This article analyzes some of the key facts and trends revealed by Q2'14 results reported by Energy Transfer Partners, L.P. (NYSE:ETP). It evaluates the sustainability of the partnership's Distributable Cash Flow ("DCF") and assesses whether ETP is financing its distributions via issuance of new units or debt.
A brief description of ETP's segments is provided below:
- Intrastate Transportation and Storage Segment: ETP owns and operates ~7,800 miles of natural gas transportation pipelines with ~14.0 Bcf/d of transportation capacity and three natural gas storage facilities located in Texas.
- Interstate Transportation and Storage Segment: ETP owns and operates ~12,800 miles of interstate natural gas pipeline with ~11.3 Bcf/d of transportation capacity. This includes Panhandle Eastern Pipe Line Company, LP ("Panhandle"), the successor entity to Southern Union, which owns and operates the Trunkline and Sea Robin natural gas open-access interstate pipelines. Through Southern Union ETP also acquired a 50% interest in Citrus Corp., ("Citrus") which owns 100% of Florida Gas Transmission Company, LLC ("FGT"), a ~5,400 mile pipeline system that extends from south Texas through the Gulf Coast to south Florida. ETP also has a 50% interest in the joint venture that owns the 185-mile Fayetteville Express pipeline ("FEP").
- Midstream Segment: ETP owns and operates ~6,700 miles of natural gas and natural gas liquids ("NGLs") gathering pipelines with ~6 Bcf/d of gathering capacity, 5 natural gas processing plants, 15 natural gas treating facilities and 3 natural gas conditioning facilities with an aggregate processing, treating and conditioning capacity of ~4.2 Bcf/d. The midstream segment focuses on natural gas gathering, compression, treating, blending, and processing. Operations are currently concentrated in major producing basins and shale formations, including Austin Chalk and Eagle Ford in South and Southeast Texas, the Permian Basin in West Texas and New Mexico, the Barnett Shale and Woodford Shale in North Texas, the Bossier Sands in East Texas, the Marcellus Shale in West Virginia, and the Haynesville Shale in East Texas and Louisiana.
- NGL Transportation and Services Segment: consists of ETP's 70% interest in Lone Star NGL LLC ("Lone Star"), a joint venture that owns and operates ~2,000 miles of NGL pipelines with an aggregate transportation capacity of ~388,000 Bbls/d, three NGL processing plants with an aggregate processing capacity of ~904MMcf/d, three fractionation facilities with an aggregate capacity of 251,000 Bbls/d and NGL storage facilities with aggregate working storage capacity of ~47 million Bbls. The NGL pipelines primarily transport NGLs from the Permian and Delaware basins and the Barnett and Eagle Ford shale formations to Mont Belvieu, Texas. Lone Star's gas liquids storage, fractionation and transportation assets are located in Texas, Louisiana and Mississippi. Regency Energy Partners LP (NYSE:RGP), an MLP controlled by Energy Transfer Equity L.P. (NYSE:ETE), ETP's general partner, owns the other 30% of Lone Star.
- Investment in Sunoco Logistics Segment: ETP's interests in Sunoco Logistics Partners L.P. (NYSE:SXL) consist of a 2% general partner interest, 49.95% of the incentive distribution rights ("IDRs") and 33.5 million SXL common units representing 32% of the limited partner interests in SXL as of 12/31/13. SXL owns and operates ~4,900 miles of crude oil trunk pipelines and approximately 500 miles of crude oil gathering lines, principally in Oklahoma and Texas, aggregate storage capacity of ~46 million barrels, ~39 refined products marketing terminals and several refinery terminals. SXL has ~2,500 miles of pipelines that transport refined products, including multiple grades of gasoline, middle distillates (such as heating oil, diesel and jet fuel) and liquefied petroleum gas ("LPG") such as propane and butane, from refineries to markets. SXL also has joint venture interests in four refined products pipelines in selected areas of the United States.
- Retail Marketing Segment: ETP's retail marketing operations consists of retail locations and convenience stores selling gasoline (including gasoline blend stocks such as ethanol), distillates, and other petroleum products in 24 states, primarily on the east coast and in the mid west region of the U.S. On April 27, 2014, ETP entered into an agreement to acquire Susser Holdings Corporation in a unit and cash transaction valued at ~$1.8 billion. Upon closing (expected in Q3'14), ETP will own approximately 11 million (~50.2% of the outstanding units), the general partner interest and the IDRs in Susser Petroleum Partners LP and its 630 convenience stores.
