This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Enterprise Products Partners L.P. (EPD) 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. In addition, each MLP may define these terms differently, making comparison across MLPs very difficult. In an article titled "Distributable Cash Flow" I present EPD's definition and also provide definitions used by other MLPs.
Estimating sustainable DCF is an exercise that must be undertaken in conjunction with evaluating an MLP's growth prospects. Sustainable distributions coverage provides some protection in a downside scenario. When faced with such a scenario, MLPs that cannot maintain their distributions, or are totally reliant on debt and equity to finance growth capital, are likely to suffer significantly greater price deterioration.
Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA), and DCF for the periods under review 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:
Fluctuations in revenues and cost of sales amounts are explained, in part by, changes in energy commodity prices, especially those for natural gas liquids ("NGL"), natural gas and crude oil. Energy commodity prices in 2012 were lower than they were in 2011 (by ~23% for NGLs, by ~31% for natural gas, and by ~1% for crude oil). The trend continues in 2013. The weighted average indicative NGL market price was down ~24% in 1Q13 vs. 1Q12 and down ~13% ($0.95 vs. $1.09 per gallon) in 2Q13 vs. 2Q12. However, lower commodity prices also decrease the associated cost of sales as purchase cost drop. Hence EPD's focus on operating margins rather than revenues.
Ethane accounts for the largest volume of NGLs extracted from the natural gas stream (~40% of NGLs produced from natural gas processing and fractionation operations) and its production has increased more rapidly than the ethylene industry's current capability to consume the increase in supplies. This oversupply situation has contributed to a significant decrease in average ethane prices since the beginning of 2012, to ethane rejection by producers and natural gas processors in an effort to balance supply and demand, to lower the value of EPD's equity NGL production, and to reductions in the volumes that would otherwise be handled by EPD's NGL fractionators and pipelines.
All this adversely impacts NGL Pipelines & Services. This segment includes EPD's natural gas processing plants and related NGL marketing activities, ~16,700 miles of NGL pipelines, NGL and related product storage facilities, 14 NGL fractionators and NGL import and export terminal operations. Segment revenues, summarized in Table 2 below, illustrate the decline in NGL Pipeline Services revenues in the TTM periods under review.
Table 2: Figures in $ Millions
Much of the improvement in EPD's total gross margins in 2Q13 and the TTM ended 6/30/13 is attributed to Onshore Crude Oil Pipelines Services. This segment benefited from increased crude oil production and transportation volumes from the Eagle Ford Shale, Permian Basin and Rocky Mountains regions, as shown in Table 3 below:
Key drivers of the improvement in Onshore Crude Oil Pipelines Services segment include a new 24-inch pipeline within the South Texas Crude Oil Pipeline System that began service in June 2012 and the Seaway Pipeline that was reversed in June 2012 and was fully powered up during 1Q13. These accounted for 83% of the increase in the segment's gross operating margin in 2Q13.
Total segment gross operating margin in Table 3 above is defined by EPD as operating income before: (1) depreciation, amortization and accretion expenses; (2) non−cash asset impairment charges; (3) operating lease expenses for which it did not have the payment obligation; (4) gains and losses from sales of assets and investments; and (5) general and administrative costs.
EPD reported DCF for the TTM ended 6/30/13 was $3,450 million ($3.81 per unit), down from $4,790 million ($5.45 per unit) in the prior year 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." A comparison between reported and sustainable DCF is presented in Table 4 below:
The principal difference for the decline in reported DCF in the TTM periods under review relates to EPD's proceeds from asset sales ($241 million vs. $1,960 million). The bulk of the prior year amount is accounted for by the sale of EPD's ownership interests in the Crystal natural gas storage facilities (located in Petal and Hattiesburg, Mississippi) for ~$548 million and the sale of 36 million Energy Transfer Partners, LP (ETE) units for ~$1,351 million. The $241 million proceeds from asset sales in the TTM ended 6/30/13 include those generated by the sale of the Stratton Ridge-to-Mont Belvieu segment of the Seminole Pipeline (~$87 million), the sale of lubrication oil and specialty chemical distribution assets (~$35 million), the sale of chemical trucking assets (~$30 million), and from the sale of marine transportation assets (~$15 million). As readers of my prior articles are aware, I do not include proceeds from asset sales in my calculation of sustainable DCF. As shown in Table 4, sustainable DCF increased significantly in the periods under review.
