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Targa Resources Partners LP (NYSE:NGLS)

Q3 2010 Earnings Call Transcript

November 4, 2010 12:00 pm ET

Executives

Anthony Riley – Senior Manager, Finance/IR

Jim Whalen – President, Finance and Administration

Jeff McParland – EVP and CFO

Analysts

Darren Horowitz – Raymond James & Associates

Yves Siegel – Credit Suisse

Operator

Good day, ladies and gentlemen, and welcome to the Targa Resources Partners third quarter 2010 earnings conference call. (Operator instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Mr. Anthony Riley. Sir, you may begin.

Anthony Riley

Thank you, Operator. I'd like to welcome everyone to Targa Resources Partners LP third quarter 2010 investor call. Before we get started, I would like to mention that the partnership has published an earnings release, which is available on our website at TargaResources.com.

Speaking on the call today will be Jim Whalen, President, Finance and Administration, and Jeff McParland, Executive Vice President and Chief Financial Officer. Jim and Jeff are going to be comparing the third quarter of 2010 results to prior period results as well as providing additional color on our results, current performance, and other matters of interest.

Before we begin I would like to remind you that any statements made during this call that might include the Partnership's expectations or predictions should be considered forward-looking statements and are covered by the Safe Harbor provision of the Securities Acts of 1933-1934. Please note that the actual results could differ materially from those projected in any forward-looking statements. For a discussion of factors that could cause actual results to differ, please refer to our SEC filings, including our Annual Report on Form 10-K for the year ended December 31, 2009, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2010 and June 30th, 2010.

One quick reminder before starting into the results. With the closing of the acquisition of the Downstream business in 2009 and the three transactions in 2010, and in accordance with the accounting treatments for entities under common control, the results of operations of the Partnership include the historical results of the aforementioned businesses

With that, I will turn it over to Jim Whalen.

Jim Whalen

Thanks, Anthony. Welcome, and thanks to everyone for participating in Targa Resource Partners Third Quarter 2010 Conference Call. I'm filling in for Rene today because he is out of the country at a Board meeting.

Besides Jeff and myself, there are several members of Management who will be available to assist in the Q&A session. By way of agenda, I will start off with a review of our key accomplishments and business highlights, followed by a segment performance overview for the quarter. I will then turn it over to Jeff to review our consolidated financial results and other financial matters. Following Jeff's comments, I will provide updates on some ongoing activities at the Partnership, and finally, we will take your questions.

One housekeeping item before we dive into the results. As you may know, TRII, or Targa Resources Investment, Inc., is in registration with the SEC, and therefore we cannot discuss or make comments with respect to the S-1 filing.

Turning now to the accomplishments and business segment performance, the Partnership had a successful third quarter 2010. We had a very productive quarter with respect to acquisitions at the Partnership. We are pleased to have closed the accretive Versado and VESCO transactions, which add scale and diversity to the Partnership's business mix. With the closing of VESCO, we completely the final drop-down transaction from the parent, our Targa Resources, Inc.

Third quarter inlet volumes for the Permian, SAOU and North Texas systems showed impressive year-over-year gains. The combined plant inlet volume for the two Gathering and Processing segments decreased approximately 3% compared to last year's third quarter, while fractionation volumes in the Logistics Asset segment were essentially flat to last year. In the Marketing and Distribution segment, operating margin was flat compared to last year.

Our solid financial performance results in distributable cash flow of $57.1 million, which corresponds to strong distribution coverage of over 1.2 times for the quarter. We recently announced another increase in our distribution for the third quarter, which will be paid on November 12th. We believe our recent distribution increases are supported by the underlying strength of our businesses.

In fact, as Rene stated in the earnings release, for the fourth quarter distribution, we plan to recommend an increase to the Board of Directors in the annualized cash distribution rate of $0.04 to $2.19 per common unit compared to the current rate of $2.15 per common unit. If approved, this increase represents an almost 6% increase over last year's fourth quarter distribution.

We also had successes in launching two new fee-based organic growth projects in the Downstream business, the previously mentioned benzene treating project for Marathon, and the recently announced expansion of Gulf Coast Fractionators, where we own a 38.8% interest. I'll talk more about those projects, and other recently approved capital expenditures, towards the end of the call.