- All Other Segment: includes interests in numerous entities, including: a) 3.1 million units of AmeriGas Partners, L.P. (APU; b) ~33% non-operating interest in PES, a joint venture that owns a refinery in Philadelphia; c) an investment in RGP related to the RGP common and Class F units received by Southern Union in exchange of its interest in Southern Union Gathering Company, LLC to RGP on April 30, 2013; and d) the natural gas marketing operations (moved from the Midstream Segment in Q1'14).
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.
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 FGT and 100% of FEP, even though ETP owns 50% of these latter two ventures and, prior to Q1'13, 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 6/30/14 and 6/30/13 is presented in Table 1 below:
Notable improvements on a TTM basis were exhibited by Midstream (increased production and increased capacity from assets recently placed in service in the Eagle Ford Shale), NGL (increase in volumes transported on Lone Star and increases in processing plants' NGL production), Sunoco Logistics (the 12-month period ended 6/30/13 excludes ~3 months of contributions since SXL and Sunoco's retail marketing operations were acquired on 10/4/12), Retail Marketing (mostly reflecting a non-cash valuation adjustment and the October 2013 acquisition of Mid-Atlantic Convenience Stores, LLC, and All Other.
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 6/30/14 was $2,759 million, up from $2,087 million in the TTM ended 6/30/13, as shown in Table 2:
The manner in which ETP determines coverage ratio is presented in Table 3 below:
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:
The risk management activities consist primarily of adjustments for derivative activities relating to interest rate swaps and commodity price fluctuations.
But the principal differences between reported DCF and sustainable DCF in the TTM ending 6/30/14 relate to a variety of items grouped under "Other," the largest components of which are a $168 million charge for environmental remediation taken in Q4'13 and a $85 million income tax charge taken in Q1'14 in connection with a February 19, 2014, transaction in which ETP transferred Trunkline LNG, the entity that owns a LNG regasification facility, to ETE in exchange for the redemption by ETP of 18.7 million ETP units held by ETE. 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).
Of course one could argue one-time items should not impact DCF. But when these "one-time" events occur not infrequently, and are of significant magnitude, it makes more sense to include them, or at least to reduce DCF by establishing a reserve for such items.
The impact of adjusting for non-sustainable items on coverage ratios is shown in Table 5 below:
Sustainable DCF coverage in the latest TTM periods improved considerably compared to the prior-year period. ETE's relinquishment of distributions to which it is entitled by virtue of its IDRs has provided considerable help in achieving the improvement. So far in 2014 they amounted to $53 million and are expected to amount to $106 million for the year. They are expected to average ~$47 million per year between 2015-2019.
Table 6 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:
Simplified Sources and Uses of Funds
Net cash from operations less maintenance capital expenditures exceeded distributions (including distributions to non-controlling interests) by $349 million in the TTM ended 6/30/14. The corresponding prior-year period fell short of covering distributions by $541 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) coverage ratios are boosted by exclusion of several "one-time" items and by ETE's relinquishment of some of its IDR distributions; 3) the IDR burden is high (48% of every incremental dollar distributed); 4) numerous, large, related-party transactions create unhealthy conflict of interests situations and more such transactions are on the horizon; and 5) additional exposure to environmental liabilities posed by retail gasoline stations currently, or previously, owned or leased by ETP.
Trunkline LNG and Susser provide but the latest illustration of the conflicts problem. "Better than expected performance" was reported in Q1'14, very shortly after Trunkline LNG 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. ETE has agreed, upon closing of the Susser merger, to relinquish an aggregate of $350 million in IDR distributions that it would potentially receive over the first forty fiscal quarters after the merger. Such relinquishment would cease upon the agreement of an exchange of the Susser Petroleum general partner interest and the incentive distribution rights between ETE and ETP. 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) the 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; 4) 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 5) two major pipeline construction projects recently announced by ETP: the 1,100 mile, ~$5 billion, crude oil pipeline from the Bakken shale to Patoka, IL and the 820 mile, ~$4 billion, ET Rover natural gas pipeline from the Marcellus shale to numerous markets in the U.S. and Canada (for the latter, binding, fee-based, predominantly 20-year commitments have already been obtained for ~91% of design capacity). Both projects are expected to commence service in Q4 2016.
I continue to hold my position and remain overweight on ETE vs. ETP.
Disclosure: The author is long ETP, ETE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.