In a prior article dated July 17, I concluded that if Energy Transfer Partners, L.P. (NYSE:ETP) sustains or improves its Segment Adjusted EBITDA and generates ~$600 million of Distributable Cash Flow ("DCF") in 2Q13, we may see a modest distribution increase. This article analyzes ETP's second quarter report and looks "under the hood" to properly ascertain DCF sustainability and assess whether these objectives have been reached.
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 and each MLP may define the terms differently, making comparison across MLPs very difficult.
In the case of ETP, the level of complexity is particularly high for several reasons. One is that in 4Q12 management changed its definition of Segment Adjusted EBITDA to reflect amounts for less than wholly owned subsidiaries based on 100% of the subsidiaries' results of operations. In prior periods, amounts for less than wholly owned subsidiaries were reflected in Segment Adjusted EBITDA based on ETP's proportionate ownership, such that the measure was reduced for amounts attributable to non-controlling interests. In periods prior to 4Q12, NGL Transportation and Services was the only segment that included a less than wholly owned subsidiary - the Lone Star joint venture. Lone Star is 70% owned by ETP and 30% by Regency Energy Partners, L.P. (NYSE:RGP). It operates natural gas liquids storage, fractionation and transportation assets in Texas, Louisiana and Mississippi. In 2Q13, Segment Adjusted EBITDA includes not only 100% of Lone Star but also 100% of the Florida Gas Transmission Pipeline ("FGT") and 100% of the Fayetteville Express Pipeline ("FEP"), even though ETP owns 50% of these latter two ventures and previously accounted for them using the equity method.
The structural changes ETP is undergoing adds another level of complexity and makes it exceedingly difficult to compare across periods, to say nothing of trying to draw forward-looking conclusions based on ETP's past performance. For example, ETP's consolidated financial statements have been retrospectively adjusted to reflect consolidation of the Southern Union Company ("Southern Union") into ETP beginning March 26, 2012 and the consolidation of Sunoco, Inc. ("Sunoco") beginning October 5, 2012. These consolidations were enabled by the formation of a company called ETP Holdco ("Holdco"), an entity that was owned 40% by ETP and 60% by its general partner, Energy Transfer Equity L.P. ("ETE"). On April 30, 2013, ETP acquired ETE's 60% stake in Holdco for $3.75 billion (consisting of $2.35 billion in newly issued ETP common units and $1.4 billion in cash). Also on that date, Holdco spun out to RGP its interest in Southern Union Gathering Company ("SUGS"), one of Southern Union's subsidiaries, for $1.5 billion (consisting of $750 million of newly issued RGP units, $150 million of new RGP Class F units, and $600 million in cash). Net of closing adjustments for these two transactions, ETP paid ~$800 million using its revolving credit facility.
Several significant transactions occurred subsequent to 2Q13. On July 12, ETP sold 7.5 million of the ~26.9 million shares of AmeriGas Partners L.P. (NYSE:APU) received (together with ~$1.46 billion in cash) upon the contribution of its propane business to APU in January 2012. On August 8, ETP and ETE announced ETE's exchange of 50.16 million ETP units for 50% of the incentive distribution rights ("IDR") held by the general partner of Sunoco Logistics Partners L.P. ("SXL"). This general partner is owned by ETP.
I generally review trailing twelve months ("TTM") data, but in ETP's case a TTM comparison of revenue, operating income, income from continuing operations is not meaningful given all the changes in the businesses owned by ETP and the manner in which it accounts for them. But ETP did provide pro-forma data for 2Q12 and the 6-months ending 6/30/12 (1H12). Table 1 below shows ETP's numbers for these periods as adjusted for the sale of the propane business, the Sunoco acquisition, the Southern Union acquisition, and the Holdco transaction.
Table 1: Figures in $ Millions except units outstanding
Table 1 shows operating income and net income from continuing operations modestly improved in the 6-months ended 6/30/13 vs. the prior year period on a per unit basis.
Segment Adjusted EBITDA is a metric developed by ETP management to measure the core profitability of its operations. Segment Adjusted EBITDA forms the basis of ETP's internal financial reporting and is one of the performance measures used by senior management in deciding how to allocate capital resources among business segments. The data is summarized in Table 2 below:
Table 2: Figures in $ Millions, except per unit amounts
Interstate transportation and storage revenues increased primarily due to the consolidation of Southern Union's transportation and storage operations beginning March 26, 2012. The main asset purchased via the $2 billion Southern Union acquisition was a 50% joint venture interest in Citrus Corp., an entity that owns 100% of the FGT pipeline system (a 5,400 mile pipeline system that extends from south Texas through the Gulf Coast to south Florida). The other 50% of FGT is owned by Kinder Morgan, Inc. (NYSE:KMI).
Segment Adjusted EBITDA contributed via the $5.3 billion Sunoco acquisition (consisting of 55 million ETP Common Units and $2.6 billion in cash and completed October 5, 2012) is split in two: "Investment in Sunoco Logistics" and "Retail Marketing." The former includes the operations of SXL. The latter includes the Sunoco retail operations (gas stations and convenience stores in 25 states). ETP's interests in SXL consist of a 2% general partner interest, 100% of the IDRs (as mentioned above, ETE will be acquiring 50%), and 33.53 million SXL units representing ~32% of the limited partner interests as of December 31, 2012.
