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Targa Resources Partners LP (NYSE:NGLS)

Q2 2011 Earnings Call

August 8, 2011 10:30 am ET

Executives

Joe Brass – Director, Finance

Rene R. Joyce – Chief Executive Officer

Matthew J. Meloy – Senior Vice President, Chief Financial Officer and Treasurer

Analysts

Darren Horowitz – Raymond James

Bradley Olsen – Tudor, Pickering, Holt & Co.

John Tysseland – Citigroup

T J Schultz – RBC Capital Markets

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Targa Resources Second Quarter 2011 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to introduce our host for today, Mr. Joe Brass, Director of Finance. Sir, please go ahead.

Joe Brass

Thank you, operator. I’m Joe Brass, and I would like to welcome everyone to our second quarter 2011 investor call for both Targa Resources Corp. and Targa Resources Partners LP.

Before we get started, I would like to mention that Targa Resources Corp., TRC or the Company and Targa Resources Partners LP, Targa Resources Partners or the partnership have published their joint earnings release which is available on our website at www.targaresources.com.

Speaking on the call today will be Rene Joyce, Chief Executive Officer and Matt Meloy, Chief Financial Officer and Treasurer. Rene and Matt are going to be comparing our second quarter 2011 results to prior-period results, as well as providing additional color on our results, business 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 company’s or 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 and 1934. Please note that actual results could differ materially from those projections and any forward-looking statements.

For a discussion of factors that could cause actual results to differ, please refer to our SEC filings including the partnership’s annual report on Form 10-K for the year ended December 31, 2010 and other quarterly reports on Form 10-Q, as well as the company’s registration statement on Form S-1 as amended.

One quick reminder before starting into our results. With the closing of multiple acquisitions from TRC over the previous years and in accordance with accounting treatment for entities under common control, the results of operations of the Partnership includes historical results from these businesses for all periods reported.

With that, I will turn it over to Rene Joyce.

Rene R. Joyce

Thanks Joe. Welcome and thanks to everyone for participating in our second quarter conference call. Besides Matt and myself, there are several other members of management who will be available to assist in the Q&A session.

For today’s agenda, I will start off with a high-level review of performance, key accomplishments and business highlights for the quarter. We will then turn it over to Matt to review the Partnership’s consolidated financial results, the segment result and other financial matters for the Partnership. Matt will also review key financial matters related to Targa Resources Corp. Following Matt’s comments, I will provide additional updates on some of our ongoing activities, and of course, we will take your questions at the end.

The Partnership reported very strong results for the second quarter of this year driven by favorable industry dynamics and the increased NGL volumes throughout the first asset base. Operating margins strengthened in both our Natural Gas Gathering and Processing division and our Logistics and Marketing division. We reported a strong second quarter adjusted EBITDA of almost $130 million, which helped drive distributable cash flow to $90 million. The result was a healthy distribution coverage ratio of almost 1.6 times based on our second quarter declared distribution of $0.57 or $2.28 on an annual basis.

The Partnership’s distribution represents an 8% increase compared to the second quarter of ’10. We are very proud of our consistent year-over-year distribution growth.

Drilling and production activity remains high for our Gathering and Processing segment, significantly increasing inlet volumes at San Angelo in North Texas year-over-year. Our Coastal Gathering and Processing segment turned in a strong second quarter performance led by increased VESCO plant inlet volumes in a favorable pricing environment, resulting NGL production helps drive notable operating activity throughout system of downstream assets.

For our Logistics and Marketing division, healthy operating results benefited from increased CBF and LSNG volumes, continued strong NGL prices and LPG export activity. At Galena Park LPG export activity was supported by multi-year deals as well as spot export opportunities. Mostly sea-based LPG exports benefit both our Logistics Assets in our Marketing and Distribution segments.

As mentioned in our first quarter call, we closed the purchase of the Targa Channelview Terminal and we are currently pursuing incremental growth capital investment asset at the facility to expand its capabilities. Additionally, we continue to develop, negotiate and work to close additional refined products and crude storage and terminaling acquisitions that complement this existing business. I am pleased to report that the 78,000 barrel per day expansion at Cedar Bayou fractionator ramped up commercial operation through out the quarter completed on schedule and under budget this expansion increases our fee-based income to the segment.

At the TRC level, TRC declared a second quarter cash annualized dividend of a $1.60 per share which was a 13% increase over the annualized rate paid with respect to the pro-rated fourth quarter 2010. That wraps up my initial review and I will hand it over to Matt.