Turning now to segment performance, in the Gathering and Processing segment, the third quarter 2010 plant natural gas inlet for fuel Gathering and Processing segment was 584 million cubic feet per day, a 1% increase compared to the same period in 2009. All fuel segment inlet volumes are up compared to last year except for Versado.

North Texas, SAOU and Permian increased by approximately 6%, 12% and 11% compared to last year. The increase at North Texas was driven primarily by new Barnett shale well connected activity in the oilier Wise and Southern Montague Counties. The increase at SAOU was primarily driven by increased Wolfberry drilling activity, while Permian increased primarily due to new producer dedications from existing production, some of which was associated with the Wolfberry.

Somewhat offsetting these impressive inlet gains, Versado System inlet volume decreased, driven primarily by plant down time at Eunice due to a planned turnaround for maintenance work followed by an unexpected disruption caused by a water tank rupture. The plant is up and running at volume levels above those prior to the turnaround.

Fuel Gathering and Processing operating margins increased 8% compared to last year, driven primarily by higher NGL, gas and condensate prices, which rose 19%, 36% and 13% year-over-year. On a sequential basis, third quarter plant natural gas inlet for the Fuel Gathering and Processing segment decreased less than 1% compared to the second quarter of 2010, driven largely by the plant down time at Eunice during the quarter.

North Texas and SAOU both saw healthy sequential inlet volume increases of 4% and 5% due primarily to new well activity. The Permian system was flat, with new connection volumes offsetting production declines, while the Versado system's 7% decrease is primarily a result of the down time at Eunice. The third quarter operating margin was lower than the second quarter driven primarily by the operating expenses resulting from the Eunice plant down time.

Moving to Coastal Gathering and Processing, third quarter 2010 plant natural gas inlet was 1.6 billion cubic feet a day, a decrease of approximately 4% compared to the same period in 2009. The year-over-year decrease was driven by a 9% decrease in the Straddle System and an 18% decrease at LOU, somewhat offset by a 24% increase at VESCO. Straddle System inlet volumes were lower primarily due to the negative impact of flow disruptions stemming from producer operational issues and tropical storms, as well as the loss of some contracted volumes.

The decrease at the LOU System was driven primarily by lower well head volumes and declines. The strong increase at VESCO was driven primarily by the addition of new volumes, somewhat offset by reductions due to repairs on VGS, or the Venice Gas Gathering System.

Coastal Gathering and Processing operating margin increased approximately 17% compared to last years, driven primarily by the 19% increase in average realized NGL prices and lower operating expenses due to lower systems maintenance. On a sequential basis, third quarter plant natural gas inlet for the Coastal Gathering and Processing segment decreased 7% compared to the second quarter of 2010, driven primarily by decreases at both LOU and the Straddle System. VESCO was marginally down.

The 16% LOU System decrease over the second quarter is a result of lower well head and discretionary volumes primarily stemming from weak drilling activity and declines. The 8% decrease at the Straddle is primarily due to the negative impacts from turnaround activity, tropical storms, and other producer operational disruptions. Third quarter operating margin was marginally lower than the second quarter, primarily a function of the 5% decline in the average realized NGL prices and slightly lower NGL production.

Next, I'll provide an overview of the two segments in the Downstream business. Starting with the Logistics Asset segment, fractionation volumes for the third quarter of 2010 were approximately flat at 225,000 barrels a day compared to a year ago with a slight decrease, driven primarily by lower back-end volumes at the Cedar Bayou Fractionator, or CBF, somewhat offset by higher volumes at the Lake Charles Fractionator, or LCF.

Third quarter operating margin in the Logistics Asset segment increased 10% to $24 million compared to last year's, driven primarily by increases in the fixed portion or fractionating fees. Compared to the second quarter of 2010, third quarter operating margin in the Logistics Asset segment increased approximately 31%, driven primarily by higher chemical and LPG terminaling activity at the Galena Park Marine Terminal, increased capacity utilization at the Lake Charles Fractionator due to wide-grade offloads from Mont Belvieu to Lake Charles, and favorable system product gain.

