El Paso Pipeline Partners, L.P. (NYSE:EPB) reported its results of operations for 4Q 2013 on January 15, 2014. This article focuses on some of the key facts and trends revealed by this report. Given the significant quarterly fluctuations in important business parameters, full year 2013 figures are reviewed in addition to the quarterly numbers.
EPB's assets consist of Southern Natural Gas Company ("SNG"), an interstate natural gas company located in the southeastern United States; Colorado Interstate Gas Company ("CIG"), an interstate pipeline company which is located in the Rocky Mountains; Wyoming Interstate Company, L.L.C. ("WIC"), an interstate pipeline company primarily located in Wyoming and Colorado; Southern LNG Company, L.L.C. ("SLNG"), which owns a liquefied natural gas ("LNG") storage and regasification terminal near Savannah, Georgia; Elba Express Pipeline Company (Elba Express), an interstate pipeline company which is located in Georgia and South Carolina; and Cheyenne Plains Gas Pipeline Company ("CGP"), a pipeline extending from the Rocky Mountain region to Kansas. Combined, these businesses consist of more than 13,000 miles of pipeline and associated storage facilities with aggregate storage capacity of nearly 100 billion cubic feet (BCF).
As shown in Table 1 below, EPB has not generated quarter vs. prior-year quarter revenue growth for the past six quarters. Its full year 2011 revenues totaled $1,531 million; it then dropped in 2012 and again in 2013.
Revenues in 2013 were slightly lower than in 2012 despite the Elba Express pipeline expansion project coming online on April 1, 2013 and despite full period contributions by CIG and CGP. As a reminder, EBD acquired the remaining 14% interest in CIG and 100% of CPG on May 24, 2012; thus, results for 2012 include ~7 months of incremental contributions from 14% of CIG and 100% of CPG compared to 12 months of contributions for 2013.
Operating income and EBITDA increased slightly in 2013 vs. 2012, but were lower in each of the last 2 quarters of 2013 compared to the corresponding prior year periods, as shown in Table 2 below:
Management reported that two recent rate case settlements approved by the Federal Energy Regulatory Commission resulted in lower rates on the SNG and WIC pipeline systems. The SNG rate settlement includes a two-phase reduction in rates effective on September 1, 2013 and November 1, 2015, which will reduce annual revenues by approximately $34 million and an additional $14 million, respectively. WIC also renewed contracts at lower rates. A portion of these negative impacts was offset by good results on the Elba Express Pipeline, attributable to an expansion project that added capacity to the pipeline in the spring of 2013.
Distributable cash flow ("DCF") dropped in each of the last 3 calendar quarters of 2013, principally due the decline in operating income and to larger incentive distribution rights ("IDR") payments made to Kinder Morgan Management Inc. (NYSE:KMI), EPB's general partner. For the full year, DCF per unit was down ~7% compared to 2012, as shown in Table 3 below:
EPB's distributed $0.65 per unit in 4Q13, unchanged from 3Q13, and $2.55 per unit in 2013, up 13% from 2012. But DCF per unit decreased 12% in 4Q13 and 7% in 2013 vs. the corresponding prior year periods. Coverage ratios based on reported DCF are therefore very tight in 2013 (1.01 in 4Q13).
Investors should note that the Kinder Morgan entities calculations of DCF (and consequently DCF coverage) appearing in Table 3 are derived differently than some of the other MLPs I cover. The difference has to do with respect to the general partner's share of DCF (see article dated June 2, 2013). Specifically, EPB reports a DCF number that covers only that portion attributable to limited partners. I prefer to look at total coverage ratio, one that includes all sustainable cash generated by the partnership vs. the distributions made to all the partners (general and limited).
I will calculate sustainable DCF and sustainable DCF coverage, as I define those terms, once EPB provides additional data as part of its Form 10-K.
Table 4 below reflects EPB's method of determining DCF. This method is detailed in an article titled Distributable Cash Flow (DCF) that also provides a comparison to definitions used by other MLPs. EPB's method of deriving DCF (referred to as "DCF before certain items") complex differs considerably from the method used by other MLPs I cover.
Table 4 also highlights an issue previously mentioned - the size of the IDR payments made by EPB to KMI. They claim a significant portion of EPB's net income and cash flows. Incentive payments to KMI totaled $195 million in 2013, an increase of approximately $65 million vs. 2012 as a result of higher distributions to limited partners and a slightly higher number of EPB units outstanding. KMI's IDRs are currently entitled to ~28% of EPB's total DCF and to 48% at the margin (i.e., to 48% of each incremental dollar of DCF generated by EPB). KMI also owns ~41% of EPB's limited partner units in addition to its 2% general partner's interest.