Matthew J. Meloy

Thanks, Rene. I would like to add my welcome and thank you for joining our call today. As Joe mentioned, under common control accounting treatment, the partnership’s reported results of operations now include all Targa assets for all periods presented. Let’s start with a review of the consolidated results.

For the second quarter of 2011 the partnership reported net income of $55.2 million compared to $16.7 million for the second quarter of 2010. The income per diluted limited partner unit was $0.55 and $0.23 respectively.

These quarterly results reflect a non-cash hedge charge of $3.8 million in 2011 and a non-cash hedge charge of $8.2 million in the second quarter of 2010. Please also note that under common control accounting net income reported for the second quarter of 2010 included $9.9 million in non-cash affiliate interest expense related to drop-down businesses for periods prior to the acquisition of those businesses by the partnership.

As mentioned earlier, adjusted EBITDA for the quarter was $129.8 million compared to $93.9 million for the same period last year, the increase was primarily the result of higher operating margins in both the Gathering and Processing and the Logistics and Marketing divisions, partially offset by lower cash hedge settlements and higher general and administrative expenses.

Gross margin increased 38% for the second quarter compared to last year. Again, strong performance across both divisions drove our gross margin higher and I will review the drivers of the strong performance in our segment review.

Operating expenses increased 15% compared to last year, primarily due to increased compensation and benefits, fuel and utilities. The increase in depreciation and amortization expense for the quarter compared to last year is primarily attributable to new assets, which have been placed in service since the second quarter of 2010, partially offset by the impact of assets that have become fully depreciated.

While total interest expense dropped as compared to last year due to affiliate interest expense, third-party interest expense increased significantly as compared to last year, as the partnership increased its borrowings to fund multiple drop-down transactions from TRC and to fund growth capital expenditures.

Gross maintenance capital expenditures were $21.6 million for the second quarter of 2011 compared to $10.2 million in 2010. Adjusting for the non-controlling interest portion of maintenance capital expenditures and certain reimbursements from TRC to the partnership, net maintenance capital expenditures were $15.6 million in the second quarter of 2011 compared to $8.6 million in 2010.

Turning to the segment level, I’ll first summarize the second quarter’s performance on a year-over-year basis. And then I will summarize the performance on a sequential basis. Let’s start in our Gathering and Processing segments.

Overall, second quarter 2011 plant and natural gas inlet for the Field Gathering and Processing segment was 612 million cubic feet per day, a 4% increase compared to the same period in 2010. North Texas and SAOU natural gas inlet increased by approximately 12% and 11% compared to last year.

The increase at North Texas was driven primarily by Barnett Shale activity in the oilier portions of the shale in Wise and Southern Montague County. The increase at SAOU was driven by increased well connects primarily from the prolific Wolfberry play. SAOU was on track to set another record for single year well connects.

Offsetting these notable inlet gains was a decrease in Versado natural gas inlet volumes caused by traditional wellhead production declines as producers are focused on Permian Wolfberry, Avalon and Bone Spring more than work overs and older fields. Over time Versado may benefit from Avalon Shale to the West and Wolfberry and other plays to the East.

Field Gathering and Processing operating margin increased by approximately 35% compared to last year, driven by increased volumes, higher commodity prices and richer gas. Natural gas prices were 8% higher, while NGL and condensate prices were 44% and 33% higher respectively.

Turning now to the Coastal Gathering and Processing segment, plant inlet volumes were approximately 1.6 billion cubic feet per day, a 9% decrease compared to the same period in 2010. However NGL production for the segment was up slightly.

Relative to other Coastal G&P volumes, VESCO volumes are significantly richer in NGL content. While the Coastal segment volumes decreased 9% in total, volumes at VESCO increased 16% when compared to the second quarter 2010 and the higher VESCO NGL yields slightly increased total segment NGL production.

The performance at VESCO was driven by new gas packages tied into the facility. These new volumes of VESCO and more favorable processing economics across the segments drove a 93% increase in second quarter 2011 operating margins compared to last year.

Next I’ll provide an overview of the two segments in the downstream business. Starting with the Logistics Assets segment, fractionation volumes for the second quarter 2011 were approximately 22% higher compared to 2010 due primarily to the 78,000 barrel a day fractionation expansion at CBF. Second quarter operating margin increased 86% driven by sustained LPG export activity at Galena Park, increase fractionation volumes and increased LSNG treating volumes.

In the Marketing and Distribution segment, NGL sales volumes for the quarter increased by approximately 13% compared to 2010, driven primarily by increased LPG export sales.

Operating margin for the segment more than doubled increasing 116% over the second quarter 2010. The increase was driven by a favorable contract settlement growing NGL sales volumes and an approximately 31% increase in NGL prices over 2010.