The "All other" segment includes ETP's compression operations, its equity method investment in APU, Southern Union's distribution operations, a ~30% non-operating interest in PES, a joint venture that owns a refinery in Philadelphia, and the wholesale propane businesses. In 2Q12 and the TTM ending 6/30/12 this segment consisted primarily of: 1) the natural gas compression operations; 2) Southern Union's local distribution operations beginning March 26, 2012; 3) Sunoco's ~30% non-operating interest in PES; and 4) the retail propane operations prior to its contribution to APU in January 2012 and the investment in APU for the balance of the 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." ETP's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow." Using ETP's definition, DCF for the TTM ended 6/30/13 was $2,095 million ($6.95 per unit), up from $1,191 million ($5.39 per unit) in the prior year period.
Table 3 below provides a comparison between sustainable DCF and the DCF number reported by management:
Table 3: Figures in $ Millions
Overall, Table 3 shows that the ~$600 million target for DCF in 2Q13 mentioned in the first paragraph of this article was achieved.
The principal differences between reported DCF and sustainable DCF relate to working capital and to risk management activities.
Under ETP's definition, reported DCF always excludes working capital changes, whether positive or negative. My definition of sustainable DCF only excludes working capital generated (I deduct working capital consumed). Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the MLP should generate enough capital to cover normal working capital needs. On the other hand, cash generated by the MLP through the liquidation or reduction of 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. In the TTM ending 6/30/13 working capital consumed $645 million. Management adds back working capital consumed in deriving reported DCF while I do not.
The $150 million adjustment for risk management activities in the TTM ending 6/30/13 consists primarily of adjustments from derivative activities relating to interest rate swaps and commodity price fluctuations. Management adds back these losses in calculating reported DCF. I do not do so when calculating sustainable DCF.
Coverage ratios are presented in Table 4 below:
Table 4 ($ millions, except ratios)
Distributions actually made increased in total dollars but remained constant ($0.89375 per quarter) on a per unit basis for the periods under review. This is due to three main factors. First, the number of ETP units outstanding has increased by ~36% between 2Q12 and 2Q13; second, the increasing amount that must be distributed to joint venture partners (the non-controlling interests); and third because the amount now includes SXL distributions (~$85 million in 1Q13 and ~$91 million in 2Q13).
Although sustainable DCF coverage in the TTM ended 6/30/13 remains below the 1x threshold number (principally due to $645 million investment in working capital, mostly in 4Q12 and 1Q13), it improved by 16% compared to 2Q12. This is encouraging.
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 net income from non-controlling interests fell short of covering distributions by ~$207 million in the TTM ended 6/30/13 and by ~$226 million in the prior year period (both numbers are net of the increase in cash). So for these TTM periods distributions were partially funded by issuing debt and limited partnership units.
ETP's current yield is at the high end of the MLPs I cover. A comparison is provided in Table 6 below:
As of 08/19/13:
Magellan Midstream Partners (NYSE:MMP)
Plains All American Pipeline (NYSE:PAA)
Enterprise Products Partners (NYSE:EPD)
Targa Resources Partners (NYSE:NGLS)
El Paso Pipeline Partners (NYSE:EPB)
Buckeye Partners (NYSE:BPL)
Kinder Morgan Energy Partners (NYSE:KMP)
Regency Energy Partners
Energy Transfer Partners
Williams Partners (NYSE:WPZ)
Boardwalk Pipeline Partners (NYSE:BWP)
Suburban Propane Partners (NYSE:SPH)
The August 8 announcement whereby ETE will exchange 50.16 million ETP units for 50% of IDRs held by ETP by virtue of its ownership of the general partner of SXL is positive news. These IDRs generated $55 million in the 6 months ended 6/30/13 (including $2 million for the general partner's interest), or ~$110 million per annum. So a 50% reduction costs ETP ~$55 million a year. Over the next 3.5 years, ETP will also forgo ~$226 million of IDR subsidies previously agreed to by ETE, an average of ~$65 million during this period. On the other hand, by retiring the units held by ETE it saves $3.575 per unit per annum in regular distributions to ETE and $2.08 per unit per annum in IDR distributions to ETE; this reduces the cash outflow by ~$284 million per year. On balance, ETP appears to save ~$164 million per annum for the next 3.5 years and ~$229 million thereafter.
Although ETP forgoes potential increases in SXL IDR distributions, the overall impact of this transaction is positive for ETP. In addition, the trends in DCF and Segment Adjusted EBITDA are positive. I maintain my conclusion that there will be a modest distribution increase.
Nevertheless, some concerns regarding ETP remain: 1) sustainable DCF is still not covering distributions; 2) the structural complexity (although recent transactions are a step forward); 3) the IDR burden is still high (notwithstanding the August 8 announcement and temporary waivers provided by ETE): 4) lack of progress on the disposition of the non-core Sunoco retail operations; and 5) the high ratio (>5x) of long-term debt to TTM EBITDA.