Targa Resources Partners LP (NGLS) will report results of operations for Q2 2013 before the NYSE opens for trading on Thursday, Aug. 1, 2013. This article focuses on some of the parameters I will look at closely when the report is issued.
NGLS' revenues are principally derived from percent-of-proceeds (POP) contracts under which it receives a portion of the natural gas and/or natural gas liquids as payment for its gathering and processing services. POP contracts share price risk between the producer and processor. Operating income generally increases as natural gas prices and natural gas liquid prices increase, and decreases as they decrease.
Revenues have shown declines in each of the past four quarters compared to the same period in the prior year, as shown in the table below. It will be interesting to see if Q2 2013 breaks the trend.
Table 1: Figures in $ Millions, Except % Changes
Another metric of note in Table 1 is the growth in midstream services fee income. This portion of the revenue stream is important because it serves to mitigate the impact of fluctuations in commodity prices on NGLS' results and to enhance both gross and operating margin percentages. Fee-based operating margin accounted for ~46% of total operating margin in Q4 2012 and ~53% in Q1 2013. It is expected to continue to increase to 55%-65%+ over next several years.
Gross margin is defined by NGLS as revenues less purchases, while operating margin is defined as gross margin less operating expenses. Table 2 highlights both these margin percentages over the past eight quarters. It shows that operating margin has declined, in absolute dollar terms, in each of the past four quarters compared to the same period in the prior year. It will be interesting to see if Q2 2013 breaks the trend.
Table 2: Operating Margin in $ Millions, Except % Changes
EBITDA (earnings before interest, depreciation and amortization and income tax expenses) has also declined in each of the past four quarters compared to the same period in the prior year. With the exception of Q3 2012, the same is true of adjusted EBITDA, as shown in Table 3 below:
Table 3: Figures in $ Millions, Except % Changes
NGLS derives adjusted EBITDA by adding or deducting to or from EBITDA gains or losses on: a) debt repurchases and redemptions; b) early debt extinguishments; and c) asset disposals. It also excludes non-cash risk management activities related to derivative instruments and, with respect to Q1 2013, changes in the fair value of the Badlands acquisition contingent consideration
Management's 2012 guidance for adjusted EBITDA was $515-$550 million. NGLS was able to reach the low end of this target. The midpoint of the 2013 adjusted EBITDA guidance is $625 million, up 10%-15% from the midpoint of the initial range of $540-$575 million to take into consideration expected contribution from the Bakken Shale Midstream acquisition (Saddle Butte Pipeline, renamed Targa Badlands). In Q2 2012, NGLS reached 52% of the low end of its 2012 adjusted EBITDA guidance. Reaching 52% of the low end of the 2013 adjusted EBITDA guidance ($595 million) by midyear requires ~$177 million adjusted EBITDA in Q2 2013. To the extent this is not achieved, the burden placed on management in Q3 2013 and Q4 2013 will become much heavier.
The Q2 2013 EBITDA and adjusted EBITDA numbers should also be reviewed on a per unit basis, especially given the significant increase in the number of units shown in Table 4 below:
Table 4: Figures in Millions, Except % Changes
The impact is shown in Table 5 below:
Table 5: Figures in Millions, Except % Changes
In a prior article, I noted that NGLS was acquiring Targa Badlands at an expensive EBITDA multiple and that the effect would be dilutive. Distributions in 2013 are projected to increase by 10%-12%, so the combination of hard-to-achieve EBITDA targets and higher unit counts will cause distribution coverage to drop.
Management expects Q2 2013 distribution coverage could be somewhat lower than the 0.94x reported for 1Q13 due to historic seasonality in the downstream business. It projects distribution coverage will average ~0.9x in the first half of 2013, but will increase significantly thereafter and end up averaging 1.0x for the entire year. Results for Q2 2013 will provide additional insight on how hard it will be to avoid sharper declines in coverage ratios.
Table 6 below shows how NGLS' current yield of 5.23% compares with some of the other MLPs I cover:
As of July 9, 2013:
Magellan Midstream Partners (MMP)
Enterprise Products Partners (EPD)
Plains All American Pipeline (PAA)
Targa Resources Partners
El Paso Pipeline Partners (EPB)
Buckeye Partners (BPL)
Kinder Morgan Energy Partners (KMP)
Williams Partners (WPZ)
Boardwalk Pipeline Partners (BWP)
Regency Energy Partners (RGP)
Energy Transfer Partners (ETP)
Suburban Propane Partners (SPH)
The report being issued on Aug. 1 will not contain sufficient information to enable an analysis of distributable cash flow (DCF). A comparison of reported to sustainable DCF will be possible a few weeks later, once NGLS issues its quarterly report on Form 10-Q. I will then undertake a DCF analysis. In the meantime, my concerns regarding NGLS remain centered on the expensive acquisition, the low coverage ratio, the high cost of the IDRs, the increased debt level, and the still significant exposure to commodity prices. I also believe developing the infrastructure for the Bakken shale is more risky than the Texas shale plays and the Marcellus shale.