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This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Targa Resources Partners LP (NYSE:NGLS) 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 NGLS' 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, earnings before interest, depreciation & amortization and income tax expenses (EBITDA), and DCF reported by NGLS for 2Q13, 2Q12, and the TTM ending 6/30/13 and 6/30/12 are summarized in Table 1 below. Given the seasonality of the businesses of some MLPs 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, and both show significant declines in per unit EBITDA and per unit DCF, as can bee seen in Table 1 below:

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Table 1: Figures in $ Millions, except units outstanding and margins

Following 1Q12, quarterly revenues declined compared to the comparable prior year period for 4 consecutive quarters (through 1Q13). In 2Q13 we see a reversal of that trend, as shown in Table 2:

(click to enlarge) Table 2: Figures in $ Millions, except % changes

NGLS derives its revenues principally rom percent-of-proceeds ("POP") contracts under which it receives a portion of the natural gas and/or natural gas liquids as payment for its gathering and processing services. POP contracts share price risk between the producer and processor. Operating income generally increases as natural gas prices and natural gas liquid prices increase, and decreases as they decrease.

In that context, it is important to note the growth in midstream services fee income. This portion of the revenue stream is important because it serves to mitigate the impact of fluctuations in commodity prices on NGLS' results and to enhance both gross and operating margin percentages. Also, a large portion of the fee income revenues flows through directly to the operating margin line. Fee income accounted for 52% of operating margins in 2Q13 vs. 39% in the comparable prior year quarter. In 2014 management expects it will account for 55%-65% of total operating margins. The 12/31/12 Saddle Butte Pipeline acquisition (renamed Targa Badlands) positions NGLS to participate in the Bakken Shale infrastructure build-out in return for fee-based revenue to gather crude oil, or gather and process natural gas, from the wellhead to various takeaway options (including LPG exports).

Fee-based revenue growth is an encouraging trend. On the other hand, expenses have risen and income from operations has declined, in absolute dollar terms, in each of the past 5 quarters compared to the same period in the prior year, as shown in Table 3 below:

(click to enlarge) Table 3: Income from operations in $ Millions

NGLS reported DCF of $328 million ($3.37 per unit) for the TTM ended 6/30/13, down from $363 million ($4.18 per unit) in the prior year period. 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 NGLS is presented in Table 4 below:

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Table 4: Figures in $ Millions

The principal differences between reported and sustainable DCF for the periods reviewed are attributable to working capital consumed and risk management activities. See a prior article for an explanation of why I exclude these items from my definition of sustainable DCF. Under "Other" I group items such as non-cash compensation and accretion of retirement obligations that management adds back to derive reported DCF but I do not included in my definition of sustainable DCF.

Distributions, reported DCF, sustainable DCF and the resultant coverage ratios are as follows:

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Table 5: Figures in $ Millions, except per unit amounts and coverage ratios

In a prior article I noted that NGLS was acquiring Targa Badlands at an expensive EBITDA multiple and that the effect would be dilutive. Management expected distribution coverage to be ~ 0.9x in the first half of 2013 (the actual figure came in at 0.88) and expects coverage to average 1.0x in 2013 due to the dilutive effect of Badlands. It expects Badlands to be accretive in 2014 and beyond. However, these lower coverage ratios will also reflect 10%-12% increases in projected distributions for 2013.

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

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Table 6: Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners equaled distributions in the TTM ended 6/30/13 vs. $40 million excess that was generated in the prior year period. While NGLS is not using cash raised from issuance of debt and equity to fund distributions, it is also not generating excess cash that would enable it to reduce reliance on the issuance of additional partnership units that dilute existing holders, or issuance of debt to fund expansion projects.

Table 7 below compares NGLS' current yield of some of the other MLPs I follow:

As of 9/04/13:

Price

Quarterly Distribution ($)

Yield

Magellan Midstream Partners (NYSE:MMP)

$53.02

$0.53250

4.02%

Enterprise Products Partners (NYSE:EPD)

$58.30

$0.68000

4.67%

Plains All American Pipeline (NYSE:PAA)

$49.78

$0.58750

4.72%

Targa Resources Partners

$48.48

$0.71500

5.90%

Buckeye Partners (NYSE:BPL)

$69.49

$1.06250

6.12%

El Paso Pipeline Partners (NYSE:EPB)

$40.50

$0.63000

6.22%

Kinder Morgan Energy Partners (NYSE:KMP)

$79.06

$1.32000

6.68%

Regency Energy Partners (NYSE:RGP)

$26.60

$0.46500

6.99%

Energy Transfer Partners (NYSE:ETP)

$51.10

$0.89375

7.00%

Williams Partners (NYSE:WPZ)

$49.26

$0.86250

7.00%

Boardwalk Pipeline Partners (NYSE:BWP)

$29.96

$0.53250

7.11%

Suburban Propane Partners (NYSE:SPH)

$44.63

$0.87500

7.84%

Table 7

The midpoint of the 2013 Adjusted EBITDA guidance is $625 million. Through mid-year, Adjusted EBITDA totals ~$260 million, so to achieve guidance NGLS must generate $365 million in the second half of 2013, the bulk of which is expected in 4Q13. That seems a tall order, but NGLS has $1 billion of major capital expenditure projects coming online in the second half of 2013. Using a 6x EBITDA estimate for what these projects yield and assuming half begin generating cash flow in 3Q13 and half in 4Q13, I estimate they could contribute ~$60 million in 2013. There is an additional $700 million of major capital expenditure projects coming online in 2014.

My concerns regarding NGLS center on the expensive acquisition, the low coverage ratio, the high cost of the Incentive Distribution Rights payable to Targa Resources Corp. (NYSE:TRGP), the general partner, and the still significant exposure to commodity prices. I also believe developing the infrastructure for the Bakken shale is more risky than the Texas shale plays and the Marcellus shale. While management's claim that 2Q13 is an inflection point for NGLS may be correct, the unit price seems to already reflect this.

Disclosure: I am long EPB, EPD, ETP, PAA, SPH, WPZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.