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Summary

  • Results have deteriorated for 2 years in a row. 2013 compares unfavorably with 2012, and even more so with 2011.
  • Low DCF coverage resulting from increased distributions in the face of an adverse NGL pricing environment and significant equity issuances.
  • In latest drop-down transaction, WPZ is acquiring assets with commodity risk.
  • Cash flows in 2014 will get a boost from payments related to Geismar business interruption insurance policies.
  • If achieved, the ~60% increase in DCF projected to materialize from 2013 to 2015 will reward patient investors.

This article analyzes the most recent quarterly and annual results of Williams Partners, L.P. (NYSE:WPZ), looks "under the hood" to properly ascertain sustainability of Distributable Cash Flow ("DCF"), and assesses whether WPZ is financing its distributions via issuance of new units or debt.

Effective January 1, 2013, management reorganized WPZ's businesses into the following geographically based operational segments:

  1. 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% (going up to ~59% in 2Q14) equity investment in Caiman Energy II, LLC ("Caiman").
  2. Atlantic-Gulf: This segment includes the Transcontinental Gas Pipe Line Company, LLC ("Transco"), WPZ's 10,200-mile pipeline system that transports natural gas to markets throughout the northeastern and southeastern United States. 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").
  3. 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").
  4. 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 an 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.

Results have deteriorated for 2 years in a row. 2013 compares unfavorably with 2012, and even more so with 2011. Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for these years and the quarters ending 12/31/13 and 12/31/12 are presented in Table 1 below:

(click to enlarge)Table 1: Figures in $ Millions, except net income per unit and units outstanding. Source: company 10-K, 10-Q and 8-K filings

In 2013, WPZ reported continued pressure on processing margins for natural gas liquids ("NGL"), reduced ethane recoveries and decreases in average NGL per-unit sales prices, as well as lower olefin margins associated with lost production related to the Geismar incident described in an article dated August 4, 2013. These adversely impacted revenues, operating income, EBITDA and net income.

Table 2 below compares segment performance in the periods under review:

(click to enlarge)

Table 2: Figures in $ Millions. Source: company 10-K, 10-Q and 8-K filings

Segment operating profit at Atlantic Gulf increased in 2013 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 4Q13 and year-to-date segment operating profit decreased due to lower NGL margins, including the effects of system-wide ethane rejection and higher natural gas prices. Decreases in gathering and processing fee revenue in 2013 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 due to less favorable producer economics that caused a reduction in drilling in western Colorado in 2012 and in 2013. Production decreases, in turn, decrease the quantity of natural gas available to gather and process. Increased natural gas transportation revenues associated with Northwest Pipeline's new rates partially offset the Piceance basin production declines.

Segment operating profit at NGL & Petchem Services would have declined sharply in 2013 but for $50 million of insurance recoveries in 3Q13 related to the Geismar incident previously referred to. WPZ estimates it will receive approximately $430 million of total cash recoveries from insurers related to business interruption losses and a further $20 million related to the repair of the plant. The insurance coverage is expected to significantly mitigate WPZ's financial loss from the incident. However, WPZ could face fines and penalties from the various federal and state governmental agencies investigating the matter; these would not be covered by its insurance policy. Additionally, multiple lawsuits, including class actions for alleged offsite impacts, property damage, and personal injury, have been filed against various WPZ subsidiaries. Following the repair and plant expansion, the Geismar plant is expected to be in operation in June 2014 (the initial estimate was April).

The generally downward trend in revenues, operating income and EBITDA for 2013, 2012 and the past 6 quarters is shown in Table 3 below:

(click to enlarge)Table 3: Figures in $ Millions, except % changes and per unit amounts. Source: company 10-K, 10-Q and 8-K filings, author estimates

The only encouraging trend visible in Table 3 is the growth in fee-based income, primarily due to higher fee revenues associated with the growth in businesses acquired in 2012, as well as contributions from processing and fractionation facilities placed in service in the latter half of 2012 and in 2013. It partially offsets continuing declines in NGL margins. However, 2014 results will see an upward spike as 2013 Geismar business interruption losses are followed in 2014 by insurance recoveries.

Ethane exposure has contributed significantly to the decrease in product revenues. Sharp declines in NGL prices have pushed down processing margins (40% lower in 2013 vs. 2012). 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 2013 was $1,771 million ($4.21 per unit) vs. $1,489 million ($4.35 per unit) in the prior year period.