With that review of the year-over-year results, let’s now discuss a few key sequential comparisons for the second quarter of 2011.

Starting with the Field Gathering and Processing segment, second quarter plant natural gas inlet increased 7% over the first quarter of 2011, driven by volume increases across the segment; drilling and production activity remained strong. Operating margin for the Field G&P segment increased 31% over the first quarter of 2011 driven by higher volumes and higher natural gas, NGL and condensate prices.

Moving to the Coastal Gathering and Processing segment, plant natural gas inlet was essentially flat while operating margin for the segment increased 26% over the previous quarter. The operating margin improvement was driven by the increased NGL production from higher VESCO volumes and by NGL prices which were 10% higher in the second quarter of 2011.

Turning now to the downstream business, in the Logistics Assets segment, fractionation volumes for the second quarter 2011 increased approximately 34% due to the CBF 78,000 barrel expansion. The Logistics Asset segment operating margin increased 49% sequentially driven by higher fractionation volumes, higher LSNG treating volumes and Galena Park LPG export activity.

The Marketing and Distribution segment operating margin decreased 6% compared to the previous quarter. The first quarter is usually a very strong quarter due to higher seasonal NGL sales.

With that, let’s now move briefly to capital structure and liquidity.

At June 30, we had approximately $816 million in capacity available under the partnership, senior secured revolving credit facility, after giving effect to outstanding borrowings of approximately $198 million and $86 million in letters of credit. This capacity and approximately $73 million of cash on hand resulted in approximately $890 million of liquidity, leaving us with substantial flexibility to pursue organic growth and acquisition opportunities.

Total funded debt on June 30 was approximately $1.2 billion or about 47% of total capitalization and the partnerships consolidated leverage ratio at quarter end was approximately 2.7 times debt-to-EBITDA.

Next, I'd like to make a few comments about our hedging and capital spending programs for the year. As of June 30, we estimate the partnership has hedged approximately 75% of its 2011 expected natural gas and 80% of its 2011 expected combined NGL and condensate equity volumes.

At this point in 2011, our hedge percentages for next year are similar to how we hedged in years past. In 2012, gas is hedged 60% to 70% of expected 2011 volumes and NGLs and condensate in 2012 are hedged approximately 75% to 85% of the 2011 volumes, recognizing that we believe Field G&P volumes in ‘12 will be higher than in 2011.

Moving on to capital spending, we estimate we will spend on a net basis approximately $335 million of capital expenditures in 2011, with approximately 20% of the total comprising maintenance capital spending. This amount includes the $29 million to acquire the Channelview Terminal. However it does not include our share of the investment related to our minority 38.8% ownership in the expansion of the Gulf Coast fractionator.

The increase in our total 2011 CapEx estimate from the previous quarter is largely due to the recently announced CBF Train 4 new bill as well as additional G&P expenditures.

Before handing the call back to Rene, I'd like to make some brief remarks about the results of Targa Resources Corp. At June 30, the balance of the TRC HoldCo loan was $89.3 million, where we are currently paying LIBOR plus 300 basis points. Also at June 30, there were no borrowings under the senior secured credit facility with $75 million of remaining availability.

At June 30, TRC had a cash balance of approximately $82 million this gives TRC total liquidity of approximately $160 million. TRC continues to seek prudent, but financially more attractive investments for our cash among the alternatives being considered is using a portion of the cash to purchase additional partnership.

TRC’s standalone general and administrative expenses in the second quarter were $1.9 million, which includes $600,000 of expenses related to the April secondary offering. For the remainder of 2011, we expect TRC standalone G&A expenses to be approximately $3 million.

On July 11, TRC declared a second quarter cash dividend of $0.29 per common share or $1.16 per common share on an annualized basis, representing an approximate 6% increase over the annualized rate paid with respect to the first quarter of 2011. TRC’s standalone distributable cash flow for the second quarter came in a bit stronger than expected at $12.7 million, which represents a coverage ratio of just over 1 times at 1.03 times.

That concludes my review. So, now I'll turn the call over to Rene.

Rene R. Joyce

Thanks, Matt. To wrap up the final portion of our prepared remarks, I would like to quickly provide an update on our growth projects and an overall assessment of future prospects.

We have mentioned that the 78,000 barrel fractionation expansion at CBF is online has ramped up to stated capacity. It is contributing to solid fee-based return for our downstream business.

CBF’s 100,000 barrel per day Train 4 expansion is progressing. We are in the early stages of the project and at this point, engineering is on track, major equipment items have been placed on order and site preparation is underway.