In the Marketing and Distribution segment, third quarter NGL sales volumes decreased 9% to 243,000 barrels a day compared to last year's primarily due to a contract change with a PETCO Chemical supplier that has minimal impact on gross margin. Third quarter Marketing and Distribution operating margin increased 3% year-over-year to $15 million. You may have noticed that I have indicated positive improvement in the third quarter operating margin for all four of the segments as compared to the prior year, yet operating margin for the quarter is basically flat to the prior year's third quarter. The explanation is other primarily hedge revenues, which are down over the third quarter of 2009.

That wraps up my review, so now I'll turn it over to Jeff to give you more details on our consolidated and segment financial performance.

Jeff McParland

Thanks, Jim. I'd like to add my welcome, and thank you all for joining our call today.

As Anthony mentioned, under our common control accounting treatment, the Partnership's reported results of operations now include the historical results of the Downstream business, as well as the Permian and Straddle and Versado Systems, and VESCO for all periods presented.

For the third quarter of 2010, the Partnership reported net income allocable to limited partners of $10.1 million, or $0.14 per diluted limited partner unit, compared to $11.4 million, or $0.23 for the second quarter 2009. These quarterly results reflect noncash hedge charges of $7.8 million in 2010 and $17.1 million in 2009. Please also note that, under common control accounting, net income reported for the third quarters of 2010 and 2009 includes $3.9 million and $29.4 million in noncash affiliate interest expense related to drop-down businesses for periods prior to the acquisition of those businesses by the Partnership.

The 2% increase in gross margin for the third quarter compared to last year is primarily a reflection of higher average realized commodity prices and higher fixed portion of fractionation fees, somewhat offset by lower NGL and condensate sales volumes, lower business interruption proceeds, and lower hedge settlements. Operating expenses increased 4% compared to last year, primarily due to increased compensation and benefit cost and increased non-capitalized maintenance costs, offset by decreased costs associated with outside contract services.

The increase in depreciation and amortization expense for the quarter compared to last year is primarily attributable to assets acquired last year that have full period depreciation this year and to our year-to-date capital expenditures of $36.5 million. Third quarter G&A expense increased compared to last year primarily due to higher compensation costs and to timing differences. The decrease in interest expense was primarily due to the repayment or cancellation of higher interest rate affiliate debt associated with the predecessor operations for the drop-down acquisitions.

Adjusted EBITDA for the quarter declined to $91.4 million compared to $98.9 million last year. The decrease was primarily the result of less favorable hedge settlements and higher G&A expense. Maintenance capital expenditures were $12.9 million for the third quarter of 2010.

Let's move briefly to capital structure and liquidity. At September 30, we had approximately $245 million in capacity available under our senior secured revolving credit facility after giving effect to outstanding borrowings of $753 million and $102 million in letters of credit. We also had approximately $55 million of cash on hand at quarter-end.

Total funded debt at September 30 was approximately $1.4 billion, or about 56% of total capitalization, and our consolidated leverage ratio at quarter-end was approximately 3.6 times. The third quarter was very active from a financing and acquisition perspective, with the new senior secured revolving credit facility, over $430 million raised in the capital markets, and two acquisitions from Targa.

Our new five-year, $1.1 billion revolving credit facility due July 2015 increased availability by $141 million and also contains a $300 million agrarian [ph] feature. The new credit facility is secured by substantially all of the Partnership's assets and has an initial LIBOR spread of 275 basis points that will adjust starting next year between 225 and 350 basis points subject to leverage ratio.

The Partnership completed two capital markets transactions, a public offering of 7.475 million common units, which included the exercise in full of the Greenshoe option, and a separate private offering of 250 million of 7.78% senior notes due 2018. The net proceeds from these offerings were used to reduce borrowings under our senior secured credit facility.

During the quarter, we closed approximately $423 million in accretive acquisitions from Targa, including the Versado System and VESCO, which are both attractive Gathering and Processing businesses.

One last point on a common control basis, our estimated 2010 capital expenditures are approximately $145 million, with maintenance capital expenditures accounting for approximately 35% of that amount.

