable DCF only excludes working capital generated (I deduct working capital consumed). Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the MLP should generate enough capital to cover normal working capital needs. On the other hand, cash generated by the MLP through the liquidation or reduction of 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. In the TTM ending 3/31/12 working capital consumed $611 million. Management adds back working capital consumed in deriving reported DCF while I do not.
The $71 million adjustment for risk management activities in the TTM ending 3/31/13 consists primarily of adjustments from derivative activities relating to interest rate swaps and commodity price fluctuations. Management adds back these losses in calculating reported DCF. I do not do so when calculating sustainable DCF.
Coverage ratios are presented in Table 4 below:
Distributions actually made increased in total dollars but remained constant ($0.89375 per quarter) on a per unit basis for the periods under review. This is due to three main factors. First, the number of ETP units outstanding has increased by ~30% between 1Q12 and 1Q13; second, the increasing amount that must be distributed to joint venture partners (the non-controlling interests); and third because the amount now includes SXL distributions (~$85 million in 1Q13).
While coverage ratio based on reported DCF exceeded 1x in 1Q13, sustainable DCF coverage (which takes into account the need to invest $303 million in working capital) remains below that threshold number. I would not wish to see distributions increased until the increase can be sustained. Based on the most recent numbers, we are not there yet. A review of the simplified cash flow statement in Table 5 below further illustrates this point:
Simplified Sources and Uses of Funds
Table 5: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests fell short of covering distributions by $221 million in 1Q13. However, if we net out the $217 increase in cash balance in the period we see the shortfall was very small.
Applying the same analysis to the TTM ended 3/31/13 shows net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests fell short of covering distributions by $623 million in the TTM ended 3/31/13. Netting out the $359 increase in cash balance means the shortfall was $264 million. So for the TTM period ending 3/31/13 distributions were partially funded by issuing debt and limited partnership units.
In any event, the cash flow situation is still too tight in my view to warrant a distribution increase. All the more so when one considers ETP's capital structure. Increasing distributions is very costly from a cash flow standpoint because of the general partner's incentive distribution rights ("IDR"). The IDRs entitle the general partner to 48% of amounts distributed in excess of $0.4813 per unit per quarter. Given the ~300 million units outstanding, if the quarterly distribution rate increases by 5% this will require generating ~$28 million of additional DCF in the quarter. This is equivalent to an almost 9% increase in sustainable DCF using 1Q13 numbers- not a minor burden.
ETP's current yield is at the high end of the MLPs I cover universe. A comparison is provided in Table 6 below:
As of 05/14/13:
Magellan Midstream Partners (NYSE:MMP)
Plains All American Pipeline (NYSE:PAA)
Enterprise Products Partners (NYSE:EPD)
El Paso Pipeline Partners (NYSE:EPB)
Targa Resources Partners (NYSE:NGLS)
Kinder Morgan Energy Partners (NYSE:KMP)
Buckeye Partners (NYSE:BPL)
Williams Partners (NYSE:WPZ)
Boardwalk Pipeline Partners (NYSE:BWP)
Regency Energy Partners
Energy Transfer Partners
Suburban Propane Partners (NYSE:SPH)
From a price per unit standpoint, year-to-date ETP's unit price is up ~17% vs. ~23% for SPH, ~22% for RGP and ~24% for BWP. For additional metrics comparing the MLPs in Table 6 see Performance Comparison of Selected MLPs.
ETP needs to pay off the ~$800 million of revolving credit debt used to finance the Holdco acquisition (net of amounts received from RGP). In addition, for the remaining 3 quarters of 2013 ETP expects to spend ~$1570 million on capital expenditures ($1,250 million to fund growth net of RGP's $100 million contribution to Lone Star and ~$320 million for maintenance). Although ETP is not yet generating excess cash which could help fund these capital expenditures, it does have $1.3 billion worth of APU units that are not a core asset and could be disposed of if agreement can be reached to do so in an orderly manner. The sale of Southern Union's utility operations to the Laclede Group will generate ~$1 billion. In addition to the $528 million of cash on the balance sheet as of 3/31/13, $657 million generated on April 10, 2013, upon the issuance of 13.8 million units at $48.05. But even if we annualize the record breaking ~$898 million of EBITDA achieved in 1Q13, long-term debt is at ~4.5x EBITDA. This level is quite high and even more so when measured on a TTM basis, as is more traditionally done.
My concerns regarding ETP revolve around: 1) sustainable DCF still not covering distributions and therefore remaining uncertainty regarding distribution growth; 2) the structural complexities (these remain, although recent transactions are a step forward); 3) the high burden created by the IDRs (notwithstanding temporary waivers and reductions by ETE): 4) the need to get rid of non-core assets (APU units, the Sunoco retail operations); and 5) the relatively high debt burden; and 6) the continuing dilution through large issuances of limited partner units.
Disclosure: I am long EPB, EPD, ETP, ETE, PAA, SPH, WPZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.