This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Buckeye Partners L.P. (BPL) and looks "under the hood" to properly ascertain sustainability of DCF. The task is not easy because the definitions of "Adjusted EBITDA" and Distributable Cash Flow ("DCF"), 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 BPL'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. The seasonality of BPL's business is such that the second and third quarters typically generate lower cash flows than the first and fourth quarters. For example, in the winter months, the Pipelines & Terminals segment benefit from butane blending and heating oil volumes. Given that, and given quarterly fluctuations in 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:
The favorable comparison of operating income and net income numbers for the TTM ended 6/30/13 vs. the TTM ended 6/30/12 is partially driven by a $170 million goodwill impairment charge for the Lodi acquisition in 3Q11. Absent that charge, operating income would have been $343 million. The increase to $401 million in the TTM ended 6/30/13 is still impressive, helped by contributions from Perth Amboy and the BORCO expansion, which are absent from the numbers in the prior year period.
Adjusted EBITDA is the primary measure used by BPL's management to evaluate each business segment, overall performance, resource & capital allocation, and the viability of, and rates of return on, proposed projects. As was seen in Table 1, Adjusted EBITDA improved significantly on both a TTM basis and a quarterly basis. Table 2 below shows that the Pipelines & Terminals segment and the International Operations segment were the primary drivers of this improvement:
Table 2: Figures in $ Millions
The increase in Adjusted EBITDA at the Pipelines & Terminals segment for the periods reviewed is driven by several factors, including volume growth, improved margins, lower operating costs, expanded butane blending capabilities and crude-handling services, as well an increase in storage contracts, including those associated with the Perth Amboy Facility acquired in July 2012
The increase in Adjusted EBITDA at the International Operations segment for the periods reviewed reflect customer utilization of incremental storage capacity (1.6 million barrels) brought online at the BORCO facility during Q2 13. A further 1.2 million barrels of storage is expected to be brought online in September.
The Natural gas Storage segment remains challenged by reduced lease rates year-over-year, a delay in executing firm lease agreements for a portion of the facility, and less favorable summer-winter spreads compared to the prior year. Management does not expect a significant improvement in the second half of the year.
BPL's reported DCF for the TTM ended 6/30/13 was $468 million ($4.60 per unit), up from $309 million ($3.25 per unit) in the prior year period. However, reported DCF may differ from sustainable DCF for a variety of reasons. These are reviewed in an article titled "Estimating sustainable DCF-why and how". An analysis specific to BPL is presented in Table 3 below:
Table 3: Figures in $ Millions
There are appreciable differences between reported and sustainable DCF for the quarter and TTM ending 6/30/13. These relate primarily to the treatment of working capital and to risk management activities.
Under BPL's definition, reported DCF always excludes working capital changes, whether positive or negative. In contrast, as detailed in my prior articles, I generally do not include working capital generated in the definition of sustainable DCF but I do deduct working capital invested. 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 the $61 million of working capital consumed to net cash provided by operating activities in deriving sustainable DCF for the TTM ending 6/30/13.
The risk management item reflects large fluctuations in the value of derivatives used to hedge exposure to commodity prices and interest rates. BPL's results can be significantly impacted by these fluctuations. The cash outflow on risk management activities in 2Q13 and the TTM ended 6/30/13 relates principally to a $62 million payment to terminate interest rate swap agreements in connection with BPL's issuance in June 2013 of $500 million 4.15% notes due July 1, 2023. Management's reported DCF number is higher than my sustainable DCF number in part because management adds back this cash outflow, while I do not. Having reviewed the history of similar types of cash outflows, I conclude it is hard to argue that they reflect events of a "one-time" nature. For example, risk management cash outflows in excess of $70 million were recorded in 2Q13, 3Q11 and 1Q11; a cash inflow in excess of $70 million was recorded in 4Q11. Some of the gains and losses related to these cash flows are not reflected in BPL's statement of operations. Rather, they increase or reduce total equity through the statement of comprehensive income.