The benzene treating project is scheduled for completion at the end of this year. The GCF expansion is underway and is scheduled for completion in Q2 of 2012.

Our Gathering and Processing business continues to perform very well and we expect to authorize additional capital expenditures significantly beyond announced levels to meet increasing producer volume requirements in both North Texas and San Angelo. We are in discussions with the market regarding a potential LPG export opportunity at Galena Park facility. We continued to be optimistic about this attractive project.

So to sum up, we continue to benefit from very strong industry fundamentals across all of our businesses and are solidly focused on execution to capture the growth opportunities. Technology-driven E&P activity is driving growth in liquids-rich natural gas production for our Gathering and Processing operations, the growing NGL supply profile in turn drives our fee-based downstream business, and investment opportunities are abundant in both areas. For the time being, we’ve seen these strong fundamentals as continuing and are working very hard to expand our business scale and footprint.

And with that, we’ll turn it over for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from the line of Darren Horowitz from Raymond James.

Darren Horowitz – Raymond James

Good morning, guys. Rene, just a couple quick questions. I want to go back to few of the points that you made when you’re discussing the project updates. As you’re talking to producers and looking at expansions around North Texas and San Angelo, can you give us a sense for just how much capital you’d be looking to get the board to authorize, so we can get a feel for the type of volumes that could be coming across the system and ultimately how big you think the system could get?

Rene R. Joyce

I’m not going to get into the, I would say that the capital expenditures could be dramatic. We’ve got ongoing discussions regarding dedications at both San Angelo and North Texas, so I’d rather not get into absolute amount, but it would be a dramatic increase in capital expenditures for both systems and could require the addition of gas processing at both San Angelo and a new major plant in North Texas.

Darren Horowitz – Raymond James

Okay. The shifting over to the opportunity for LPG export at Galena Park, I appreciate your comments that you guys are working to secure some additional volumes, but can you just have us an idea of the type of scale and scope of this type of project. I mean is it something that you think could be somewhere around $200 million to $250 million of cost?

Rene R. Joyce

Depending on how we finally engineer and go forward with that project at somewhere in the range of $250 million to $300 million is the number.

Darren Horowitz – Raymond James

Okay. And is it correct, if we are assuming that you’d be looking to target three to four year contracts on average?

Rene R. Joyce

Well, again. I’m not going to get into the negotiations for that facility, but definitely they would be of terms less than what we are doing on the onshore portion with regard to like the fractionation expansions.

Darren Horowitz – Raymond James

Okay. Thanks, Rene. I appreciate it.

Operator

Thank you, sir. And our next question comes from the line of Bradley Olsen from Tudor, Pickering, Holt.

Bradley Olsen – Tudor, Pickering, Holt & Co.

Good morning, guys.

Rene R. Joyce

Good morning, Bradley.

Matthew J. Meloy

Good morning.

Bradley Olsen – Tudor, Pickering, Holt & Co.

My first question is about the North Texas segment of your Field Gathering and Processing. Has rig activity in North Texas in the Barnett Combo play ramped up beyond your expectations and do you believe that the rig count in that area will continue to trend upwards?

Rene R. Joyce

Yes definitely. Based on our discussions with two, three, four of the major players in Northern Wise of Montague County, we are kind of surprised at the level activity that we could see up there in terms of well and ultimately the rich gas production.

Bradley Olsen – Tudor, Pickering, Holt & Co.

Great and as far as the Wolfberry in your SAOU segment, is that mostly from kind of work over activity of legacy production or is it from horizontal drilling in the emerging plays in that area?

Michael A. Heim

This is, Mike Heim. Most of the growth are from formations that the producers that known have been out there for decades and they have worked productive without the increased technology. These are new areas they primarily were not HBP and we are surprised almost every time we have a meeting with the new producer or an existing producer that more and more horizontal wells are being drilled and are going deeper than what we’ve heard in the past.

Bradley Olsen – Tudor, Pickering, Holt & Co.

Okay and one more question, this applies to TRGP, you guys mentioned that potential for additional purchases of Targa Partners units, would purchases of additional LP units affect tax deferral at the GP level at all?

Michael A. Heim

In that regard, it kind of depends about how we were to go about acquiring the units. We are still evaluating many alternatives up there, the potential purchase of those units is one of them, but I don’t really see how that would have much of a significant impact on the deferral other than right now the dollar we have set aside for cash is obviously not getting a very great return, if there was more than a 100% shield on those units we acquired, there could be some gain there, or some pick up and a sort of depreciation, but I’d characterize it more as just an absolute kind of return that we’d be looking at it as apposed to kind of earning minimal returns in the money markets.