Another principal difference between reported DCF and sustainable DCF relates to risk management activities. The $239 million downward adjustment for the TTM ended 6/30/13 reflects monetization of interest rate derivative instruments. I generally ignore cash generated or consumed by interest rate hedging activities in calculating sustainable DCF. EPD accounts for these losses as a component of "accumulated other comprehensive income" and amortizes them to earnings (as an increase in interest expense) over ten years.
Finally, reported DCF for the TTM ending 6/30/13 includes $711 million of cash consumed by working capital needs that management added back. Under EPD's definition, reported DCF always excludes working capital changes, whether positive or negative. In contrast, as detailed in my prior articles, in deriving sustainable DCF I generally do not add back working capital used but, on the other hand, I exclude working capital generated. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the master limited partnerships should, on the one hand, generate enough capital to cover normal working capital needs. On the other hand, cash generated from 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. I therefore do not add working capital consumed to net cash provided by operating activities in deriving sustainable DCF.
TTM numbers tends to be more meaningful than quarterly numbers for the purpose of coverage ratios. However, I present both. As indicated in Table 5 below, sustainable DCF coverage ratios appear strong:
Table 6 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:
Simplified Sources and Uses of Funds
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-controlling interests exceeded distributions by $474 million in the TTM ending 6/30/13 and by $464 million in the comparable prior year period. EPD is not using cash raised from issuance of debt and equity to fund distributions. On the contrary, the excess cash it generates enables EPD to reduce reliance on the issuance of additional partnership units or debt to fund expansion projects. Absent an acquisition, EPD management does not expect to be issuing additional partnership units in 2013. Internal cash generation and the balance sheet's debt capacity should be sufficient to fund growth capital expenditure requirements.
Of the $96 million capital contribution from non-controlling interests in 2Q13, ~$90 million reflects the amount paid by Western Gas Partners, LP (an affiliate of Anadarko Petroleum) for a 25% stake in a joint venture EPD (75% stake) that will own 2 new NGL fractionators at Mont Belvieu.
EPD recently announced its 36th consecutive quarterly cash distribution increase to $0.68 per unit ($2.72 per annum), a 1.5% and 7.1% increase over the distribution declared with respect to 1Q13 and 2Q12, respectively. EPD's current yield is at the low end of the MLPs I follow:
As of 08/09/13:
Magellan Midstream Partners (MMP)
Plains All American Pipeline (PAA)
Enterprise Products Partners
Targa Resources Partners (NGLS)
El Paso Pipeline Partners (EPB)
Buckeye Partners (BPL)
Kinder Morgan Energy Partners (KMP)
Regency Energy Partners (RGP)
Energy Transfer Partners (ETP)
Williams Partners (WPZ)
Boardwalk Pipeline Partners (BWP)
Suburban Propane Partners (SPH)
Overall, major capital projects in which EPD had invested $2.9 billion were completed and put into service in 2012 (i.e., started generating fee-based cash flows). Management expects to complete another $2.6 billion of projects in 2013, of which $1.1 billion was completed through 6/30/13 and $1.5 billion is to be completed in 2H13. Management expects an additional $4.8 billion of projects under construction to be completed in 2014 and ~$.5 billion in 2015. The revenues from these projects will be predominantly fee-based and supported by long-term contracts.
EPD's breadth of operations and diversification is expressed through an asset portfolio that includes ~50,000 miles of onshore and offshore pipelines, 200 MMBls of storage capacity for NGLs, petrochemicals, refined products and crude oil, 14 billion cubic feet of natural gas storage capacity, 24 natural gas processing plants, 21 NGL and propylene fractionators, six offshore hub platforms located in the Gulf of Mexico, a butane isomerization complex, NGL import and export terminals, and octane enhancement and high-purity isobutylene production facilities.
I think EPD's premium price is justified on a risk-reward basis given this breadth, as well as EPD's size, strong management team, portfolio of growth projects, structure (no general partner incentive distributions), excess cash from operations, history of minimizing limited partner dilution and performance track record. I consider EPD to be a core MLP holding and would continue to accumulate on weakness.