Examples In MLP Due Diligence - Genesis Energy

| About: Genesis Energy, (GEL)

Summary

This is the ninth in a series of "due diligence example" articles on MLPs.

GEL is a $4 billion market capped MLP with good diversification attributes.

GEL offers the prospects of superior distribution growth along with some higher than average risks.

This is the seventh in a series where I provide my example of "What is good due diligence for MLP (energy Master Limited Partnership) investors?" For many of you, this will appear to be hyper due diligence. You can opt to weed out some of the hyper diligence to arrive at the level that feels right to you. Prune prudently.

This article will be on Genesis Energy (NYSE:GEL) - and Genesis has some atypical attributes. This can be seen in the operating margin numbers from Q1-16:

Segment results for the first quarters of 2016 and 2015 were as follows:

Three Months Ended
March 31,
2016 2015
(in thousands)
Offshore pipeline transportation 78,618 25,198
Onshore pipeline transportation 15,677 14,323
Refinery services 21,199 19,160
Marine transportation 18,916 25,693
Supply and logistics 10,471 9,747
Total Segment Margin $ 144,881 $ 94,121
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Offshore transportation is currently contributes 54% of total operating margin. We know that pipelines face headwinds as the rig count has fallen - which should result in lower volumes of crude being transported in the USA. The drilling decline has been significantly less sever in offshore drilling. The data that is below is from a June 2016 Genesis presentation:

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Going back to the segment margin numbers, one can see a huge increase in the 2016 offshore numbers. The increase is primarily due to GEL's Enterprise (NYSE:EPD) acquisition, which closed in July 2015, in which they obtained approximately 2,350 miles of additional offshore natural gas and crude oil pipelines and six offshore hub platforms. Much of that acquisition was financed by debt - and that shows up is the income and balance sheets numbers - creation some rather ugly credit metrics. Be forewarned that several quirks you have not seen in my prior articles will show up in the following spreadsheet. Let's look at those numbers:

Genesis Energy metrics

Q1-2016 Q4-2015 Q3-2015 Q2-2015 Q1-2015 Q4-2014 Q3-2014 Q2-2014 Q1-2014 Q4-2013 Q3-2013 Q2-2013 Q1-2013
Revenues 378,414 491,011 572,334 656,327 526,857 847,282 964,114 1,015,049 1,019,719 961,035 1,090,293 1,068,694 1,014,808
Costs 318,566 433,141 527,536 626,947 502,036 816,656 928,846 983,792 984,317 397,735 1,066,203 1,035,333 984,803
EBITDA 133,826 137,583 126,901 87,278 82,377 82,523 81,783 70,130 66,580 62,020 56,531 58,999 60,754
DCF dollars 97,794 102,289 96,308 68,786 64,038 62,902 60,798 55,492 53,435 48,393 43,269 45,709 48,694
Average Units 109,979 109,979 107,617 99,174 95,029 93,873 88,941 88,691 88,691 88,691 83,878 81,973 81,203
DCF/unit $0.8892 $0.9301 $0.8949 $0.6936 $0.6739 $0.6701 $0.6836 $0.6257 $0.6025 $0.5456 $0.5159 $0.5576 $0.5997
Upcoming Distrib. $0.6725 $0.6550 $0.6400 $0.6250 $0.6100 $0.5950 $0.5800 $0.5650 $0.5500 $0.5350 $0.5225 $0.5100 $0.4975
Coverage 1.322x 1.420x 1.398x 1.1097x 1.105x 1.262x 1.179x 1.107x 1.095x 1.020x 0.978x 1.093x 1.205x
The adjustments to calculate the GEL reported Coverage using units 'at the time of the earnings report'
Ending Units 109,979 109,979 109,979 99,629 95,029 95,029 93,291 88,691 88,691 88,691 88,691 82,941 81,203
Post quarter/Pre Release Offerings 10,350 4,600
Adjusted Units 109,979 109,979 109,979 109,979 99,629 95,029 93,291 88,691 88,691 88,691 88,691 82,941 81,203
Adjusted DCF/unit $0.8892 $0.9301 $0.8756 $0.6254 $0.6428 $0.6619 $0.6517 $0.62 $0.60 $0.54 $0.4879 $0.5511 $0.5997
Adjusted Coverage 1.322x 1.420x 1.368x 1.001x 1.054x 1.113x 1.124x 1.107x 1.095x 1.020x 0.934x 1.081x 1.205x
GEL reported Coverage 1.32x 1.42x 1.37x 1.00x 1.05x 1.11x 1.12x 1.11x 1.10x 1.02x 0.93x 1.08x 1.21x
Broker1 DCF/unit $0.86 $0.89 $0.81 $0.69 $0.52 $0.63 $0.61 $0.58 $0.58
Broker2 DCF/unit $0.88 $0.69 $0.67 $0.66 $0.65 $0.63 $0.60
Broker3 DCF/unit $0.93 $0.89 $0.69 $0.67 $0.67 $0.68 $0.62 $0.60
Broker1 produces a DCF for 'maintenance cap ex incurred' number, which can be lumpy - while GEL DCF calculation appears to use a yearly average expense number
For example, GEL used a $1 million maintenance expense in Q3-15 while it spent $10 million. WFC's DCF subtracted an additional $9 million from DCF
LTM EBITDA 485,588 434,139 379,079 333,961 316,813 301,016 280,513 255,261 244,130 238,304 237,534 237,625 232,885
Long Term Debt 1,808,575 1,807,054 1,840,000 1,100,000 1,051,000 1,051,000 1,051,000 1,051,000 701,000 701,000 701,000 701,000 701,000
Debt/EBITDA 3.72x 4.16x 4.85x 3.29x 3.32x 3.49x 3.75x 4.12x 2.87x 2.94x 2.95x 2.95x 3.01x
With the large acquisition from EPD - the forward ratio using 4 times Q1 EBITDA may be meaningful - and it is 1.808/0.535304 = 3.38x
There is $1.280 billion of secured credit facility debt - which is not included in the $1.808 billion - making Debt/EBITDA 5.12x when using $591 million pro forma EBITDA
My Debt/EBITDA numbers use only long term debt - this calculation replicates brokerage numbers. GEL's short/long term debt ratio is high - it merits different treatment
Short Term Debt 1,280,000 1,115,000 1,014,100 585,200 648,400 550,400 335,000 492,200 640,500 582,800 411,300 319,100 271,000
Total Debt 3,088,575 2,922,054 2,854,033 1,685,200 1,699,004 1,601,039 1,385,673 1,542,907 1,341,240 1,283,572 1,112,104 1,019,935 971,865
Total Debt/EBITDA 6.36x 6.73x 7.53x 5.05x 5.36x 5.32x 4.94x 6.04x 5.49x 5.39x 4.68x 4.29x 4.17x
Interest Expense 34,387 33,859 29,617 17,905 19,215 19,325 20,441 14,069 12,804 12,300 12,587 12,255 11,441
Interest Coverage 3.89x 4.06x 4.28x 4.87x 4.29x 4.27x 4.00x 4.98x 5.20x 5.04x 4.49x 4.81x 5.31x
On 7-16-15 GEL offered 10,350,000 common units at $43.77 per common unit
On 5-14-15 GEL offered $400,000,000 6% senior unsecured notes due 2023
On 4-10-15 GEL offered 4,600,000 common units at $44.42 per common unit
On 5-12-14 GEL offered $350,000,000 in 5.625% senior unsecured notes due 2024
On 9-16-13 GEL offered 5,750,000 common units at $47.51 per common unit
On 1-27-12 GEL offered $100 million 7.625% senior unsecured notes due 2018 via private placement
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The two big quirks need explanation. I will try to err on the side of brevity. The DCF/unit requires two calculations if one wants confirmation from both the brokerages that you have arrived at the right number - and a second calculation to confirm from GEL's coverage numbers that you have the right DCF/unit. And even with the brokerages, you have the problem with the maintenance subtraction - which one brokerage does differently (or the one that does it accurately).

