- There are significant differences between EBITDA and Adjusted EBITDA because investments in unconsolidated affiliates are treated as if they were fully consolidated.
- Even on an adjusted basis, EV/EBITDA multiple is high vs. other MLPs.
- RGP has not been generating excess cash that could help fund its capital expenditures and reduce reliance on raising debt and equity.
- Transformative acquisitions plus large backlog of approved organic growth projects underpin expected volume growth, earnings growth, and distribution growth.
This article analyses some of the key facts and trends revealed by Q2'14 results reported by Regency Energy Partners LP (NYSE:RGP). It evaluates the sustainability of the partnership's Distributable Cash Flow ("DCF") and assesses whether RGP is financing its distributions via issuance of new units or debt.
RGP provides midstream energy services to producers and consumers of natural gas (gathering and processing, compression, treating and transportation), natural gas liquids ("NGLs") (transportation, fractionation and storage), crude oil and condensates (gathering, transportation and terminal services). It also manages coal and natural resource properties. RGP's activities are concentrated in key natural gas producing shale formations in the United States: Eagle Ford, Haynesville, Barnett, Fayetteville, Marcellus, Utica, Bone Spring, Avalon and Granite Wash. RGP's assets include ~26,000 miles of gathering pipelines; 44 processing plants; storage capacity of 47 million barrels of NGLs; and NGL fractionators able to process 225,000 barrels per day. RGP acquired a significant portion of these assets in a series of transformative transactions. Most recently:
- On April 30, 2013, RGP closed on the ~$1.5 billion acquisition of Southern Union Gathering Company, LLC, the owner of Southern Union Gas Services, Ltd. ("SUGS"), from a jointly owned affiliate of Energy Transfer Equity, L.P. (NYSE:ETE) and Energy Transfer Partners, L.P. (NYSE:ETP). This significantly expanded RGP's presence in the Permian Basin (west Texas). ETE is the general partner of both ETP and RGP.
- On February 3, 2014, RGP acquired the midstream business of Hoover Energy Partners ("HEP") for $293.2 million. This acquisition further enhances RGP's geographic footprint in the Delaware Basin in West Texas and expands its suite of producer services by adding crude and water gathering services in one of its core operating regions.
- On March 21, 2014, RGP acquired PVR Partners, LP ("PVR") for $5.7 billion. This acquisition further enhances RGP's geographic diversity by providing presence in the Marcellus and Utica shales in the Appalachian Basin, and the Granite Wash in the Mid-Continent region.
- On July 1, 2014, RGP acquired the midstream business of Eagle Rock Energy Partners LP ("EROC") for $1.3 billion. This acquisition complements RGP's core gathering and processing business, and when combined with the proposed acquisition of PVR, further diversifies RGP's basin exposure in the Texas Panhandle, East Texas and South Texas
RGP is organized into 6 business segments:
- Gathering and Processing transports raw natural gas from the wellhead through gathering systems, processes raw natural gas to NGLs from the raw natural gas, and sells or delivers pipeline-quality natural gas and NGLs to various markets and pipeline systems. This segment includes SUGS, Edwards Lime Gathering ("ELG") in which a non-controlling interest owns 40%, Grey Ranch (a 50% joint venture between SUGS and a subsidiary of SandRidge Energy), RGP's non-controlling 33.33% interest in Ranch JV, (a venture that processes natural gas delivered from shale formations in west Texas), and RGP's 51% interest in Aqua - PVR (a venture that transports and supplies fresh water to natural gas producers in the Marcellus shale in Pennsylvania);
- Natural Gas Transportation includes a 49.99% general partner interest in RIGS Haynesville Partnership Co. ("HPC"), which owns a 450 mile intrastate pipeline that delivers natural gas from northwest Louisiana to downstream pipelines and markets; a 50% membership interest in Midcontinent Express Pipeline LLC ("MEP"), which owns an interstate natural gas pipeline with approximately 500 miles stretching from southeast Oklahoma through northeast Texas, northern Louisiana and central Mississippi to an interconnect with the Transcontinental Gas Pipe Line system in Butler, Alabama; and Gulf States, a small (10-mile), wholly-owned, regulated, interstate pipeline that extends from Harrison County, Texas to Caddo Parish, Louisiana.
- NGL Services includes the 30% membership interest in Lone Star, an entity owning a diverse set of midstream energy assets including NGL pipelines, storage, fractionation and processing facilities located in the states of Texas, Mississippi and Louisiana. ETP owns 80% of Lone Star.