That wraps up my overview, so I'll turn it back to Jim.

Jim Whalen

Thanks, Jeff. Regarding our 78,000 barrel a day fractionation expansion at CBF, we're still on track, on time, and within budget to commence operations no later than the second quarter of 2011, which is in line with our initial projection schedule. And just recently, we contracted the remaining 2,000 barrels a day of Y-grade fractionation capacity associated with this expansion. This final deal was done at attractive terms, reflecting the continuing tight market conditions for frac space at Mont Belvieu, the nation's number one hub for fractionation capacity, where the Partnership has a leading market presence.

Along those same lines, hopefully you've seen our third quarter announcement for two separate growth projects in addition to the CBF expansion in Mont Belvieu, the first of those being the benzene treating project and the other an expansion of fractionation capacity at Gulf Coast Fractionators, a partnership of which we own 38.8%. As discussed previously, we've entered into a long-term contract with Marathon Corporation to install, own and operate treating equipment to reduce the benzene content of natural gasoline. The treater has an estimated gross cost of approximately $33 million, and we expect the new integrated facility to commence operations during the fourth quarter of 2011.

Gulf Coast Fractionators, a partnership among ConocoPhillips, Devon Energy Corporation and Targa Resources Partners, announced plan to expand the capacity of its natural gas liquids fractionation facility by approximately 42%, or 43,000 barrels a day, to a total of 145,000 barrels per day. Total capital expenditures of the expansion are estimated to be approximately $75 million, and the facility should commence operations during the second quarter of 2012. The Partnership will be responsible for its prorated share of the $75 million, or approximately $30 million.

As we have been discussing for quite some time, you can see that the Downstream business is creating very attractive growth opportunities for the Partnership as the combined three projects just discussed represent almost $130 million of net capital expenditures are being executed at very attractive rates of return and are fee-based projects with long-term firm space volume commitments. And all of this opportunity just adds to the already strong performance of our existing Logistics assets that have been benefiting from higher margins as industry demand for fractionation and NGL services remains strong.

Moving to the Gathering and Processing division, the business outlook is very similar to the Downstream in terms of growth opportunities. As most of you are aware, there is a shift going on in the oil and gas industry, given the high price of crude and the low price of gas. We believe that the current strength of oil, condensate and NGL prices, and our forecasted prices for these energy commodity, has caused producers in and around the Partnership's natural gas Gathering and Processing areas of operation to focus their drilling programs on regions rich in these forms of hydrocarbon.

Liquid-rich gas is prevalent from the Wolfberry trend and the Canyon Sand plays, which are accessible by the SAOU system. The Wolfberry and Bone Springs plays, which are accessible by the Permian system, and from oilier portions of the Barnett shale natural gas play, especially portions of Montague, Cook, Clay and Wise County, which are accessible by the North Texas system.

As a result of these dynamics, we have recently approved up to $30 million of growth capital expenditures for the SAOU system alone, most of which will be spent across the next 18 months. Part of these dollars will be used by the Partnership to restart the 25 million cubic feet a day Conger plant by the end of 2010, or very early in 2011, to provide for rapidly increasing volumes in SAOU, where we still are expecting a record number of well connects for this year.

In the very near future, we plan on bringing another growth CapEx package worth up to $30 million to the Board for approval. This package would mostly contain expansion plans around our North Texas system, where we continue to see incremental growth opportunities. We have a positive volume outlook for the Gathering and Processing division, which is similar relative to previous guidance. Based on information available to date, we believe our North Texas volumes in 2010 will exceed those of 2009, and SAOU and Permian system volumes should exceed those of 2009.

2009 inlet volumes for the Versado System will be lower compared to last year primarily due to the third quarter operational disruptions, which I have already discussed, combined with the falloff in gas production from the Morrow [ph] formation. The capital expenditures I just discussed will have a positive impact on 2011 volumes.

For the Coastal segment, we believe 2010 inlet volumes at both the Straddle System and VESCO will exceed those of 2009, while LOU volumes will be approximately those of last year.

