This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Williams Partners, L.P. (WPZ), evaluates the sustainability of its Distributable Cash Flow ("DCF"), and assesses whether WPZ is financing its distributions via issuance of new units. 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.
Effective January 1, 2013, management reorganized the businesses into geographically based operational areas. WPZ's reorganized reportable segments are as follows:
Northeast G&P: this midstream gathering and processing segment is in the early stages of developing large-scale energy infrastructure solutions for the Marcellus and Utica shale regions. It also includes a 51% equity investment in Laurel Mountain Midstream, LLC ("Laurel Mountain") and a 47.5% equity investment in Caiman Energy II, LLC ("Caiman");
Atlantic-Gulf: this segment includes the Transcontinental Gas Pipe Line Company, LLC, WPZ's major interstate natural gas pipeline ("Transco"). It also includes natural gas gathering and processing and crude production handling and transportation in the Gulf Coast region, a 50% equity investment in Gulfstream Natural Gas System L.L.C. ("Gulfstream"), a 60% equity investment in Discovery Producer Services LLC ("Discovery"), and a 51% consolidated interest in Constitution Pipeline Company, LLC ("Constitution").
West: this segment includes gathering, processing and treating operations in New Mexico, Colorado, and Wyoming and WPZ's interstate natural gas pipeline, Northwest Pipeline GP ("Northwest Pipeline").
NGL & Petchem Services: this segment includes WPZ's NGL and natural gas marketing business, an NGL fractionator and storage facilities near Conway, Kansas, a 50% equity investment in Overland Pass Pipeline ("OPPL"), and a ~83.3% interest in an olefins production facility in Geismar, Louisiana, along with a refinery grade propylene splitter and pipelines in the Gulf Coast region.
TTM segment operating income numbers based on the new reporting segments are not available. Table 1 below compares segment performance in the 3 and 6 months ended 6/30/13 to the comparable periods in 2012:
For four consecutive quarters (up to and including 1Q13), both revenues and operating income showed declines compared to the same period in the prior. It is encouraging to see operating income finally increase compared to the prior year period. Moreover, the increase in 2Q13 over 1Q13 occurred despite continued pressure on processing margins for natural gas liquids ("NGL"). Margins were down 44% from the prior year period and product sale revenues were sharply lower in the West segment. Due to a reduction in drilling in western Colorado during 2012 and so far in 2013, management decided to delay until mid-2016 the in-service date of WPZ's 350MMcf/d cryogenic natural gas processing plant (in Parachute) that was to have been put in service in 2014. Based on less favorable producer economics, a decrease in production and thus a lower supply of natural gas available to gather and process in 2013 is expected in the West segment.
The increase in 2Q13 operating income over 1Q13 is also notable given ~2 weeks of lost production at Geismar olefins plant located south of Baton Rouge. This was due to the June 13, 2013, explosion and fire (the "Geismar Incident") that resulted in the death of two employees and injuries of others. It rendered the facility temporarily inoperable. Management expects to restart the plant in April 2014 and estimates the property damage at $102 million. WPZ has $500 million of business interruption and property damage insurance. The partnership will absorb a $10 million deductible, so $92 million of the property damage will be covered. The remaining $384 of insurance is estimated to cover losses from business interruption through April 2014. But if operations resume later than expected, WPZ may incur losses and may have to revise its guidance downward.
WPZ's revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for the quarters and TTM ending 6/30/13 and 6/30/12 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 2: Figures in $ Millions, except net income per unit and units outstanding
Of course, care must be taken not to make too much of an improvement in one quarter's operating income results, but the 2Q13 uptick should not be ignored in light of the significant deterioration in per unit EBITDA and net income in the 3 and 12 months ended 6/30/13 shown in Table 2. Ethane exposure has contributed significantly to the poor results. Sharp declines in NGL prices (e.g., ~23% percent lower in 2012 than in 2011, ~21% lower in 1Q13 vs. 4Q12, 44% lower in 2Q13 vs. 2Q12) have pushed down processing margins. Reduced processing margins led to ethane rejection and thus generated lower equity volumes under keep-whole agreements and percent-of-liquids arrangements. WPZ provides natural gas gathering and processing services under fee contracts (volumetric-based), keep-whole agreements and percent-of-liquids arrangements. A glossary of terms provides further explanations of these terms and of ethane rejection. Under keep-whole and percent-of-liquid processing contracts, WPZ retains the rights to all or a portion of the NGLs extracted from the producers' natural gas stream (these are the equity volumes referred to above). It recognizes revenues when the extracted NGLs are sold and delivered. Lower NGL prices coupled with lower volumes produce lower revenues, lower operating income and lower net income.
