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Ron Hiram, Wise Analysis (216 clicks)
Research analyst, dividend investing, oil & gas, mid-cap
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Williams Partners, L.P. (WPZ) will report results of operations for 4Q 2013 on February 19, 2014. The results will give some indication as to whether the negative trends in WPZ's operational results are reversing, moderating or continuing. This article points out some of the important key metrics and developments investors should look at.

For the 6 consecutive quarters ending 9/30/13 (the latest date for which data is available), revenues have been declining when compared to revenues in the same prior-year period. Revenues have also been declining on a trailing twelve months ("TTM") basis, as shown in Table 1 below:

(click to enlarge) Table 1: Figures in $ Millions, except per unit amounts and % changes

The only encouraging trend visible in Table 1 is the growth in fee-based income.

As shown in Table 2 below, operating income and EBITDA per unit have also been declining for 6 consecutive quarters compared to the same period in the prior year, as well as on a TTM basis. This is largely due to continued pressure on processing margins for natural gas liquids ("NGL"), particularly in WPZ's West segment where lower NGL margins reflected the effects of system-wide ethane rejection and higher natural gas prices.

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

Ethane exposure has contributed significantly to the poor results presented in Tables 1-2. Sharp declines in NGL prices (e.g., 44% lower in 2Q13 vs. 2Q12 and 42% lower in 3Q13 vs. 3Q12) pushed down processing margins. Reduced processing margins (i.e., lower "frac spreads") led to 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. 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, result in lower revenues and lower operating income.

On December 20, 2013, WPZ announced it had delivered a record amount of natural gas on its Transco interstate gas pipeline to meet demand driven by recent cold weather in markets on the U.S. Eastern Seaboard. Another positive development is that propane prices rallied significantly in 4Q13. Given that propane is a major component of the average NGL barrel, this probably had a positive effect on WPZ's frac spreads during the quarter. On the other hand, ethane is also a major component of the average NGL barrel. In addition to insufficient petrochemical demand to absorb all of the ethane being produced in the U.S., colder weather has boosted demand for, and the price of, natural gas. Consequently, ethane is being sold as natural gas at fuel value rather than being extracted and used as a petrochemical feedstock. This leads to ethane rejection and has a negative effect on WPZ's frac spreads. Results for 4Q13 will indicate the overall impact of these trends on WPZ.

At first glance, the improvement in net income per unit in 2Q13 and 3Q13 over the same prior year periods, as shown in Table 3 below, may seem encouraging:

(click to enlarge) Table 3: Figures in $ Millions, except per unit amounts and % changes

But the reason 3Q13 and 2Q13 net income per unit in Table 3 are up vs. the prior-year periods is that Williams Companies, Inc. (WMB), WPZ's general partner, waived some of its incentive distribution rights ("IDRs"). This results in a shift of net income from the general partner to the limited partners. As of 9/30/13, 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.

WPZ has been increasing distributions despite the negative operational trends, resulting in below 1x coverage ratios:

(click to enlarge)Table 4: Figures in $ Millions, except per unit amounts and % changes

On January 27, 2014, WPZ again increased its quarterly distribution. The fourth quarter distribution was raised to $0.8925, up 1.7% from 3Q13 and 7.9% from 4Q12. It would seem to me more prudent to hold off on distribution increases until such increases are adequately supported. Perhaps management's rationale is that holding off on distribution increases will cause sharp declines in the unit price, thus forcing WPZ to sell more units to fund its expansion capital expenditures

Other developments investors should watch for include:

  1. Bluegrass. A 50/50 joint venture between WMB and Boardwalk Pipeline Partners, LP (BWP) that has the potential to power significant growth in distributions is the building of a 1,123-mile pipeline (the "Bluegrass Pipeline") to transport natural gas liquids ("NGL") from the Marcellus and Utica shale formations to the petrochemical and export complex on the U.S. Gulf Coast. In addition to constructing a new pipeline, the proposed project would include a new large-scale fractionation plant and related liquids storage and transport facilities. If FERC approval is obtained and other hurdles are overcome, the Bluegrass Pipeline could be placed in service in 2015. On October 29, 2013, WMB and BWP commenced a binding Open Season to determine industry commitments to Bluegrass. It was to have concluded on December 16, 2013, but was extended to January 17, 2014. Results are yet to be announced.
  2. Geismar. The incident is described in an article dated August 4, 2013. The April 2014 target date for resumption of Geismar's operations presumably still stands. Management may provide an update when it reports 4Q13 results. Delays may increase losses and force downward revisions to WPZ's guidance for 2014.

There is significant potential in the Northeast shale formations (Marcellus and Utica) where WMB and WPZ have invested heavily (~$3.3 billion by WPZ in 2013) and obtained very strong positions. WPZ is also about to greatly increase its Canadian exposure. The next major drop-down was slated to occur in January 2014 and will include WMB's Canadian operations. These are expected to contribute ~$200 million of DCF to WPZ in 2014 and 2015. The ~7x cash flow price indication takes into consideration the commodity risk presented by these assets. Patient investors will be rewarded if the ~60% increase in DCF projected to materialize from 2013 to 2015 will be achieved. In the meantime, as shown above, they face significant headwinds.

Source: Ahead Of Williams Partners' Q4 2013 Results