Table 5 below compares EPB's current yield to some of the other MLPs I follow:
As of 01/17/14:
Magellan Midstream Partners (NYSE:MMP)
Enterprise Products Partners (NYSE:EPD)
Plains All American Pipeline (NYSE:PAA)
Targa Resources Partners (NYSE:NGLS)
Buckeye Partners (NYSE:BPL)
Kinder Morgan Energy Partners (NYSE:KMP)
Energy Transfer Partners (NYSE:ETP)
Williams Partners (NYSE:WPZ)
Regency Energy Partners (NYSE:RGP)
El Paso Pipeline Partners
Suburban Propane Partners (NYSE:SPH)
Boardwalk Pipeline Partners (NYSE:BWP)
As noted in a prior article, EPB's distribution growth is slowing and will be at lower levels beyond 2013. Management projects distributions in 2014 will total $2.60 per unit, up less than 2% from the $2.55 per unit in 2013. The current $0.65 current quarterly distribution will therefore not increase for the remainder of 2014.
EPB did not meet its target of $25 million of excess coverage for 2013. The shortfall was attributed to the postponement of the dropdown of KMI's 50% interest in Gulf LNG Energy, LLC ("GLNG"), a project to build a future LNG liquefaction export terminal with a total capacity of up to 10 million tons per annum on a site adjacent to an existing LNG import and regasification facility at Pascagoula, Jackson County, Mississippi.
The proposed terminal will liquefy domestic natural gas delivered by pipeline, store the LNG in the terminal's existing LNG storage tanks, and load it into LNG vessels via the terminal's existing marine jetty. The terminal will retain its current capability to receive, store, regasify, and deliver natural gas into the interstate pipeline system as originally constructed, thereby making the Gulf LNG Terminal bi-directional. In June 2012, the proposed LNG export project received authorization from the Department of Energy ("DOE") to export ~1,500MMcf/d of domestically produced liquefied natural gas LNG to Free Trade Agreement ("FTA") countries for a 25-year period.
In April 2013, management stated EPB is expected to purchase GLNG in 3Q13. Analysts have estimated a $750 million purchase price for this asset. But on July 31, 2013 KMI disclosed that it had 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 dropdown assets.
This highlights the conflict issue investors should think about when several MLPs share the same general partner. KMI has a fiduciary duty to act in the best interest of both EPB and KMP. This is almost impossible to achieve in a situation where both MLPs vie for the same assets. 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.
On December 3, 2013, management disclosed that GLNG would, after all, be dropped down to EPB and that the dropdown will occur in 2014. Management also disclosed that KMI's 50% interest in the 680-mile Ruby Pipeline extending from Wyoming to Oregon would also be dropped down to EPB in 2014. This pipeline transports natural gas supplies from the major Rocky Mountain basins to consumers in California, Nevada, and the Pacific Northwest. KMI's 47.5% interest in Young Gas Storage will also be dropped down in 2014.
The additional cash flows generated by these dropdowns will be largely offset by the impacts of the rate cases and expected lower rates on contract renewals previously discussed. Unlike the dropdowns, EPB's major growth projects will not generate additional cash flows in the near term, as they are not scheduled to commence production until 2016. These projects currently include:
- Up to 1 billion cubic feet per day of incremental gas transportation capacity serving customers in GA, SC and northern FL. Total capital invested by the EPB to accommodate the initial phase of 600 MMcf/d is expected to be in excess of $200 million, with service commencing in June 2016.
- Elba Island Liquefaction Project. A joint venture between EPB (51%) and a Royal Dutch Shell plc subsidiary (49%) to develop and own natural gas liquefaction plant at SLNG's existing Elba Island LNG terminal. EPB's portion of the capital expenditures is estimated at ~$850 million for Phase I (210 MMcf/d) and $500 million for Phase II (70-140 Mmcf/d). If all proceeds as planned, construction will begin in 4Q14 with Phase I service commencing in late 2016 or early 2017 and Phase II in 2017-2018. EPB has received DOE authorization to export the produced LNG to FTA countries and has applied for non-FTA approval. On December 19, 2013 Shell exercised its option to proceeds with the first part of Phase II.
Following the December 3, 2013, disclosure that even with the dropdowns EPB expects only a 2% increase in 2014 distributions, the units price declined ~20%, from ~$41.58 to $33.35. EPB currently yields 7.8%, substantially more than KMP's 6.7%. On the face of it, acquiring EPB at the current level would be accretive to KMP. The market value of KMI's 10% limited partner stake is valued at ~$3.5 billion vs. a ~$3 billion market value of KMI's ~41% limited partner stake in EPB. Increasing KMP's valuation is a key objective for KMI and if a purchase of EPB by KMP is seen as helping achieve that, EPB may indeed end up being absorbed. Otherwise, EPB unit holders may face the prospect of flat distributions for another 3-4 years. In the interim, however, they will receive an attractive 7.8% yield assuming no change in the price per unit.
Long-term debt to LTM EBITDA as of 12/31/13 was 3.8x, so while the balance sheet can absorb additional debt to fund the dropdowns, I expect EPB will issue additional equity to fund a portion of it and that could put further pressure on unit price.