This article supplements my preliminary review of 3Q13 and trailing twelve months ("TTM") results recently reported by El Paso Pipeline Partners, L.P. (NYSE:EPB). I now evaluate the sustainability of EPB's Distributable Cash Flow ("DCF"), and assess whether EPB is financing its distributions via issuance of new units or debt. 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 differ from one MLP to another. But it is an exercise that must be undertaken, in conjunction with evaluating an MLP's growth prospects, because 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.
EPB owns and operates interstate natural gas pipelines and terminals. Its major assets are:
- Wyoming Interstate Company, L.L.C. ("WIC"): A ~800-mile interstate natural gas pipeline serving the Rocky Mountain region. It transports natural gas from production areas in the Overthrust, Piceance, Uinta, Powder River and Green River basins. It extends from western Wyoming to northeast Colorado (the Cheyenne Hub). The WIC system includes several lateral pipelines that extend from various interconnections along the mainline into western Colorado and northeast Wyoming and into eastern Utah.
- Colorado Interstate Gas Company, L.L.C. ("CIG"): A ~4,300 mile interstate natural gas pipeline that transports natural gas from production areas in the U.S. Rocky Mountains and the Anadarko Basin directly to customers in Colorado and Wyoming and indirectly to the Midwest, Southwest, California and Pacific Northwest. CIG also owns interests in five storage facilities located in Colorado and Kansas, which collectively have approximately 35 billion cubic feet of underground working natural gas storage capacity and one natural gas processing plant located in Wyoming.
- Cheyenne Plains Gas Pipeline Company, L.L.C. ("CPG"): A ~400-mile interstate natural gas pipeline. It transports natural gas from production areas in the Central Rocky Mountain natural gas basins. It extends from near the Wyoming-Colorado border to south-central Kansas and serves market areas in the Midwest with connections to several mid-continent pipelines in south-central Kansas. CPG is owned by Cheyenne Plains Investment Company, L.L.C. ("CPI"), an EPB subsidiary.
- Southern Natural Gas Company, L.L.C. ("SNG"): A ~7,600-mile interstate natural gas pipeline that transports natural gas from production areas in Texas, Louisiana, Mississippi, Alabama and the Gulf of Mexico to market areas in Louisiana, Mississippi, Alabama, Florida, Georgia, South Carolina and Tennessee, including the metropolitan areas of Atlanta and Birmingham. SNG is the principal natural gas transporter to southeastern markets in Alabama, Georgia and South Carolina,
- Southern LNG Company, L.L.C. ("SLNG"): An interstate pipeline serving the southeastern region of the United States through its ownership of Elba Express Company, L.L.C. ("Elba Express"), a 200-mile pipeline extending from the Elba Island LNG terminal near Savannah, GA., to the Transco pipeline in Hart County, GA., and Anderson County, SC. The pipeline also connects with SNG and directly connects to various power plants in Georgia.
- Elba Island LNG Terminal: A liquefied natural gas ("LNG") storage terminal with ~11.5 billion cubic feet (BCF) of LNG storage capacity and 1,755 million cubic feet per day (MMcf/d) of peak vaporization send-out capacity. It is directly connected to four major pipelines and indirectly to two others, and thus is readily accessible to the southeast and mid-Atlantic markets. It is owned by SLNG and operated by SNG.
- Equity method investments: through CIG, EPB owns a 50%of WYCO Development LLC ("WYCO"), a joint venture with an affiliate of Xcel Energy, and operates WYCO's High Plains pipeline and Totem Gas Storage facility.
On May 24, 2012 EPB and EPB's parent, El Paso Corporation, were acquired by Kinder Morgan, Inc. (NYSE:KMI).
EPB's term for earnings before depreciation and amortization ("EBDA") is "Earnings before DD&A and certain items." EBDA and DCF reported by EPB for the periods under review are summarized 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:
As always, I attempt to assess how the reported DCF figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than just the quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.
In an article titled "Distributable Cash Flow" I present EPB's definition of DCF and also provide definitions used by other MLPs. Based on this definition, EPB's DCF per unit for the TTM ending 9/30/13 was $2.71, up from $2.60 for the TTM ending 9/30/12. In 3Q13 DCF per unit decreased ~18% to $0.58 from $0.71 in 3Q12. The primary reasons for this were the higher incentive distribution rights ("IDRs") payments made to KMI, EPB's general partner, and the increase in the number of units outstanding. These more than offset other items, including a much-discussed reduction in maintenance capital expenditures covered in my preliminary review of 3Q13 and TTM results referenced above.
