Regency Energy Partners: A Stable 6.8% Distribution Yield

| About: Regency Energy (RGP)

Summary

Regency Energy Partners L.P. (RGNC) is a master limited partnership (MLP) that holds valuable midstream assets.

Distribution Yield: 6.80%

Distribution Growth: 0% (For the most recent 12 quarters)

I think Regency would make a reasonable investment at the current price. With Incentive Distribution Rights (IDRs) still in the early stages, the owner of Regency's general partner has a strong incentive to boost Regency's quarterly distribution over time to maximize return.

Overview

In 2010, the general partner of Regency, 100% of the Incentive Distribution Rights, and approximately 26 million common units were acquired by Energy Transfer Equity L.P. (NYSE:ETE), which also owns the general partner and many common units of Energy Transfer Partners L.P. (NYSE:ETP).

Regency includes four main segments.

Gathering and Processing

The Gathering and Process Segment gathers raw natural gas from producers, treats it, and delivers pipeline quality natural gas to markets. Regency has 4 plants and 442 miles of pipeline in north Louisiana, 2 plants and 541 miles of pipeline in south Texas, 1 plant and 806 miles of pipeline in west Texas, and 1 plant and 3,470 miles of pipeline in the mid-continent region of the US.

Transportation

Through two joint ventures, Regency holds intrastate and interstate pipeline assets. Regency holds slightly under 50% of HPC, which holds RIGS, a 450 mile intrastate pipeline system in Louisiana, and slightly under 50% of MEP, which owns and operates a pipeline stretching 500 miles between Oklahoma, and Alabama, crossing through Texas, Louisiana, and Mississippi.

Contract Compression

Regency's Contract Compression segment designs, owns, insures, operates, installs, repairs, and maintains natural gas compressors and related equipment.

Contract Treating

Regency offers treating services (carbon dioxide removal, hydrogen sulfide removal, cooling, etc) to producers and pipeline companies.

Financial

Regency's cash flows are subject to volumes and to some extent, commodity cost fluctuations. Since partnerships like Regency are asset-heavy businesses with huge depreciation reductions, cash flow statements and EBITDA are particularly important for determining the health of the income.

Revenue

2010 $1.222 billion
2009 $1.043 billion
2008 $1.785 billion
2007 $1.138 billion
2006 $0.862 billion
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Operating Income

2010 $34.7 million
2009 $226.5 million
2008 $149.7 million
2007 $53.5 million
2006 $35.8 million
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Operating Cash Flows

2010 $169.6 million
2009 $144.0 million
2008 $181.3 million
2007 $79.5 million
2006 $44.2 million
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Adjusted EBITDA

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2010 $326.9 million
2009 $211.0 million
2008 $259.3 million
2007 $157.8 million
2006 $95.7 million
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Net Income per Unit

2010 ($0.19) 2009 $1.63 2008 $1.10 2007 ($0.51) 2006 ($0.42)

Regency took a significant hit to income after the financial crisis, but cash flows and EBITDA remain intact and strong.

The balance sheet for Regency is stable. Long term debt is only 35% of partnership capital, but approximately $1.5 billion, or roughly 1/3rd, of total partnership assets consist of goodwill or intangible assets. Even factoring goodwill and intangibles out, the debt/capital ratio is acceptable. There have been a few years where operating income did not cover interest on debt, but cash flow easily covers interest with comfort room. Reported operating income in 2010 does not include a substantial amount of income from unconsolidated subsidiaries.

Distribution

Regency, unfortunately, has held the distribution payout flat for 12 quarters now. The partnership started with strong distribution growth but has entered into a flat period throughout the recession. The current yield, however, is rather robust, at nearly 6.8%, and is supported by cash flows.

Annual Distribution

2010 $1.78
2009 $1.78
2008 $1.71
2007 $1.52
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Investing Thesis

Regency is a growth-oriented MLP, based on the current phase in terms of Incentive Distribution Rights (IDRs).

Under the IDR agreement, when the distribution is under $0.4025/quarter, 98% of distributed cash goes to unitholders and 2% goes to the holder of the general partner interest and the IDRs (which is Energy Transfer Equity LP). Between $0.4025/quarter and $0.4375/quarter, 85% of the distributed cash goes to unitholders, while the other 15% goes to the holder of the general partner interest and the IDRs. Between $0.4375/quarter and $0.5250/quarter, 75% of the distributed cash goes to unitholders, while the other 25% goes to the holder of the general partner interest and the IDRs. Then, as the distribution exceeds $0.5250/quarter, 50% of the distributed cash goes to unitholders, while the other 50% goes to the holder of the general partner interest and the IDRs.

Therefore, ETE, the holder of the general partner and IDRs, has a strong incentive to see Regency boost its quarterly distribution from $0.445 (the current quarterly rate) to well beyond $0.5250 in order to maximize income from Incentive Distribution Rights. Currently, most of ETE's income from Regency comes from the holding of common units of Regency, but as Regency grows the distribution to unitholders, ETE's share of the total cash will grow abundantly.

ETE's acquisition of the general partner of Regency may offer investing opportunities for Regency in the future. ETE has significant industry experience, and the scale necessity to make big agreements. For example, Regency acquired its first major interstate asset, MEP, from ETE.

In addition, ETE is currently discussing a deal to acquire Southern Union (NYSE:SUG) as part of a bidding war against another business. If ETE ultimately wins the bidding war and makes the acquisition, ETE will drop down Southern Union's large Florida pipeline system to Energy Transfer Partners (ETE's other master limited partnership holding), and may also drop down Southern Union's gathering and processing assets to ETP. But if ETP waives this right to the gathering and processing assets, these assets may be dropped down to Regency instead.

Over the past couple of years, Regency has been investing in more fee-based sources of income, including the joint ventures for the intrastate and interstate pipelines.

Risks

MLPs like Regency offer great current yields, but they are not "widow and orphan" stocks. When combined with a diversified portfolio of other businesses, an MLP can be a great way of boosting both total returns and current income, but there is always substantial risk.

The good news is that infrastructure investments tend to have very stable cash flows. Regency draws most of its income from fees, and its established assets typically have reasonable economic moats around them. But Regency is susceptible to a variety of risks, including some exposure to commodity price risk, weather risk, environmental/catastrophe risk, risks associated with cost of capital, competition from other pipeline businesses, tax risks associated with their MLP status, environmental/ litigation risk, and so forth. Regency's fairly small size can potentially increase risk and volatility of income.

Conclusion

In conclusion, Regency may be in a position to offer investors significant returns. The distribution yield is high, the balance sheet is stable, and despite a lack of distribution growth lately, ETE's holding of the general partner and Incentive Distribution Rights of Regency provides a powerful incentive for ETE to encourage distribution growth in the units of Regency, because its share of the cash would grow at a disproportionate rate. Regency has invested heavily over the last few years, including obtaining assets from ETE.

Disclosure: I am long ETE.