Energy Transfer Partners (ETP) is at a crossroad. It is one of the largest publicly traded MLPs (Master Limited Partnerships); owning and operating extensive natural gas and NGL pipeline, storage and related facilities.
Management has been advancing a strategic plan that entails concentrating its footprint in some of the most prolific U.S. natural gas fields (Barnett, Eagle Ford, Marcellus, Haynesville), acquiring or constructing complementary pipelines within these regions, and exiting the retail propane business.
These efforts have created significant financial turbulence for this mid-cap company. During the transition, the unit price has stagnated and unit holder distributions have been flat.
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Let's take an overview of ETP's business ventures, review some fundamental metrics, and check the charts to see how this company stacks up.
ETP Management has been Busy
One needs a scorecard to keep track of the multiple divestitures, acquisitions and proposed projects. In addition, ETP management is simultaneously digesting other recently completed major business.
Here's an overview of the most significant projects on the table:
Divest Propane Business: In January, ETP closed on its sale of its retail propane business to AmeriGas Partners LP (APU). In consideration for the business, Energy Transfer Partners obtained $1.32 billion in AmeriGas shares and $1.46 billion in cash. The company must hold the shares for at least one year.
Purchase Assets from Southern Union: In conjunction with General Partner Energy Transfer Equity's (ETE) purchase of Southern Union Company (SUG), ETP entered into an agreement with ETE to acquire SUG's 50 percent interest in Citrus, which owns 100 percent of the Florida Gas Transmission (FGT) pipeline system. Energy Transfer Partners financed the deal with debt ($2 billion in Senior notes), equity ($105 million in new common units), and $1.90 billion in cash. The transaction is expected to be completed sometime in March.
Eagle Ford Shale Projects: ETP expects to spend about $1.25 billion on a number of projects that expand the company's footprint in the Eagle Ford shale region. These projects include pipeline and natural gas processing plant construction. The bulk of the projects are planned for completion in 2012 and early 2013.
These activities have been on the heels of several other major acquisition and construction projects that closed within the last year or so. Such projects are now being digested by ETP:
Lone Star NGL Venture: In May 2011, Energy Transfer Partners and Regency created a joint venture called Lone Star NGL (70 percent owned by ETP). This venture now operates NGL storage, fractionation and transportation facilities acquired from Louis-Dreyfus. The partnership has announced plans to build an additional 100,000 bbl/d fractionation plant at Mont Belvieu, Texas, to be completed in early 2013. The cost is anticipated to be $400 million.
On top of that, Lone Star plans to build a 570-mile natural gas pipeline spanning the State of Texas, called the West Texas Gateway Project. The cost estimate is about $920 million, and the timetable for operations to begin is projected for 1Q 2013.
Other Pipeline Expansion Projects: In September 2011, Energy Transfer Partners placed into service the Freedom and Liberty pipelines. These smaller projects expanded its existing pipeline system. The ancillary 130-mile Justice pipeline is expected to be completed in the second half of 2012, at a cost of $300 million.
FEP and Tiger Pipelines: ETP is a 50-percent owner in the Fayetteville Express pipeline and a 100% owner of the the Tiger pipeline. These pipelines, which began operations in late 2010 were built under budget and faster than proposed. Now operational, the FEP has take-or-pay volumes locked in for 93 percent of its capacity via 10 and 12-year lease agreements. Meanwhile, 100 percent of the Tiger pipeline capacity is under contract for 10 and 15-year agreements.
So what does this mean?
The way I see it, Energy Transfer Partners management has focused the business on becoming one of the the largest pure-play natural gas / NGL transportation companies in the United States. Management has concentrated efforts on the strongest shale gas fields; primarily in Texas, and the southern U. S. It divested its retail propane business, and effectively used the cash to buy the Florida Gas Transmission assets from ETE as part of that company's purchase of Southern Union.
I like the idea that it dropped retail propane, as this segment was non-core, less predictable and less profitable than the gas pipeline business. Indeed, the retail propane segment was a primary driver of ETP's 2011 forth-quarter earnings miss. That business is now out the door. I also like the strong bets on natural gas and NGLs concentrated around Texas. Certainly, the pipeline business is the safest way to play the current natural gas boom. Gas transmission revenues are less susceptible to underlying commodity price fluctuations than dealing with the commodities themselves. ETP is setting itself up as the "toll gate" of choice for moving natural gas and NGLs. As an investor, I am on board with the strategy.
Nonetheless, the divestitures, acquisitions, and related projects have caused a lot of cash to slosh around. Multi-year capital expenditures totaling north of $5 billion, coupled with debt and equity issuance have increased the risk profile of this MLP. It's a cause of concern and warrants more investigation.
Evaluating a MLP is not the same as regular stock companies. Standard fundamental metrics such as the PE ratio aren't particularly useful. I don't even pay a great deal of attention to the EPS figures. Revenue, EBITDA, debt management, and distribution metrics are better measures. Let's run through the financial statements and pick off some information that may be useful.
Revenue: For ETP to succeed with the plan, revenue must go up significantly. Revenue was up 16 percent year over year. While this was below some street analyst's short-term expectations, I'm OK with the overall trend as an investor with a long view.
