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Summary

  • Improvements in Adjusted EBITDA, DCF and sustainable DCF.
  • Constructive plans unveiled to exit retail marketing and to supply natural gas to Mexico.
  • No-core operations were largest contributors to the 1Q14 increase Adjusted EBITDA; core operations helped by cold weather.
  • Coverage based on sustainable lower DCF than on reported DCF; latter buoyed by large “one-time” items added back for 2nd consecutive quarter.
  • Concerns regarding related-party transactions remain.

Energy Transfer Partners, L.P. (NYSE:ETP) recently reported its results of operations for 1Q 2014. This article analyses some of the key facts and trends revealed by this and prior ETP reports, evaluates the sustainability of ETP's Distributable Cash Flow ("DCF") and assesses whether ETP is financing its distributions via issuance of new units or debt.

ETP owns and operates approximately 35,000 miles of natural gas and natural gas liquids pipelines, including 100% of Panhandle Eastern Pipe Line Company, LP (the successor of Southern Union Company), Sunoco, Inc., and a 70% interest in Lone Star NGL LLC, a joint venture that owns and operates natural gas liquids storage, fractionation and transportation assets. ETP also owns the general partner, 100% of the incentive distribution rights ("IDRs"), and approximately 33.5 million common units in Sunoco Logistics Partners L.P. (NYSE:SXL), which operates a geographically diverse portfolio of crude oil and refined products pipelines, terminals and crude oil acquisition and marketing assets. ETP's general partner is Energy Transfer Equity L.P. (NYSE:ETE).

Segment Adjusted EBITDA is a metric developed by management to measure the core profitability of ETP's operations. Segment Adjusted EBITDA forms the basis of ETP's internal financial reporting and is one of the performance measures used by management in deciding how to allocate capital resources among business segments. A brief description of ETP's segments is provided in a prior article dated March 11, 2014.

Management defines Segment Adjusted EBITDA as earnings before interest, taxes, depreciation & amortization (EBITDA) less various non-cash items (e.g., non-cash compensation expense, gains and losses on disposals of assets, allowance for equity funds used during construction, unrealized gains and losses on commodity risk management activities, non-cash impairment charges, loss on extinguishment of debt, and gain on deconsolidation). Segment Adjusted EBITDA includes 100% of Lone Star (although ETP owns 70%) and also 100% of the Florida Gas Transmission Company, LLC ("FGT") and 100% of the Fayetteville Express Pipeline ("FEP"), even though ETP owns 50% of these latter two ventures and, prior to 1Q13, accounted for them using the equity method (i.e., based on the ETP's proportionate ownership), as it does for other unconsolidated affiliates.

Segment Adjusted EBITDA for recent quarters and the trailing twelve months ("TTM") ended 3/31/14 and 3/31/13 is presented in Table 1 below:

(click to enlarge)Table 1: Figures in $ Millions, except per unit amounts and % change. Source: company 10-Q, 10-K, 8-K filings and author estimates.

TTM numbers in Table 1 are not entirely comparable because the 12-month period ended 3/31/13 excludes ~6 months of Sunoco's contributions (since SXL and Sunoco's retail marketing operations were acquired on 10/4/12). This should be also borne in mind when reviewing subsequent tables in this report. 1Q14 and 1Q13 are more comparable. The largest contributors to the $250 million increase in Segment Adjusted EBITDA in the first quarter were operations I consider non-core, namely Retail Marketing (increase of $72 million, mostly reflecting the October 2013 acquisition of "MACS", Mid-Atlantic Convenience Stores, LLC) and All Other (increase of $71 million), The latter includes ETP's investment in AmeriGas Partners L.P. (NYSE:APU), its natural gas compression operations and natural gas marketing operations, a ~33% non-operating interest in a refining joint venture, and an investment in Class F units issued by Regency Energy Partners, L.P. (NYSE:RGP) on 4/30/13. A core segment, Interstate Transportation & Storage, would have shown a greater increase in 1Q14 results over 1Q13 but for the February 19, 2014, sale of Trunkline LNG Company, LLC ("Trunkline"), a liquefied natural gas regasification facility in Lake Charles, Louisiana, to ETE in exchange for the redemption by ETP of 18.7 million ETP units held by ETE.

In an article titled "Distributable Cash Flow" I present ETP's definition of DCF and also provide definitions used by other MLPs. Based on this definition, ETP's DCF for the TTM ended 3/31/14 was $2,599 million, up from $1,790 million in the TTM ended 3/31/13, as shown in Table 2:

(click to enlarge) Table 2: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings.