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". WPZ's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow". Using WPZ's definition, DCF for the TTM ended 6/30/13 was $1,605 million ($4.15 per unit) vs. $1,580 million ($5.20 per unit) in the prior year period.
Table 3 below provides a comparison between reported and sustainable DCF:
Table 3: Figures in $ Millions
The gap between reported DCF and sustainable DCF shown under "other" includes acquisition-related and reorganization-related costs, certain reimbursements from WMB and the excess cash flow over earnings from WPZ's equity investments. A significant portion of the TTM differences reflect pre-acquisition cash flows allocated to Williams Companies, Inc. (WMB), the general partner of WPZ. These totaled $78 million in the TTM ending 6/30/13 and $173 million in the TTM ending 6/30/12.
WPZ increased 2Q13 distributions to $0.8625 (up ~2% from 1Q13 and up ~9% from 2Q12). I calculate the coverage ratios in Table 4 below in two ways: first based on the actual distributions made (e.g., the distribution announced for 1Q13 was actually made in 2Q13); second, based on declared distributions (e.g., assuming the distribution declared for 2Q13 had been made in 2Q13). TTM numbers tends to be more meaningful than quarterly numbers for the purpose of coverage ratios. However, I present both:
Table 4: $ millions, except coverage ratios
The low coverage ratios reflect the decline in NGL prices and also the rapid growth in the number of units outstanding as a result of issuing equity to partially finance large drop-down acquisitions. The number of units outstanding has increased 23% from 2Q12 to 2Q13. On 8/2/13 WPZ issued 21.5 million additional units raising over $1 billion, albeit at a sharply lower price vs. the pre-announcement unit price.
To see whether WPZ is financing its distributions via issuance of new units it is 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 WPZ:
Simplified Sources and Uses of Funds
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $39 million in the TTM ending 6/30/13 and by $582 million in the prior year period. So while key performance parameters have deteriorated, distributions in the TTM ending 6/30/13 were not funded through the issuance of additional equity. This is not in contradiction with the below-1 coverage ratios shown in Table 4 because WPZ has been able to generate cash by reducing working capital. Granted, this is not a sustainable source but it provided ~$266 million in that period.
Management has lowered its DCF and DCF coverage guidance several times over the past year or so. This can be seen in Table 6 below:
Management's decision to significantly dilute unitholders in executing two transformative transactions, in conjunction with an adverse NGL pricing environment and its decisions, despite all that, to increase distributions has brought about significant shortfalls in DCF coverage. Given that poor operational performance has been coupled with an unrelenting pace of equity issuances ($490 million in 1Q12, $1,581 million in 2Q12, $488 million in 3Q12, ~$760 million in 1Q13 and over $1 billion in August 2013), it is not surprising that the unit price has languished (WPZ unit price is up only ~2.2% year-to-date, far less than many other MLPs). On top of that, the Geismar Incident has increased WPZ's risk profile and unitholders likely face further dilution through additional issuances between now and 2015.
On the other hand, WPZ is making huge growth capital investments (~$3.7 billion in 2013) the bulk of which are devoted to the Northeast G&P and the Atlantic-Gulf segments. If achieved, the ~66% DCF increase in DCF projected to materialize from 2013 to 2015 will reward patient investors. Relative to the magnitude of the opportunity, WPZ seems reasonably priced and its yield compares favorably with many of the other MLPs I cover:
As of 08/03/13:
Magellan Midstream Partners (MMP)
Enterprise Products Partners (EPD)
Plains All American Pipeline (PAA)
Targa Resources Partners (NGLS)
Buckeye Partners (BPL)
El Paso Pipeline Partners (EPB)
Kinder Morgan Energy Partners (KMP)
Regency Energy Partners (RGP)
Boardwalk Pipeline Partners (BWP)
Energy Transfer Partners (ETP)
Suburban Propane Partners (SPH)
There is significant potential in the Northeast shales (Marcellus and Utica) where WMB and WPZ have invested heavily and obtained very strong positions. Investors with very strong stomachs who believe in the enormous production and transportation volume growth expected from these shale formations, and have the patience to wait until 2015, may be well rewarded.