Margins: In any business, margins are important. Indeed, margin trends are even more important. I checked 2011 FY margins using the latest unaudited statements provided by ETP. Gross margins were stable at 38.7 percent in 2010, versus 38.8 percent last year. Not much change. Likewise the operating margins were flat at 18.0 and 18.1 percent, respectively. The 2011 EBITD margin was 24.4 percent.
While stable, these margins are toward the lower end of several MLP peers, but I really want to see them "post-propane business divestiture" and watch the ensuing trends as some of the large construction projects wind up, come online, and generate cash.
Debt: ETP total debt has increased YoY from $7.41 billion in 2010 to $9.17 billion in 2011. It has offset this somewhat with a $750 million cash tender offer to retire certain debt. The tender offer closed successfully in January of this year. Management has stated they want to maintain a strong balance sheet and liquidity. The Debt / Adjusted EBITDA ratio target is 4.00 - 4.25. I calculated the current ratio to be 5.3X. This is up from a 4.8X ratio for 2010. Unfortunately, this is going the wrong way. At the same time, the standard debt-to-equity ratio has dropped from 156% in 2010 to 144% last year. While somewhat improved, there is a boatload of debt to service.
I checked an alternative debt metric: Interest Coverage. It's normally a ratio function of EBIT (Earnings Before Interest and Taxes) divided by Interest Expense. A good industrial business should look for a minimum of 3X coverage. Using 2011 figures, Energy Transfer Partners has Interest Coverage of only 2.5X.
The current ratio (Current Assets / Current Liabilities) has declined YoY from 1.3 (solid) to 0.8 (questionable). A 1.0 target is generally acceptable. ETP management counters that they have a revolving credit agreement to cover short-term cash needs. Note this liquidity is via more debt, not cash on the books.
These figures put out the yellow caution flag. They must "come in" or concerns over management biting off more than it can chew will materialize. The only way it can manage going forward is by the recent investments paying off: in other words, the denominator (EBITDA) of the equation must go up, as the numerator (Total Debt) is not likely to go down based upon current strategic plans.
Here's a selected summary table of the foregoing:
ETP Financial Metrics
Distributable Cash Flow
Distribution Yield and Safety: The current distribution is 89.5 cents per unit and has remained stable for a number of quarters, despite management indicating it would increase it in the second half of 2011. The distribution yield is very strong: coming out to nearly a 7.5 percent yield based upon the latest closing price. My rule-of-thumb is that a good MLP should pay at least 300 basis points above the 10-year treasury note to compensate investors for the additional business risk. ETP blows this away with a roughly 550 point margin.
But is the distribution safe?
My short answer is, "yes," but with some reservations. Distributable Cash Flow increased 10 percent last year from 2010. The distribution did not, despite management saying it planned to do so. That got my attention. The calculation of DCF is complicated and includes some items that could be questioned as to whether or not they are sustainable. What this confirms, when coupled with the previous discussion about margins and debt, is that the company navigating a transition period. Assuming the expansion and acquisition projects pan out, EBITDA will increase, and consequently the distribution yields will, too. If the distribution goes up, it is reasonable to assume the underlying unit price will rise with it. If the projects will not roll out as planned, Energy Transfer Partners will be stretched on debt load and saddled with a bunch of under performing assets.
My go-forward view tends to be more optimistic than pessimistic.
First, ETP management is taking a bet on the future of U.S.-based natural gas and NGL transportation: I think this is a good bet. Second, management has a recent track record of bringing in major projects under budget and under time line (specifically the Fayetteville Express and Tiger pipelines). This is a positive. Capital cost overruns can cripple even a good strategic plan. I think ETP can handle it. Third, the transportation business itself tends to be lower-risk than the outright commodity business itself. Energy Transfer Partners wants to create a diversified base of assets that move gas and NGLs for others who take the underlying commodity price risk. The divestiture of the retail propane business accents this initiative.
I like to review the charts for confirmation and clues. I tend to favor long charts versus short-term technicals as I am not looking at ETP as with a trader mentality.
On the bullish side, the units have exhibited the "Golden Cross," whereas the 50-day average has crossed the 200-day moving average to the upside. The three-year weekly MACD looks good, too.
On the other hand, the OBV (on balance volume) indicator is less than inspirational. The Money Flow Index is approaching the Overbought level.
Some other technical studies I use appear neutral. Overall, I don't find much in the charts to sway me one way or the other.
The Bottom Line
Energy Transfer Partners is making a big move to focus the business on the transportation of natural gas and NGLs. However, a lot rides on its ability to manage debt and ongoing capex. I have concerns about the debt level and various metrics around it. So I'm cautious about the future until I see some tangible evidence that management has its arms around covering the debt. Likewise, I'd like to see some margin improvement. I am generally positive on the company's ability to manage capex costs, as evidenced by the FEP and Tiger pipeline projects. While the current distribution is generous versus peers, I harbor a little nagging doubt about its sustainability.
My opinion for the greatest probability going forward is the distribution will not be cut, and eventually raised once the dust settles. I'd be patient on an increase since the current payout is already near the top of the MLP universe.
The charts appear generally neutral.
ETP represents a MLP that offers a bountiful distribution yield coupled with above average near-term risk. If growth plans are successful. I anticipate a nice uplift for investors. I plan to remain long but watch carefully.