Table 4 below provides a comparison between reported and sustainable DCF:

(click to enlarge)Table 4: Figures in $ Millions. Source: company 10-K, 10-Q and 8-K filings, author estimates

Most of the gap between reported DCF and sustainable DCF shown under "other" for 2013 reflects management's adjustment for the Geismar Incident and pre-acquisition cash flows allocated to WMB. The gap in 2012 reflects larger pre-acquisition cash flows allocated to WMB. The gap in 4Q13 mostly reflects an adjustment related to Geismar incident. Management estimates this hurt 4Q13 DCF to the tune of $122 million. I realize that the absence of Geismar's contribution to 2013 DCF is a one-time event to be reversed in 2014 as insurance proceeds are received. I also understand that by adding it back management is reducing the variability of DCF. But this does not convert the Geismar adjustments into distributable cash flow. I prefer the DCF to more closely track the sustainable cash generated even if it means having to deal with lumpy results.

WPZ increased 4Q13 distributions to $0.8925 (up ~1.7% from 3Q13 and up ~7.8% from 4Q12). 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 3Q13 was actually made in 4Q13); second, based on declared distributions (e.g., assuming the distribution declared for 4Q13 had been made in 4Q13). Annual numbers tends to be more meaningful than quarterly numbers for the purpose of coverage ratios. However, I present both:

(click to enlarge)Table 5: $ millions, except coverage ratios. Source: company 10-K, 10-Q and 8-K filings, author estimates

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

(click to enlarge)Table 6: Figures in $ Millions. Source: company 10-K, 10-Q and 8-K filings, author estimates

Net cash from operations, less maintenance capital expenditures exceeded distributions by $171 million in 2012 but fell short by $40 million in 2013 due to deterioration in key performance parameters accompanied by distribution growth. Table 6 shows distributions in 2013 were funded through the issuance of additional equity or debt, and through cash received from affiliates and non-controlling interests.

Management has lowered its DCF and DCF coverage guidance several times in the recent past. This can be seen in Table 7 below. However, the recent presentation of 4Q13 results held the 2014-2015 forecast steady.

(click to enlarge)Table 7 ($ millions except coverage ratios). Source: company 10-K, 10-Q and 8-K filings, author estimates

The 6% distribution growth forecasted for 2014-2015 incorporates the accretive effect anticipated from the March 2014, $1.2 billion, acquisition of some of the Canadian operations owned by Williams Companies, Inc. (NYSE:WMB), WPZ's general partner. The transaction was funded with $25 million of cash, the issuance of 25.6 million Class D payment-in-kind units that will be convertible to common units at a future date. WPZ may issue additional Class D units to WMB on a quarterly basis through 2015 for up to a total of $200 million in cash for the purpose of funding certain facility expansions. The price indication, considering the assets have commodity risk, is ~7 times cash flow (the assets purchased increase WPZ's exposure to commodity price fluctuations).

Table 8 below provides selected metrics comparing WPZ to some of the other MLPs I follow based on the latest available TTM results.

As of 03/14/14:

Price

Current Yield

TTM

EBITDA

EV / TTM EBITDA

2014 EBITDA

Guidance

Buckeye Partners (NYSE:BPL)

$73.64

5.91%

627

18.3

710

Boardwalk Pipeline Partners (NYSE:BWP)

$12.60

3.17%

689

9.4

650

El Paso Pipeline Partners (NYSE:EPB)

$29.91

8.69%

1,113

9.6

1,200

Enterprise Products Partners (NYSE:EPD)

$67.81

4.13%

4,685

17.2

-

Energy Transfer Partners (NYSE:ETP)

$54.91

6.70%

2,746

12.9

-

Kinder Morgan Energy (NYSE:KMP)

$74.25

7.33%

5,165

10.0

5,900

Magellan Midstream Partners (NYSE:MMP)

$69.26

3.38%

845

21.8

936

Targa Resources Partners (NYSE:NGLS)

$53.55

5.58%

661

13.2

750

Plains All American Pipeline (NYSE:PAA)

$53.10

4.63%

2,168

11.8

2,150

Regency Energy Partners (NYSE:RGP)

$26.93

7.06%

477

18.9

-

Suburban Propane Partners (NYSE:SPH)

$42.59

8.22%

307

12.3

-

Williams Partners

$49.67

7.19%

2,215

13.9

-

Table 8: Enterprise Value ("EV") and TTM EBITDA figures in $ Millions. Source: company 10-K, 10-Q and 8-K filings, author estimates

Management's decision to significantly dilute unitholders in executing two transformative transactions, in conjunction with an adverse NGL pricing environment, the Geismar incident, 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 significant equity issuances ($2.56 billion in 2012, $1.96 billion in 2013) and with some downward guidance adjustments, it is not surprising that there has been gradual loss of investor confidence and that the unit price has languished (WPZ's unit price is up only 0.6% in the past 12 months, far less than many other MLPs).

On the other hand, WPZ is making huge growth capital investments, 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. Cash flows in 2014 will get a boost from payments related to Geismar business interruption insurance policies. Management also anticipates further improvements in the fee-based business.

Source: A Closer Look At Williams Partners' Distributable Cash Flow As Of Q4 2013