Regency Energy Partners LP (RGP) will report results of operations for 2Q 2013 around August 8, 2013. This article focuses on some of the developments investors should be watching for.
2Q13 will include 2 months of contributions from RGP's acquisition of Southern Union Gathering Company, LLC, the owner of Southern Union Gas Services, Ltd. ("SUGS"), from a jointly owned affiliate of Energy Transfer Equity, L.P. (ETE) and Energy Transfer Partners, L.P. (ETP). The ~$1.5 billion acquisition closed on April 30, 2013 and will significantly expand RGP's presence in the Permian Basin (west Texas). SUGS will be folded into the Gathering and Processing segment.
Revenues have shown declines in each of the past 4 quarters compared to the same period in the prior year, as shown in Table 1 below. I expect the SUGS contribution will help reverse this trend in 2Q13.
Table 1: Figures in $ Millions, except % changes
RGP uses "Segment Margin" as one of its key metrics to measure operating performance; it generally equals revenues less cost of sales. Segment margins for the past 8 quarters are summarized in Table 2 below:
Table 2: Segment Margin in $ Millions, except % changes
I expect the SUGS contribution will drive Segment Margin up modestly in 2Q13.
Improvements in Segment Margins are not necessarily accompanied by increases in operating income, principally due to higher operations & maintenance charges and to higher depreciation charges. These can cause sharp fluctuations in operating income, as can be seen in Table 3 below:
Table 3: Figures in $ Millions, except % changes
EBITDA (earnings before interest, depreciation & amortization and income tax expenses) has declined in each of the past 3 quarters compared to the same period in the prior year. The Adjusted EBITDA numbers present a different picture, as shown in Table 4 below:
Table 4: Figures in $ Millions, except % changes
The principal difference between EBITDA and Adjusted EBITDA relates to RGP's substantial, but non-controlling, stakes in other pipelines (e.g., a 49.99% general partner interest in HPC; a 50% membership interest in MEP; and a 30% membership interest in Lone Star). For purposes of calculating Adjusted EBITDA, RGP treats these as if they were fully consolidated by deducting its share of net income, adding its share of the earnings before interest, taxes, depreciation & amortization (EBITDA), and further adjusting to take into account its share of interest expense and maintenance capital expenditures.
On the one hand, I can accept RGP's adjustments to EBITDA because these other pipelines are similar in every respect to the pipeline assets RGP controls. On the other hand, as noted in a prior article, the cash flows attributed by RGP to these non-controlled entities do not appear on RGP's cash flow statement and do not increase RGP's end-of-period cash balance.
RGP uses Adjusted EBITDA as the starting point in determining distributable cash flow ("DCF"). Investors should carefully review the adjustments to be reported for 2Q13 to see whether there are other significant items that could affect their assessment of RGP's ability to maintain or grow distributions. For example, $18 million of the $49 million difference between EBITDA and Adjusted EBITDA in 1Q13 reflected losses related to from commodity and embedded derivatives.
The 2Q13 EBITDA and Adjusted EBITDA numbers should also be reviewed on a per unit basis, especially given the declines in recent quarters compared to the prior year periods. The per unit numbers in the past 8 quarters are shown in Table 5 below:
Table 5: Weighted average units outstanding in millions
Following publication of 1Q13 results, management stated RGP is "poised for significant earnings and volume growth for the remainder of this year. The completion and ramp up of all of our growth projects is expected to support our goals of improving coverage ratios and positioning Regency for future distribution growth." The language appears to have been carefully crafted to avoid committing to increased distributions. It will be interesting to see whether 2Q13 results indicate whether even the more modest goal of improving coverage ratios is going to be achieved in the near future. One reason for my skepticism is the sharp increase in the number of units outstanding.
RGP financed the SUG acquisition by issuing approximately 31.4 million new units and approximately 6.3 million of newly created Class F common units to Southern Union Company (SUG) (the latter are substantially equivalent to common units except they will not receive distributions for the equivalent of eight consecutive quarters post-closing). The cash portion of the consideration, which was $600 million, less $107 million of estimated closing adjustments, was funded from the proceeds of senior notes.
The 2Q13 report will provide the first indication of how the higher unit count is impacting RGP.
I previously expressed the opinion that SUGS is unlikely to contribute much to RGP's ability to increase distributions until 2015 or 2016. I will reassess this once 2Q13 results are published.
Table 6 below shows how RGP's current yield of 6.72% compares with some of the other MLPs I cover:
As of 7/12/13:
Magellan Midstream Partners (MMP)
Enterprise Products Partners (EPD)
Plains All American Pipeline (PAA)
Targa Resources Partners (NGLS)
El Paso Pipeline Partners (EPB)
Buckeye Partners (BPL)
Kinder Morgan Energy Partners (KMP)
Williams Partners (WPZ)
Regency Energy Partners
Boardwalk Pipeline Partners (BWP)
Energy Transfer Partners (ETP)
Suburban Propane Partners (SPH)
The RGP report being issued around August 8 will not contain sufficient information to enable a DCF analysis. I will compare reported to sustainable DCF a few weeks later, once RGP provides the necessary information as part of its quarterly report on Form 10-Q.
In the meantime, my concerns regarding RGP remain centered on the low DCF coverage ratios, the relatively high leverage, the high price paid for SUGS, the low likelihood of a resumption of distribution growth, and my discomfort with the structural complexity surrounding ETE and ETP. I would not buy RGP despite the attractive yield and despite the potential for its acquisition by ETP.