This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Williams Partners, L.P. (WPZ), evaluates the sustainability of its Distributable Cash Flow ("DCF"), and assesses whether WPZ is financing its distributions via issuance of new units or debt. The task is not easy because the definitions of DCF and other primary measures typically used by master limited partnerships ("MLPs") to evaluate their operating results, are complex. In addition, each MLP may define these measures differently, making comparison across MLPs very difficult.
Effective January 1, 2013, management reorganized WPZ's businesses into geographically based operational areas. WPZ's reorganized reportable segments are as follows:
- Northeast G&P: this midstream gathering and processing segment is in the early stages of developing large-scale energy infrastructure solutions for the Marcellus and Utica shale regions. It also includes a 51% equity investment in Laurel Mountain Midstream, LLC ("Laurel Mountain") and a 47.5% equity investment in Caiman Energy II, LLC ("Caiman");
- Atlantic-Gulf: this segment includes the Transcontinental Gas Pipe Line Company, LLC, WPZ's major interstate natural gas pipeline ("Transco"). It also includes natural gas gathering and processing and crude production handling and transportation in the Gulf Coast region, a 50% equity investment in Gulfstream Natural Gas System L.L.C. ("Gulfstream"), a 60% equity investment in Discovery Producer Services LLC ("Discovery"), and a 51% consolidated interest in Constitution Pipeline Company, LLC ("Constitution").
- West: this segment includes gathering, processing and treating operations in southwestern Colorado & northeastern New Mexico ("Four Corners"), northwestern Colorado (Piceance Basin), and Wyoming and WPZ's interstate natural gas pipeline, Northwest Pipeline GP ("Northwest Pipeline").
- NGL & Petchem Services: this segment includes WPZ's NGL and natural gas marketing business, an NGL fractionator and storage facilities near Conway, Kansas, a 50% equity investment in Overland Pass Pipeline ("OPPL"), and a ~83.3% interest in an olefins production facility in Geismar, Louisiana, along with a refinery grade propylene splitter and pipelines in the Gulf Coast region.
WPZ reported continued pressure on processing margins for natural gas liquids ("NGL") that adversely affected the Atlantic Gulf and West segments. Table 1 below compares segment performance in the 3 and 9 months ended 9/30/13 to the comparable periods in 2012 (segment operating income numbers based on the new reporting segments are not available on a TTM basis):
Year-to-date segment profit at Atlantic Gulf increased primarily due to higher transportation fee revenues associated with expansion projects and new transportation rates effective in 2013 for Transco, as well as lower project development costs, partially offset by lower NGL margins.
West's 3Q13 and year-to-date segment profit decreased due to lower NGL margins, including the effects of system-wide ethane rejection and higher natural gas prices. Decreases for the year-to-date period in gathering and processing fee revenue were also due to severe winter weather causing production freeze-offs in the first quarter and to declines in production in the Piceance basin area. Less favorable producer economics caused a reduction in drilling in western Colorado during 2012 and so far in 2013. That is why production has decreased, in turn decreasing the quantity of natural gas available to gather and process. In light of this management decided to delay until mid-2016 the in-service date of WPZ's 350MMcf/d cryogenic natural gas processing plant (in Parachute) that was to have been put in service in 2014. Increased natural gas transportation revenues associated with Northwest Pipeline's new rates partially offset the Piceance basin production declines.
Year-to-date segment profit at NGL & Petchem Services increased primarily due to higher NGL marketing margins and $50 million of initial insurance recoveries in the third quarter related to the Geismar incident described in an article dated August 4, 2013. The adverse impact of this incident, initially estimated at $10 million, now stands at $73 million. This excludes potential fines and penalties from the various federal and state governmental agencies investigating the matter and that would not be covered by WPZ's insurance policy. Additionally, multiple lawsuits, including class actions for alleged offsite impacts, property damage, and personal injury, have been filed against various WPZ subsidiaries.
The April 2014 target date for resumption of Geismar's operations still stands, but delays may increase losses and force downward revisions to WPZ's guidance for 2014.
The generally downward trend in revenues, operating income and EBITDA for the past 6 quarters is shown in Table 2 below:
The only encouraging trend visible in Table 2 is the growth in fee-based income. It partially offsets continuing declines in NGL margins.
WPZ's revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for the quarters and TTM ending 9/30/13 and 9/30/12 are presented in Table 3 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:
3Q13 net income per unit in Table 3 is up despite a decrease in total net income and an increase in the number of units outstanding. This non-intuitive outcome reflects a significant increase in waived incentive distribution rights ("IDRs") that results in a shift of net income from the general partner to the limited partners. As of 9/30/13 Williams Companies, Inc. (WMB) owned ~62% of WPZ's limited partner units, a 2% general partner interest and the IDRs. On 5/7/13 WMB agreed to waive IDRs of up to $200 million over the next four quarters to support WPZ's cash distribution metrics. Management currently expects to utilize $140 million of that amount.
Ethane exposure has contributed significantly to the poor results presented in Tables 1-3. Sharp declines in NGL prices (e.g., ~23% percent lower in 2012 than in 2011, ~21% lower in 1Q13 vs. 4Q12, 44% lower in 2Q13 vs. 2Q12 and 42% lower in 3Q13 vs. 3Q12) have pushed down processing margins. Reduced processing margins led to ethane rejection and thus generated lower equity volumes under keep-whole agreements and percent-of-liquids arrangements. WPZ provides natural gas gathering and processing services under fee contracts (volumetric-based), keep-whole agreements and percent-of-liquids arrangements. A glossary of terms provides further explanations of these terms and of ethane rejection. Under keep-whole and percent-of-liquid processing contracts, WPZ retains the rights to all or a portion of the NGLs extracted from the producers' natural gas stream (these are the equity volumes referred to above). It recognizes revenues when the extracted NGLs are sold and delivered. Lower NGL prices coupled with lower volumes produce lower revenues, lower operating income and lower net income.