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". Applying the method described there to EPB's results generates the comparison between reported and sustainable DCF presented in Table 2 below. This table also shows the above-mentioned reduction in maintenance capital expenditures vs. the prior year periods.
The differences between reported and sustainable DCF in the periods under review are not material.
Coverage ratios based on EPB's methodology are lower vs. the comparable prior year periods, as shown in Table 4 below:
In deriving DCF, EPB deducts the general partner's portion of net income; this can be seen in Table 2. By doing so, EPB defines DCF narrowly, including only that portion of DCF that is attributable to limited partners. In addition to adjusting for non-sustainable items, I prefer a broader definition of coverage, one whose numerator is total DCF generated and whose denominator is the total of all distributions made to all the stakeholders, including to Kinder Morgan, Inc., EPB's general partner.
Sustainable DCF coverage using the broad definition is shown in Table 4 below:
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
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners, exceeded distributions by $111 million in the TTM ending 9/30/13. A substantial portion of the excess is explained by EPB reducing amounts invested in working capital. On a TTM basis, EPB is not using cash raised from issuance of debt and equity to fund distributions. It did so in both 2Q13 and 2Q12; but as previously mentioned, I believe TTM numbers are a better indicator than quarterly numbers.
Table 6 below compares EPB's current yield to some of the other MLPs I follow:
As of 11/14/13:
Magellan Midstream Partners (NYSE:MMP)
Enterprise Products Partners (NYSE:EPD)
Plains All American Pipeline (NYSE:PAA)
Targa Resources Partners (NYSE:NGLS)
El Paso Pipeline Partners
Buckeye Partners (NYSE:BPL)
Kinder Morgan Energy Partners (NYSE:KMP)
Energy Transfer Partners (NYSE:ETP)
Williams Partners (NYSE:WPZ)
Boardwalk Pipeline Partners (NYSE:BWP)
Suburban Propane Partners (NYSE:SPH)
In April 2013, management stated EPB is expected to purchase KMI's 50% interest in Gulf LNG Energy, LLC ("GLNG") in 3Q13. Analysts have estimated a $750 million purchase price for this asset. In a move that I found surprising, KMI recently elected to postpone the drop down of GLNG "until there is more clarity regarding a potential GLNG export expansion project". It was also disclosed that KMI has not determined to which MLP (KMP or EPB) it may offer its remaining potential drop-down assets. So it appears uncertain to what extent, if at all, EPB will have a stake in this asset. KMI's conference call discussing 3Q13 results shed more light on this matter. It appears that KMI's goal of exceeding its 2013 distribution target will be achieved "largely as a result of delaying the Gulf LNG drop and that asset staying at KMI for 4 additional months and better performance on other retained assets."
This highlights the conflict issue investors should think about when several MLPs share the same general partner. Management has a fiduciary duty to act in the best interest of both EPB and KMP, as well as its own (i.e., KMI's) shareholders. This is almost impossible to achieve in a situation where both MLPs vie for the same assets and KMI also wants to retain them for its purposes. In addition, there is always a concern regarding the pricing of such related-party transactions because a higher price is advantageous for KMI but disadvantageous for its MLPs.
Absent GLNG, there seems to be only one other major growth capital opportunity, but it will take a while to develop. In January 2013, EPB and a subsidiary of Royal Dutch Shell plc formed Elba Liquefaction Company ("ELC") which is owned 51 % and 49%, respectively, and that will develop and own a LNG plant at SLNG's existing Elba Island LNG terminal. SLNG has received Department of Energy authorization to export the produced LNG to FTA countries and has applied for non-FTA approval. Phase I of this project is estimated to cost $850 million; it will have capacity of approximately 210 MMcf/d (1.5 million tons per year) and requires no additional DOE approval. Once the project is finalized, Shell will subscribe to 100% of the liquefaction capacity and EPB will modify its pipeline and LNG terminal to physically transport natural gas to the terminal and to load the LNG onto ships for export. EPB expects to file a project application with the Federal Energy Regulatory Commission during 2014. It is probably premature to provide an estimate of the in-service date.
Coverage ratios, while still solid, are being reduced as cash distributions have grown faster than cash generation. Distribution growth in 2013 is expected to be 13% but prospects for continued growth beyond 2013 are uncertain. Whether EPB is being treated fairly vis-à-vis KMP and KMI is also an issue beginning to trouble me. I would reduce positions on unit price spike-ups.