Coverage ratios are presented in Table 4 below:
Table 4 Figures in $ Millions (except Coverage Ratios)
Reported DCF showed impressive increases in the periods under review. Coverage ratio based on sustainable DCF was much lower, mostly as a result of payments on interest rate swap agreements previously discussed. For investors who prefer to regard these cash outflows as "one-time" events not indicative of core operating performance, the sustainable DCF picture is much more encouraging. It shows sustainable DCF exceeded 1.0x in both 2Q13 and 1Q13, after being below that threshold for 8 consecutive quarters (since 1Q11).
There are ~8 million Class B units outstanding. Class B units were issued in connection with the BORCO acquisition (December 2010) and received distributions in-kind (i.e., by issuing more Class B units). Beginning in the current quarter (3Q13), these will convert to regular units and start receiving cash distributions, further pressuring coverage ratios.
Distribution growth has been slow. Following zero growth in the 5 quarters ending 12/31/12, the rate was increased by $0.0125 in 1Q13 and again by $0.0125 in 2Q13. Management expects increases of no more than this same modest amount of $0.0125 per unit per quarter over the next few quarters.
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
Table 5 indicates that in 2Q13 and the TTM ended 6/30/13 BPL funded distributions by issuing debt and/or equity. This is not surprising given that the interest rate swap termination previously mentioned and changes in other derivatives consumed ~$84 million of cash in these periods. Net cash from operations, less net income from non-controlling interests, less maintenance capital expenditures fell short of distributions by ~$50 million in the TTM ended 6/30/13. However, they exceeded distributions by ~$71 million in the 6 months ended 6/30/13 and in that period BPL has reduced its reliance on non-sustainable sources of cash.
BPL's current yield has come down significantly as a result of unit price appreciation of ~53% since year-end 2012. A comparison to some of the other MLPs I follow is shown in Table 6 below:
As of 08/26/13:
Magellan Midstream Partners (MMP)
Plains All American Pipeline (PAA)
Enterprise Products Partners (EPD)
Targa Resources Partners (NGLS)
El Paso Pipeline Partners (EPB)
Kinder Morgan Energy Partners (KMP)
Regency Energy Partners (RGP)
Energy Transfer Partners (ETP)
Williams Partners (WPZ)
Boardwalk Pipeline Partners (BWP)
Suburban Propane Partners (SPH)
BPL expects to spend a total of ~$320 million on expansion and cost reduction projects in 2013, of which ~$130 million has been spent through June 20. So far BPL has not been generating excess cash which could help fund these capital expenditures, so the remaining ~$190 million will have to be funded by debt, equity or asset sales. BPL had only ~$4.9 million cash on the balance sheet and long-term debt that, at ~$2.6 billion, is at 4.6x EBITDA for the TTM ending 6/30/13 (4.1x Adjusted EBITDA). These levels are quite high. Given that and the run-up in unit price, I believe it is likely BPL will issue additional equity to partially fund expansion projects in 2013.
Management expects an appreciable uplift in cash flows in 2014 from past growth capital expenditure projects, including from the crude-by-rail Perth Amboy activities and full year contribution from the BORCO expansion.
There were no developments of significance regarding an area that is still of concern, namely the Federal Energy Regulatory Commission (FERC) order of March 30, 2012. This order disallowed proposed rate increases on the Buckeye System that would have become effective April 1, 2012. The proposed rate increases were expected to increase BPL's annual revenues (and, I presume, EBITDA) by approximately $8 million. But if forced to resort to FERC's generic rate setting mechanism, the adverse impact goes well beyond forgoing this increase and could have a substantial adverse effect on BPL because it would lower tariffs on pipelines that account for ~70% of BPL's revenues. Uncertainty remains even post the February 22, 2013 Ratemaking Methodology Order issued by FERC as to the impact on future changes to BPL's rates in markets outside the New York City market. In addition, the ultimate resolution of the complaint of certain airlines regarding jet fuel rates to the three major New York City area airports could impact rates to those destinations. BPL is in active settlement discussions with respect to the ongoing complaint regarding transportation of jet fuel to the New York City airports. I saw this is as a major issue overhanging BPL. Many observers and investors view it much less seriously. With the unit price up so sharply, the latter may be proven right but I remain uncomfortable with the risk.