After two-plus years of an active slate of acquisitions, Calumet Specialty Products Partners LP (NASDAQ:CLMT) is failing to generate enough cash flow to come close to covering the current distribution rate. A distribution cut may be the only or best course to get Calumet's distributions back in line with the generated cash flow.
For background, Calumet Specialty Products is a master limited partnership that focuses on niche and specialty products produced by the company's refining operations. According to a recent Investor Day presentation, the company owns 13 production facilities, with more than 160,000 barrels a day of production capability. Calumet produces and markets over 6,700 different products.
Historically, Calumet generated growth through the acquisitions of small refineries to increase production and the purchase of family-owned businesses that sold specialty petroleum derived products. From the market bottom in early 2009, Calumet Specialty Products generated steady, if moderate, distribution growth. The quarterly distribution increased from $0.45 per unit paid in the second half of 2008 and 2009, up to the current $0.685 which has been paid for the last 5 quarters.
Cash Flow Drops In Spite of Large Number of Acquisitions
At the start of the Investor Day presentation, CEO Jennifer Straumins noted that: "...during 2012 and 2013. we had the opportunity to make I think it was 12 accretive acquisition equating about $1.3 billion worth of acquisition and now we are just now at the point in time where we are figuring out what to do with those assets." Unfortunately, the very positive, above-average returns the company earned from the fuels side of the revenues ledger shrank back to normal in 2013, and the "look ahead" growth in distributions paid to LP unit holders over the 1 1/2 years have put Calumet deep into a cash flow hole. Here are the adjusted EBITDA, DCF and distributions paid for the years 2011 to 2013, and for the first half of 2014:
- Adjusted EBITDA: $211.0 million
- Distributable cash flow: $127.2 million
- LP distributions paid: $82.7 million
- Adjusted EBITDA: $404.6 million
- Distributable cash flow: $281.1 million
- LP distributions paid: $132.4 million
- Adjusted EBITDA: $241.5 million
- Distributable cash flow: $18.5 million
- LP Distributions paid: $201.6 million
- First half of 2014
- Adjusted EBITDA: $122 million (down $28 million)
- Distributable cash flow: $23.9 million (down $6.1 million)
- LP Distributions paid: $105.1 million
Looking at the annual numbers, you can see how cash flow fell off the cliff in 2013, with DCF going negative for the second half of last year. The first two quarters of 2014 have not been much of an improvement. Q1 2014 was OK with $49 million in DCF, but in Q2, the DCF again went negative to a minus $20 million. Putting it all together, over the last 6 quarters, Calumet has paid out $263.4 million more in LP distributions than the amount of distributable cash flow generated. Also, if I read the income statements correctly, the general partner IDR payments are not included in EBITDA and DCF, and over the 6 quarters, another $22.4 million was paid in IDRs. This chart shows the uneven DCF flows over the last several years. For reference, at the current distribution rate and units outstanding, LP distributions are $52.5 million per quarter, and GP payments add another $4.8 million.
Can Cash Flow Catch Up Going Forward?
From the numbers above, Calumet has paid, over the last 6 quarters, $286 million in distributions in excess of the DCF generated by business operations. The money came either from borrowed funds or equity raises, which means this capital was not invested to produce future EBITDA and DCF. At an estimated 8.6% cost of capital, the money used to pay distributions above DCF now costs an additional $24.5 million per year in financing expense.
At the Investor Day, Calumet management provided estimates of EBITDA growth from current organic growth projects and recent acquisitions. The recent acquisitions are expected to produce $48 million in annual EBITDA contributions. The growth projects are forecast to produce $200 to $220 million, coming on-line starting in Q1 of 2015 through Q1 of 2016. Using a general 8-times cost of EBITDA, the company needs $2 billion of capital to finance projects or purchases to generate $250 million of EBITDA. Using the cost of capital rate, you get $170 million of annual finance costs, leaving $80 million of new annual DCF from the announced growth projects. Since the start of 2013, with a $45 million per quarter shortfall in DCF over the last year and a half, the growth projects are not the entire answer to Calumet's cash flow problems.
Note: After the initial publication of this article an astute reader pointed out that Calumet has published Capex spending estimates much lower than my rule-of-thumb calculation. With the published $580 million of capex for the $200 to $220 million of growth projects and keeping the 8X cost of the acquisitions, the finance cost estimate drops to about $70 million, resulting in $180 million per year of DCF from the projects. Even with the higher DCF in 2015 and 2016, the company still faces a near term cash flow crunch.
Time to Cut the Dividend
Management at Calumet can list many reasons why the company has taken a hit on the EBITDA line to the point that distributable cash flow has almost gone to zero. What the recent quarters show is that at least a large portion of the company's business will produce variable results, extremely variable! There are forecasts, projections and hopes that business results and cash flow will move back up to 2012 levels, but the numbers above show that the company will not grow itself out of the cash flow shortfall. The one item that management and the board control completely is the distribution to LP unit holders rate.
For management, one complication is that the May 2013 distribution increase moved the partnership into the 50% IDR split. From that point, the GP gets IDR increases equal to the cash paid to increase the LP distribution. As a result, the GP IDRs went from $5.5 million in 2012 up to $14.7 million in 2013, and are now running at a $15.6 million annual rate. Any reduction in the quarterly LP distribution below $0.675 puts the GP back into the 25% IDR tier, and will suck away at least two-thirds of the IDR payments.
However, it seems inevitable that Calumet Specialty Products will be forced to cut the LP distribution rate, either sooner or later. Piling on tens of millions in additional debt or equity issuance to support the distribution while waiting for EBITDA to recover is bad for cash flow and not in the best interest of LP unit owners. One of my basic MLP investing rules is to stay away from partnerships that continue to come up short in DCF compared to actual distributions. With Calumet running 70% to 90% short, it is hard to imagine a scenario where the distribution is not reduced before the end of 2014.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.