As interest rates have fallen, income-oriented investors have been looking elsewhere to earn a decent yield. Over the past five years, master limited partnerships ("MLP") have become a popular investment class for these investors. Midstream MLPs, which are mainly pipeline and storage companies, are seen as a great play on increasing domestic production. However, not all MLPs are created equal, and investors can make major mistakes by investing based solely on yield. In fact, its high yield (previously over 8%) was a major reason investors were bullish on Boardwalk Pipeline Partners (NYSE:BWP). By contrast, Hedgeye's Kevin Kaiser called BWP a top short. Unfortunately, as this quarter showed, the longs were dead wrong.
In all honestly, BWP just delivered one of the worst quarters a midstream MLP has reported in years. The company was forced to cut its quarterly distribution by 81% from $0.53 to $0.10. Obviously, there is no way to view that cut as anything but disastrous. Units are down 33% on the news, and after this massive drop, it yields a weak 2.5% compared to the 8.8% yield it boaster on Friday. When a distribution is cut, a high yield never materializes, and the equity is almost always slammed. Essentially, BWP has an over-levered balance sheet of underwhelming assets.
In the quarter, revenue fell by 4% to $313 million while full year revenue of $1.206 billion was 2% higher. As a consequence, net income fell by 78% in the quarter to $19.5 million. For the full year, net income fell by 17% to $306 million. For MLPs, distributable cash flow ("DCF") is the key metric as that determines what the company can pay out. Quarterly DCF fell 3% to $139 million, though full year DCF was up 12% to $559 million. Basically, BWP's performance has appreciably worsened in the fourth quarter.
Unfortunately, this weakness will continue going forward. Pipelines operate on multi-year contracts, and when they expire, there is a new bidding process. BWP had some contracts expire this year, and the new deals are not as favorable. Weak contract renewals cut revenue by $13 million, and this weakness will persist for several years. Further with more expirations coming, transportation revenue will remain under pressure in 2014 and 2015. In fact, the company expects weak renewals to cut 2014 revenue by an annualized $40 million. Going forward, BWP's network will generate less revenue than it has in the past.
Moreover, $56 million of DCF came from the sale of stored gas, which will not happen this year. This item alone accounted for 10% of 2013 DCF. With backwardated natural gas prices, BWP's parking, lending, and storage results will be weaker going forward. In total, BWP expects distributable cash flow to be roughly $400 million, which would be down 28% year over year. At the end of the last quarter, there were 243 million units outstanding, so it will have a coverage ratio of roughly 4x.
Now, considering the fact most MLPs target a coverage ratio of 1.0-1.5x times, this coverage ratio may seem surprising. In fact, it would suggest BWP could cover a $0.40 payout. Why then did BWP cut its payout so massively? First, DCF will continue to decline in 2015 and probably 2016 due to weak renewals and increased maintenance requirements. The worst is yet to come as more contracts come up for renewal. In one sense, BWP is ripping the Band-Aid off rather than slowly pulling it off over several years. Second, BWP has a massively levered balance sheet and needs to retain cash to pay down debt.
In the fourth quarter, there was an operating income to interest coverage ratio of 1.42x, which is concerning. For the full year, the coverage ratio was 2.54x, which is still concerning. Operating income is falling, which will weaken the coverage this year. Moreover with higher rates and weaker performance, refinancing and rolling over debt will be extremely expensive, further eroding coverage. BWP has said it will not issue additional units this year, likely because it would struggle to get a secondary done after the price has fallen so dramatically.
Interestingly, the general partner has agreed to issue $300 million in subordinated debt if BWP needs it, which suggests that BWP is concerned about losing access to the debt market without paying exorbitant interest. With over $3.3 billion in debt, debt is 4.8x adjusted EBITDA. The company hopes to cut this to 4x EBITDA, though with EBITDA falling in 2014, this will be a multi-year effort. BWP needs to continue retaining cash to restore its financial status before it can consider paying a higher distribution.
After this dividend cut, there is no reason to buy BWP. Based on its guidance, BWP will earn about $0.75-$0.80 in 2014 while DCF will be about $400 million. However, these figures will continue to climb with weak renewals. It is hard to argue paying more than 12x earnings or $10. There is another 30% of downside in BWP. While it may be painful, BWP continues to be a sell even after this drop. This quarter completely any aspect of the bull case, and investors have to look elsewhere.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.