- Contract Services operates a fleet of compressors used to provide turn-key natural gas compression services and a fleet of equipment used to provide treating services, such as carbon dioxide and hydrogen sulfide removal, natural gas cooling, dehydration and BTU management, to natural gas producers and midstream pipeline companies;
- Natural Resources manages coal and natural resources properties and the related collection of royalties; it also earns revenues from other land management activities. This segment also includes RGP's 50% interest in Coal Handling, which owns and operates end-user coal handling facilities; and
- Corporate comprises RGP's corporate offices.
RGP uses "Segment Margin" as one of its key metrics to measure operating performance. Segment Margin is roughly equal to revenues less cost of sales. Segment Margin for the periods under review is summarized in Table 1 below:
No numbers appear for the 2nd and 3rd segments because RGP does not record segment margin for its investments in unconsolidated affiliates (HPC, MEP, Lone Star, Ranch JV, Grey Ranch, Aqua-PVR and Coal Handling). RGP only records its ownership percentage of the JV's net income as income from unconsolidated affiliates, in accordance with the equity method of accounting. This is further explained in the discussion following Table 2.
Segment Margin is the main driver of EBITDA (earnings before interest, depreciation & amortization and income tax expenses). DCF and adjusted earnings before interest, depreciation & amortization and income tax expenses ("Adjusted EBITDA") are the primary measures typically used by master limited partnerships ("MLPs") to evaluate their operating results. However, making comparisons between MLPs is difficult because there are no standard definitions for these terms. RGP's Adjusted EBITDA for recent quarters and the TTM ended 6/30/14 and 6/30/13 is presented in Table 2 below:
SUGS contributions to EBITDA began in May 2013. Thus, Q2'14 and the TTM ended 6/30/14 include full period EBITDA contributions from SUGS, while Q2'13 and the TTM ended 6/30/13 include only 2 months of contributions. Likewise, HEP began contributing in Q1'14 and PVR in Q2'14.
The principal difference between EBITDA and Adjusted EBITDA relates to RGP's substantial, but non-controlling, stakes in other pipelines. For purposes of calculating Adjusted EBITDA, RGP treats its investments in unconsolidated affiliates (HPC, MEP, Lone Star, Ranch JV, Grey Ranch, Aqua-PVR and Coal Handling as if they were fully consolidated by deducting its share of net income, adding its share of EBITDA, and further adjusting to take into account its share of interest expense and maintenance capital expenditures.
RGP's definition of DCF is presented in an article titled "Distributable Cash Flow." The article also provides definitions used by other master limited partnerships ("MLPs"). Based on this definition, DCF reported by RGP for the TTM ended 6/30/14 was $599 million ($1.92 per unit), up from $337 million ($1.85 per unit) in the prior-year period, as shown in Table 3 below:
Note that I use the "DCF per unit" metric as a proxy measure to gauge whether total DCF generated is growing or contracting. I do not use it to calculate DCF coverage and it does not imply that the limited partners are the only stakeholders in that DCF. Indeed they are not. In the case of RGP, ETE has a claim to a portion of the DCF by virtue of incentive distribution rights ("IDRs"). At the current quarterly distribution level ($0.49 per unit) ETE receives 23% of each incremental dollar distributed and, in total, $0.0261 for each $0.49 payment made to a limited partner.
Reported DCF may differ from sustainable DCF for a variety of reasons. These are reviewed in an article titled "Estimating sustainable DCF-why and how." Applying the method described there to RGP's results generates the following comparison between reported and sustainable DCF:
The principal differences between reported and sustainable DCF in the two TTM periods are attributable to various items grouped under "Other," to cash generated by asset sales and disposal of liabilities, and to an adjustment for changes in non-current assets and liabilities resulting from the SUGS acquisition.
I do not regard proceeds from asset sales as a sustainable source of DCF and therefore exclude them from my definition of sustainable DCF.
The largest component of the $154 million in "Other" for the TTM ending 6/30/14 is an $83 million management adjustment made in Q1'14 to include a full quarter of DCF contribution related to the PVR acquisition (vs. 11 days of actual contribution in that quarter). The balance consists mostly of management adjustments that increased EBITDA to reflect RGP's substantial (but non-controlling) stakes in the various entities and joint ventures mentioned in the discussion that follows Table 2. Other offsetting adjustments include a host of items such as income tax deferred and interest expense amortized.
