This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Plains All American Pipeline L.P. (PAA) 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 PAA'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:
Table 1: Figures in $ Millions
Segment performance is shown in Table 2 below. Unlike the Facilities and Transportation segments that are predominantly fee-based businesses, a substantial portion of Supply & Logistics is margin based and hence results are more volatile. In February 2013, PAA increased its 2013 Adjusted EBITDA guidance by $100 million to $2,025 million, but still a lower number than the $2,107 million achieved in 2012. This was because management looked at 2012 as a year in which market conditions were extremely favorable for the Supply and Logistics segment, and assumed there would be a "return to baseline." In May 2013, PAA increased its 2013 guidance by another $135 million because rather than returning to "baseline," Supply and Logistics segment performance improved dramatically in 1Q13. The anticipated decrease occurred in 2Q13, and this segment's profit fell below the level achieved in 2Q12.
Table 2: Figures in $ Millions
Supply & Logistics 2Q13 segment profit was also far below the extraordinary $434 million level achieved in 1Q13. Nevertheless, on 8/5/13 PAA increased its 2013 Adjusted EBITDA guidance a further $30 million (to $2,190 million at mid-point). The revised guidance assumes lower performance levels in the Supply and Logistics segment in the second half of the year. Guidance for 2013 Adjusted EBITDA is therefore lower than the $2,239 million achieved in the TTM ended 6/30/13.
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." PAA's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow." Using PAA's definition, DCF for the TTM ended 6/30/13 was $1,718 million ($5.09 per unit), up from $1,385 million ($4.43 per unit) in the prior year period.
Table 3 below shows sustainable DCF increased by ~$139 million (9%) on a TTM basis. Over the same period, reported DCF by $334 million (24%). The table provides a comparison between the components of reported and sustainable DCF:
The principal differences between reported DCF and sustainable DCF relate to risk management activities and a variety of items grouped under "Other."
The $137 million adjustment for risk management activities in the TTM ending 6/30/13 consists primarily of adjustments from derivative activities relating to interest rate swaps, foreign currency exchange rate changes and commodity price fluctuations. Management adds back these losses in calculating reported DCF. I do not do so when calculating sustainable DCF.
The $115 million adjustment for "Other" items in the TTM ending 6/30/13 consists of non-cash compensation and distributions in excess of earnings from unconsolidated investments. The prior year period includes a particularly large ($121 million) inventory valuation adjustment made in 2Q12. Again, management adds back these items in calculating reported DCF. I do not do so when calculating sustainable DCF.
PAA's most recent (8/5/13) DCF guidance for 2013 remains essentially unchanged from the level set in May and stands at $1,564 (mid-point). It is lower than the $1,718 million achieved in the TTM ended 6/30/13 for the same reasons outlined in the discussion of segment profits following Table 2.
As indicated by Table 3, the differences between reported and sustainable DCF can be pronounced. This, of course, impacts coverage ratios, as indicated in Table 4 below. 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 extraordinarily high coverage ratios are expected to drop as the effect of the above-normal results produced by the Supply & Logistics segment in 2012 dissipates. Management rightfully did not sharply increase distributions in light of the evaluation that the profit generated by this segment is "too good to continue." For the TTM ending 6/30/13, per unit DCF increased 14.9% over the prior year period, while distributions declared increased 9.8%. The 2Q13 distribution of $0.5875 represents a 10.3% increase over the 2Q12 amount and a 2.2% increase over the 1Q13 amount.
Table 5 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
Table 5: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-controlling partners exceeded distributions by $986 million in the TTM ending 6/30/13 and by $725 million in the prior year period. Clearly PAA is not using cash raised from issuance of debt and equity to fund distributions. On the contrary, the excess cash generated constitutes a significant source of capital for PAA and enables it to reduce reliance on the issuance of additional partnership units that dilute existing holders, or issuance of debt to fund expansion projects. Absent significant acquisition activity, management does not expect to execute an equity offering during the remainder of 2013 or 2014 (although funds will be raised via the continuous equity offering program).
PAA's current yield is at the low end of the MLP universe. A comparison to some of the MLPs I follow is provided in Table 6 below:
As of 08/16/13:
Magellan Midstream Partners (MMP)
Plains All American Pipeline
Enterprise Products Partners (EPD)
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)
On July 29, 2013, PAA's general partner filed a preliminary prospectus with the SEC. The plan is to raise an amount estimated at over $1 billion via an initial offering to the public of shares in PAA's general partner. Funds raised via this IPO (initial public offering) will be distributed to the existing owners of the general partner. These include PAA Management, L.P., entities affiliated with Occidental Petroleum Corporation, The Energy & Minerals Group, and Kayne Anderson Investment Management Inc.
I view this as a negative development because I believe it reduces the likelihood that PAA's significant cost of capital disadvantage when compared to peers like EPD and MMP will be addressed. This disadvantage is due to a capital structure that provides incentive distribution rights ("IDR") to the general partner. The IDRs entitle the general partner to 48% of amounts distributed in excess of $0.3375 per unit. Therefore at the current distribution rate of $0.5875 per quarter, each additional unit issued consumes ~$0.93 of DCF per quarter. This is a heavy burden that pushes up PAA's cost of capital and is a major negative factor in large acquisitions, which, under current market conditions, command high multiples and require lengthy time periods to generate the projected synergies. In my view, an IPO of PAA's general partner makes it less likely that the IDRs will be eliminated. At the very least, it pushes back the timetable for, and increases the cost of, merging the general partner entity into PAA.
In addition, PAA's general partner has, in the past, approved IDR reductions totaling $106 million in the aggregate in connection with the closing of four prior PAA acquisitions. Such approvals may be harder to obtain from a GP that is a publicly traded corporation. Public ownership of the general partner may also lead to acquisitions of general partner interests in other (i.e., non-PAA) MLPs. This could lead to reductions in the time and attention devoted to running PAA. It will also be more tempting to undertake "simplification" transactions with built-in conflict of interest issues, such as moving the general partner interest in PAA Natural Gas Storage, L.P. (PNG) from PAA to its general partner. EPD and MMP have eliminated this structural impediment. Year-to-date, both have outperformed PAA from a price per unit standpoint. PAA's unit price is up ~15.7% vs. ~18.4% for EPD and ~26.9% for MMP.