ETP reports coverage based on a narrow definition. The numerator is DCF attributable to the limited and general partners of ETP (i.e., after deducting distributions to SXL and RGP) and the denominator is distributions made to the partners of ETP. The manner in which ETP determines coverage ratio is presented in Table 3 below:

(click to enlarge) Table 3: Figures in $ Millions, except ratios. Source: company 10-Q, 10-K, 8-K filings.

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". Table 4 below provides a comparison between sustainable DCF and the consolidated DCF number reported by management:

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

The principal differences between reported DCF and sustainable DCF relate to working capital, to risk management activities and to a variety of items grouped under "Other".

Under ETP's definition, reported DCF always excludes working capital changes, whether positive or negative. My definition of sustainable DCF only excludes working capital generated (I deduct working capital consumed). Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the MLP should generate enough capital to cover normal working capital needs. On the other hand, cash generated by the MLP through the liquidation or reduction of working capital is not a sustainable source and I therefore ignore it. Over reasonably lengthy measurement periods, working capital generated tends to be offset by needs to invest in working capital. Working capital consumed $611 million in the TTM ended 3/31/13. Management adds back working capital consumed in deriving reported DCF while I do not.

The $38 million negative adjustment for risk management activities in the TTM ended 3/31/14 consists primarily of adjustments for derivative activities relating to interest rate swaps and commodity price fluctuations.

The largest components of the $348 million adjustment for items grouped under "Other" in the TTM ended 3/31/14 are a $168 million charge for environmental remediation taken in 4Q13 and an $87 million income tax charge taken in 1Q14 because the Trunkline transaction is treated as a sale for tax purposes. The balance of "Other" consists of various components, including deferred income taxes, amortization of interest expense, and unvested unit awards. Management excludes "Other" from its DCF calculation (i.e., amounts are added back).

Coverage ratios shown below are based on a broad definition (vs. a narrow definition used by ETP, as derived in Table 3).

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

Under the broader definition of coverage used in Table 5, the numerator is total DCF and the denominator is the total of all distributions made to all the stakeholders, including ETE, RGP and SXL. DCF coverage as computed by ETP is not consistently lesser or greater than it would have been had the broader definition been used. It is just different and therefore more difficult to compare to other MLPs.

Sustainable DCF coverage in the latest quarterly and TTM periods improved considerably compared to the prior year periods. Coverage has now improved for 3 consecutive quarters (1Q14, 4Q13 and 3Q13) vs. the same quarters in the corresponding prior years periods. This too is encouraging.

Table 6 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:

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

Net cash from operations less maintenance capital expenditures exceeded distributions by $156 million in the TTM ended 3/31/14. The corresponding prior year period fell short of covering distributions by $623 million mostly due to a significant increase in working capital. Distributions in the latest quarter and TTM period were not funded by issuing debt and/or limited partnership units.

My main concerns regarding ETP are as follows: 1) it is difficult to evaluate ETP's results and ascertain DCF sustainability given its structural complexity, as well as its rapid pace of acquisitions and dispositions; 2) the IDR burden is high (48% of every incremental dollar distributed); 3) for the second consecutive quarter, "one-time" items were added back resulting in reported DCF exceeding sustainable DCF; and 4) numerous, large, related-party transactions create unhealthy conflict of interests situations and more such transactions are on the horizon.

Trunkline provides but the latest illustration of the conflicts problem. "Better than expected performance" was reported in 1Q14, very shortly after this asset was transferred from ETP to ETE. Presumably the price paid by ETE reflected projections of future performance. But it is ETE that develops the projections and ETE benefits if they are too conservative. This is not to suggest crossing of any "bright lines" but shows a potentially problematic gray area requiring judgment calls made in the absence of an arm's length relationship.

Positive factors to bear in mind regarding ETP include: 1) improvement in Segment Adjusted EBITDA; 2) improvements in sustainable DCF; 3) plans are in place to eventually divest ETP's retail marketing operations, recently bolstered by the acquisition of Susser Holdings Corp. (NYSE:SUSS) that includes 50.2% of Susser Petroleum Partners LP (SUSP) for $2.1 billion (including $300 million of assumed debt); 4) the recently announced agreements with Comisión Federal De Electricidad ("CFE") to provide transportation services for 930,000 million British thermal units ("MMBtu") of natural gas per day to Mexico; 5) improving spreads on interstate pipelines and management's assessment that it will be able to roll over and/or add new contracts at rates equal to or better than current rates on both interstate and intrastate systems; and 6) ETP expects increased processing and throughput volumes in 2014 as projects recently placed in service ramp up (growth projects aggregating $830 million are expected to be placed in service through 2014, of which ~$603 million are in the Midstream and NGL Transportation and Services segments).

I continue to hold my position and remain overweight on ETE vs. ETP.

Source: A Closer Look At Energy Transfer Partners' Distributable Cash Flow As Of Q1 2014