My prior article on the cash flow sustainability of Inergy, L.P. (NRGY) was published on December 29, 2011 and noted that
…for the past two years distributions have not been funded by distributable cash flow (DCF), let alone sustainable DCF. Maintaining, let alone growing, distributions will be a challenge for NRGY unless: (i) additional debt and/or partnership units are issued; and/or (ii) internally generated growth projects substantially increase cash from operations relative to their current levels…distributions will have to be cut unless NRGY can significantly improve its results from operations. Investors looking to get a yield of 11.65% while waiting for such improvement to materialize should bear in mind how this yield is sourced and closely watch developments regarding major internal growth projects.
It appears that internally generated growth prospects are not materializing fast enough and that under current market conditions management elected not to, or cannot at a reasonable price, issue additional debt or equity to fund distributions. On January 27 NRGY issued a press release announcing that the 1QFY12 (quarter ended December 31, 2011) quarterly distribution will remain unchanged at $0.705 per unit.
However, the press release stated that for the 12 months ended December 31, 2011 the partnership "generated distributable cash flow of approximately 68% of the total cash distributions paid for the period…" and that
…management and the board of directors of Inergy are evaluating a reset of the quarterly distribution to a level that is supportable by the cash flow expected to be generated from Inergy's businesses in the near term.
Following this announcement, the unit price dropped 23.6% to $17.33 (a decline of $5.35 per unit). What level of distributions can investors expect?
We know that distributions for the 12 months ending 12/31/11 totaled $2.82 per unit. Since Generally Accepted Accounting Principles (GAAP) does not incorporate DCF, its definition is not standardized. In an article titled "Distributable Cash Flow ("DCF)" I present NRGY's definition of DCF and provide a comparison to definitions used by other MLPs. Using NRGY's definition, DCF for that 12 month period was $1.92. We know that for the 9 months ended 9/30/11 NRGY reported DCF of $1.28 per unit and can therefore conclude reported DCF in 1QFY12 (quarter ended 12/31/11) was $0.54 per unit. The declines in reported DCF and coverage ratios are summarized below:
|Period:||12 months ended 12/31||Q1 ended 12/31||Q4 ended 9/30||Q3 ended 6/30||Q2 ended 3/31|
|DCF/unit as reported FY 2011||$1.82||$0.54||$0.07||$0.11||$1.10|
|DCF/unit as reported FY 2010||$4.01||$1.03||$0.08||$0.18||$2.72|
|Distribution/unit FY 2011||$2.82||$0.705||$0.705||$0.705||$0.705|
|Distribution/unit FY 2010||$2.81||$0.705||$0.705||$0.705||$0.695|
|Coverage ratio FY 11||64.5%||76.6%||9.8%||15.6%||156.1%|
|Coverage ratio FY 10||142.8%||146.0%||11.5%||26.2%||391.1%|
The recent press release noted that "a material improvement in distribution coverage is not expected". Based on that quote and the numbers in the table above, I would hazard a guess that distributions will be cut by about 40% to roughly $1.70 per unit per annum. At that level, the units would yield ~10%. To maintain the 11.65% yield in effect at the time I wrote my prior article the distributions would have to drop by ~28% to $2.02 per annum.
Are annual distributions at a rate of $2.02 or even $1.40 sustainable?
A full analysis will have to wait until NRGY publishes its Form 10-Q (around February 4, 2012). In the interim, my best guess is that they are not. My prior article on NRGY covered periods through September 30, 2011 and showed sustainable DCF was ~45% distributions. This equates to approximately $1.27 per unit and a yield of 7.3% based on the recent closing price.
Given the risk level, seeking an 8.5% sustainable yield on NRGY seems reasonable to me. A 55% cut in distributions (to ~$1.27) accompanied by a further ~14% drop in unit price (to around $15 or lower) would be a good entry point for an investment in NRGY, an MLP with a decidedly higher risk profile.