Even with all the growth opportunities we see in our current business, much of which we have discussed, we continue to actively pursue new fee-based investment opportunities, potential opportunities for fee-base gathering, processing and NGL assets in the shale play, especially where we have advantages due to our existing Downstream assets, as well as additional expansion opportunities within our Downstream business.

That concludes the formal part of our call. We will now open it up for your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Darren Horowitz from Raymond James.

Darren Horowitz – Raymond James & Associates

Hey, guys, thanks. A couple quick questions, mostly as it relates to those closing comments. If I could, maybe you could provide us a little bit more color on the CapEx package that you're submitting for North Texas. Obviously there's more of a focus on the oil and condensate-rich areas of the Barnett, and I'm just curious as to how you best expect to deploy capital to kind of lever your existing footprint.

Jim Whalen

Generically, I would say we're going to expand the capacity of the plant, and we're going to expand our access to outlet (inaudible). I don't want to get into any more details than that.

Darren Horowitz – Raymond James & Associates

Okay. Switching gears over to the Downstream side of the business, you've got an advantageous footprint at Belvieu and also good connectivity. How do you lever that Downstream footprint as it relates to ramping Eagle Ford production?

Jim Whalen

To ramping Eagle Ford production? Well, clearly, we have one of the opportunities to take advantage of fractionation expansion. We're already doing that at CBF, and we've done that with Gulf Coast. There's other opportunities, and those will, we believe, provide us opportunities to do deals in the Eagle Ford that other people won't be able to do, or to contract with producers in that area.

Jeff McParland

In the rich gas areas of the shale.

Jim Whalen

Yes.

Darren Horowitz – Raymond James & Associates

Okay. And then final question for me as it relates to LOU, when you look at where volumes are tracking today, do you expect further organic production declines and reduced well connects as we progress through the fourth quarter, or do you think we've kind of hit a trough at current levels?

Jim Whalen

We're not projecting the LOU to have troughed. As I said in my comments, we would see in '11 LOU to continue to decline slightly.

Darren Horowitz – Raymond James & Associates

Okay. So just to quantify the magnitude of decline, are we thinking 5% year-over-year 2010 versus '10?

Jim Whalen

I don't want to get into that much detail. We do expect it to be down.

Darren Horowitz – Raymond James & Associates

Okay. That's it for me. Thanks.

Operator

(Operator instructions) Yves Siegel from Credit Suisse.

Yves Siegel – Credit Suisse

Hi, I just have a couple of questions, if I could. One, Jeff, is there an opportunity at all to refinance the 11.25% notes that are due in 2017?

Jeff McParland

Yves, that's an interesting balance sheet management question. The economic trade-off kind of goes in and out of the money when you run the simple arithmetic, and so that's something that we do watch in terms of just managing our balance sheet cost of capital, going forward.

Yves Siegel – Credit Suisse

Okay. and then the other question is do you folks have any contracts that roll over that you may be able to take advantage of in terms of rolling over at higher contract prices?

Jeff McParland

That's exactly what's been going on in the fractionation business. The improvement in the NGL logistics segment is not solely because of the expansion and addition of new capacity but because of the rollover of legacy contracts at market rates. In fact, our Chief Operating Officer has described sort of a top leasing kind of approach, where we've gone to customers whose contracts don't come up for renewal for the next year or two and have said you need to sign up now a year and two out, or we're going to have that allocated to somebody else.

So we're basically signing up commitments, going forward, on essentially a term basis, often as much as 10 years, and with minimum take-or-pay kinds of arrangements. So we're seeing just the existing operation generate higher margins as those contracts roll over to current market rates.

Yves Siegel – Credit Suisse

Is there any way for me to try to quantify what the magnitude of that could be as we look into '011?

Jeff McParland

I don't think there's enough information, Yves, for you to do any kind of bottoms-up analysis to try and support a forecast on that one in our disclosures.

Yves Siegel – Credit Suisse

Okay. All right. Thanks, guys.

Jeff McParland

Thank you.

Operator

(Operator instructions) At this time, I'm showing no further questions in the queue.

Jim Whalen

Thank you, Operator. And to the extent anyone has follow-up questions, please feel free to contact Jeff or any of us. Thank you again for your time today, and I will look forward to speaking to you again.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.

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