On the one hand, I can accept classifying RGP's share of cash flows generated from the JV entities in the sustainable category despite the fact that RGP does not control them (i.e., cannot determine what to do with the cash they generate). This is because they are similar in every other respect to RGP's other pipeline assets and because RGP and/or ETE, RGP's general partner, do exercise a significant degree of influence over them. On the other hand, RGP's share of cash flows generated from the JV entities does not appear on RGP's balance sheet and does not increase RGP's end-of-period cash balance. Similarly, amounts that PVR would have hypothetically contributed had it been acquired on January 1, 2014, do not increase RGP's end-of-period cash balance.
Coverage ratios, with and without the "Other" line item, are derived as follows:
Table 5: Figures in $ Millions, except per unit amounts and coverage ratios. Source: company 10-Q, 10-K, 8-K filings and author estimates.
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.
Simplified Sources and Uses of Funds
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, less net income from non-controlling interests exceeded distributions by $43 million in the TTM ending 6/30/14. Table 6 indicates that, at least in this period, RGP funded distributions by issuing debt and equity. But, as noted in the discussion of Table 4, there is an argument to be made for including net cash contributions from pipelines in which RGP has a minority or non-controlling stake. That would shift $73 million into net cash from operations (with a corresponding reduction in cash distributions from affiliates and non-controlling interests) in the TTM ending 6/30/14, thus tipping the balance towards a conclusion that RGP did not fund distributions by issuing debt and equity. But either way, RGP has not been generating excess cash that could help fund its capital expenditures.
Table 7 provides selected metrics comparing RGP to some of the other MLPs I follow:
As of 08/20/14:
EV / TTM EBITDA
Buckeye Partners (NYSE:BPL)
Boardwalk Pipeline Partners (NYSE:BWP)
El Paso Pipeline Partners (NYSE:EPB)
Enterprise Products Partners (NYSE:EPD)
Energy Transfer Partners (ETP)
Kinder Morgan Energy (NYSE:KMP)
Magellan Midstream Partners (NYSE:MMP)
Targa Resources Partners (NYSE:NGLS)
Plains All American Pipeline (NYSE:PAA)
Regency Energy Partners
Suburban Propane Partners (NYSE:SPH)
Williams Partners (NYSE:WPZ)
Table 7: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; TTM numbers are as of 6/30/14, except for BWP and SPH which are as of 3/31/14. Source: company 10-Q, 10-K, 8-K filings and author estimates.
It would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table. Note that BPL, EPD, and MMP are not burdened by IDRs; hence their multiples can be expected to be much higher.
ETE's IDRs are far less of an issue with respect to RGP than with respect to ETP. But I am still concerned about the potential conflicts of interest between the general and limited partners, examples of which are provided in another article. Also, I view the quality of RGP's DCF as inferior to MLPs whose Adjusted EBITDA is not based on treating investments in unconsolidated affiliates as if they were fully consolidated. The significant differences between RGP's EBITDA and Adjusted EBITDA explain why RGP's EV/TTM EBITDA multiple, 24.4x as per Table 7, is so high. The multiple, if based on RGP's Adjusted EBITDA, would be reduced to 20x. But this reduced multiple is still high vs. other MLPs. Other factors to consider: 1) it is difficult to evaluate RGP's results and ascertain DCF sustainability given its structural complexity, as well as its rapid pace of acquisitions; 2) RGP has not been generating excess cash that could help fund its capital expenditures; 3) its level of debt is very high (6.5x debt to TTM Adjusted EBITDA as of 6/30/14).
On the other hand, there are positive factors to consider. Substantial synergies could potentially be realized as RGP integrates its acquisitions. Management estimates these total $70 million per annum just based on what has been identified so far, and that doesn't include additional growth that can be captured without spending a lot more capital. In addition to its acquisitions, RGP has a backlog of approved organic growth projects totaling $1.9 billion, providing further underpinning to volume growth, earnings growth, and 6-8% distribution growth. Organic growth spending will accelerate in the second half of this year (from $443 million in 1H14 to ~$800 m in 2H14). Finally, DCF coverage is improving and RGP's 6.3% current yield is enticing.
On balance, I believe RGP's value proposition is not as compelling as some of the other MLPs I cover and remain on the sidelines.