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." WPZ's definition of DCF and a comparison to definitions used by other MLPs are described in an article titled "Distributable Cash Flow." Using WPZ's definition, DCF for the TTM ended 9/30/13 was $1,667 million ($4.10 per unit) vs. $1,528 million ($4.79 per unit) in the prior year period.
Table 4 below provides a comparison between reported and sustainable DCF:
Most of the gap between reported DCF and sustainable DCF shown under "other" for TTM ending 9/30/13 reflects management's adjustment for the Geismar Incident and pre-acquisition cash flows allocated to WMB. The gap in the prior year TTM period reflects larger pre-acquisition cash flows allocated to WMB. The gap in 1Q13 mostly reflects an adjustment related to Geismar incident. Management estimates this hurt 3Q13 DCF to the tune of $79 million.
In deriving 3Q12 reported DCF, management added back ~$55 million of cash consumed by working capital. I generally do not add back working capital used, but do deduct working capital generated, from net cash from operations in deriving sustainable DCF. 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. I therefore do not add working capital used to net cash provided by operating activities in deriving sustainable DCF.
WPZ increased 3Q13 distributions to $0.8775 (up ~1.7% from 2Q13 and up ~8.7% from 3Q12). I calculate the coverage ratios in Table 5 below in two ways: first based on the actual distributions made (e.g., the distribution announced for 2Q13 was actually made in 3Q13); second, based on declared distributions (e.g., assuming the distribution declared for 3Q13 had been made in 3Q13). TTM numbers tends to be more meaningful than quarterly numbers for the purpose of coverage ratios. However, I present both:
The low coverage ratios reflect the decline in NGL prices and also the rapid growth in the number of units outstanding as a result of issuing equity to partially finance large drop-down acquisitions. The number of units outstanding has increased 22% from 3Q12 to 3Q13.
To see whether WPZ is financing its distributions via issuance of new units or debt it is helpful to look at a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions) and separates cash generation from cash consumption. Here is what I see for WPZ:
Simplified Sources and Uses of Funds
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $35 million in the TTM ending 9/30/13 and by $366 million in the prior year period. So while key performance parameters have deteriorated, distributions in the TTM ending 9/30/13 were not funded through the issuance of additional equity or debt. This is not in contradiction with the below-1 coverage ratios shown in Table 5 because WPZ has been able to generate cash by reducing working capital. Granted, this is not a sustainable source but it provided ~$220 million in that period (see Table 4).
Management has lowered its DCF and DCF coverage guidance several times over the past year or so. This can be seen in Table 7 below. The recent presentation of 3Q13 results also included lowering the distribution growth forecasted for 2014-2015 from 6%-8% to 6% in order not to show deterioration in coverage ratios vs. the prior forecast; further, the lower number incorporates a planned Canadian asset drop-down that was not included in the prior forecast.
Management's decision to significantly dilute unitholders in executing two transformative transactions, in conjunction with an adverse NGL pricing environment and its decisions, despite all that, to increase distributions has brought about significant shortfalls in DCF coverage. Given that poor operational performance has been coupled with an unrelenting pace of equity issuances ($490 million in 1Q12, $1,581 million in 2Q12, $488 million in 3Q12, ~$760 million in 1Q13 and $1,252 billion in 3Q13) and with some downward guidance adjustments, it is not surprising that the unit price has languished (WPZ unit price is up only ~2.6% year-to-date, far less than many other MLPs). On top of that, the Geismar Incident has increased WPZ's risk profile and unitholders likely face further dilution through additional issuances between now and 2015.
On the other hand, WPZ is making huge growth capital investments (~$3.3 billion in 2013) the bulk of which are devoted to the Northeast G&P and the Atlantic-Gulf segments. If achieved, the ~60% increase in DCF projected to materialize from 2013 to 2015 will reward patient investors. Relative to the magnitude of the opportunity, WPZ seems reasonably priced and its yield compares favorably with many of the other MLPs I cover; however, as previously noted, a portion of that is funded by non-sustainable sources. It would seem to me more prudent to hold off on distribution increases until such increases are adequately supported.
As of 11/06/13:
Magellan Midstream Partners (MMP)
Enterprise Products Partners (EPD)
Plains All American Pipeline (PAA)
Targa Resources Partners (NGLS)
Buckeye Partners (BPL)
El Paso Pipeline Partners (EPB)
Kinder Morgan Energy Partners (KMP)
Energy Transfer Partners (ETP)
Regency Energy Partners (RGP)
Boardwalk Pipeline Partners (BWP)
Suburban Propane Partners (SPH)
There is significant potential in the Northeast shale formations (Marcellus and Utica) where WMB and WPZ have invested heavily and obtained very strong positions. WPZ is also about to greatly increase its Canadian exposure. The next major drop-down is slated to occur in January 2014 and will include WMB's Canadian operations. These are expected to contribute approximately $200 million of DCF to Williams Partners in 2014 and 2015 and the price indication, considering the assets have commodity risk, is ~7 times cash flow.
Investors with very strong stomachs who believe in the enormous production and transportation volume growth expected from these shale formations, and have the patience to wait until 2015, may be well rewarded. In the meantime, they face significant headwinds: lower NGL prices, Geismar, gradual loss of investor confidence from repeated downward adjustments of projected results and the resultant languishing unit price leading to greater dilution upon drop-downs.