Bradley Olsen – Tudor, Pickering, Holt & Co.

Okay that’s all from me. Thanks a lot for your time guys.

Operator

Thank you, sir. (Operator Instructions) Our next question comes from the line John Tysseland from Citigroup.

John Tysseland – Citigroup

Hi, guys. Good morning.

Rene R. Joyce

Good morning, John.

John Tysseland – Citigroup

Rene in your commentary on the quarter, you mentioned that target benefited from some spot export opportunities, can you provide just some context on that and you know what kind of capacity you have to optimize that facility?

Rene R. Joyce

We’re currently doing three to five small ships a month and some spot butane cargoes that’s what I was referring to, and the current propane shipments out of that facility are on the multiple deals long term.

John Tysseland – Citigroup

And then when you look at your, when you’re looking at expanding that facility, are the customers that are interested in that, are they predominantly interested in the propane side, the butane side, or is the combination of both?

Rene R. Joyce

No. It’s propane, primarily propane.

John Tysseland – Citigroup

Do you have any customers that are looking at the butane side of things for now?

Michael A. Heim

Yeah, we did. In fact, we’ve set up the engineering design to fully refrigerate both the propane and the butane. Some of the customers will actually want both of them loaded on board of the ship and they’ll mix them all the way to their final destination.

John Tysseland – Citigroup

Great. And then, just broadly speaking when you look at all the other activity that’s going on both in Mont Belvieu and then also out in the field, where do you guys see the most opportunities I think from a longer-term perspective on attractive rates of return, where do you think you can lock them for a good visibility? Is it more on your upstream side and the G&P side of things or do you see it more on the downstream logistic side of things in terms of deploying capital incrementally from today?

Rene R. Joyce

Definitely the gathering and processing is going to offer us opportunities over the foreseeable future, no doubt about that, just because of the shear amount of activity around our systems, and all of the projects that we’ve discussed on the downstream, that’s as much as we can see right now today. But we have high hopes for our terminals. We bought the Channelview activity, we’ve discussed in past calls that we’ve got the expertise and shop and we’re looking at a number of attractive opportunities and those are nice retired projects that we’re looking at there.

And again, it’s too early to say how far we can take that business, but as this is right now, we’re optimistic that we can do a lot more than just one terminal.

John Tysseland – Citigroup

Great, thanks guys.

Operator

Thank you. And our next question comes from the line of T J Schultz from RBC Capital Markets.

T J Schultz – RBC Capital Markets

Great, hey, good morning guys.

Rene R. Joyce

Good morning.

T J Schultz – RBC Capital Markets

Just following up on what you’re just talking about our Channelview. I think you had mentioned some opportunities for organic growth projects around that terminal. Can you just provide a little bit more color on kind of scope of that particular organic growth opportunity or what that may entail?

Rene R. Joyce

The demand certainly appears to be there. We’ve got discussions going on with four or five different customers not only the existing customers, but new customers and we have at least two opportunities for adjacent property to expand to. So it looks very bright today.

T J Schultz – RBC Capital Markets

Okay, thanks. Just hopping over briefly to Coastal G&P. Can you just talk a little bit about what you’re seeing in the Wilcox and Lower Tuscaloosa and potentially maybe what impact that could have on new volumes?

Rene R. Joyce

It's very to tell, it's an interesting play the Lower Tuscaloosa, we don’t have enough well activity to say how far other than that there maybe, it maybe very productive, but it also has some issues around the clay content, as you get close to the Mississippi River. But we are seeing the activity in the Wilcox and the Lower Tuscaloosa right now north of our LOU System. we are in discussions with producers that hold acreage and also occasions we’re optimistic that we can add additional wellhead volumes to our LOU System and if the Tuscaloosa takes off, Lower Tuscaloosa, then there will be opportunity to use the existing capacity in some of our Straddle Plants, no use in creating the wheel again, considering the size, efficiency of some of these Straddle Plants in South of Louisiana. So we'll just see, but we are seeing activity north of our LOU System.

Michael A. Heim

Yeah. Both North and West and we have connected more wells this year than we’ve probably connected in the last three years and the volumes are starting to grow.

Rene R. Joyce

Yeah. Wellhead volumes are increasing very nicely at LOU.

T J Schultz – RBC Capital Markets

Great, that’s all I got. Thanks guys.

Operator

Thank you, sir. And we have no further questions in the queue at this time. I’d like to turn the conference back to Rene Joyce for any final comments.

Rene R. Joyce

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

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a great day.

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