The Debt/EBITDA requires two calculations because GEL does not include its credit facility with long term debt. It is only by the inclusion of short term debt that one arrives at the accurate but ugly ratios.

With the minutia briefly covered, lets look at the big picture. Since the beginning of 2013, EBITDA numbers have more than doubled while the unit (MLPs call their "shares" units) count has grown 35%. The bad news - interest payments on a growing amount of debt has tripled. DCF/unit growth is up big over the last three years. Distribution growth has been consistently good.

What can we learn from these numbers?
1. I have verified the DCF/unit (or Distributable Cash Flow per unit) calculations with the DCF numbers from three different brokerage analysts. The DCF calculation is involved. Adjustments for 'normalization' have not been needed.
2. I have moderate in confidence in my DCF calculation because my numbers somewhat match those done by the professional analysts.
3. DCF/unit change since 2013 has been strongly positive - a rare attribute for a relatively long existing MLP.
Let's move on to some attributes I know due to producing similar spreadsheets for many other MLPs. As you absorb the data from future articles in this series, you will have the data in which to arrive at similar assessments.
4. DCF/unit numbers by quarter are moderately volatile.
5. The 'annual' distribution coverage has been as strong as it gets. Coverage is both a safety and growth attribute.
6. The debt metrics for GEL are ugly. That produces a higher cost of debt capital.
7. In a low inertia environment, a good forward DCF projection will be close to the LTM (last twelve month) DCF number. For GEL, getting an annualized DCF for the three quarters since its acquisition of new assets would be superior to going with a LTM number. DCF has been (.89 + .93 + .89)/3 $0.9033 per quarter or a run rate $3.61/unit per year. I could not find 2016 EBITDA guidance or 2016 DCF guidance.

I have 5 2016 DCF projections from the 12 brokerages I use to create a consensus number. The projections range from $3.37 to $3.76. The average for the projections is $3.57 - and 3 of the 5 projections are within ten cents of the average. This consensus projection is in alignment with my run rate number of $3.61. The very small spread in the analyst projections comforts me. On the other hand, GEL has one of the lower grades I give on historical DCF projection accuracy.

I thought it was important to start this article highlighting the key differences that GEL offers. As a result, I have yet to provide the year to date numbers - and what those numbers can tell us about GEL. Here is that info based on the 6-22-16 market closing prices:

Small Cap Midstream

Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR
Blueknight Energy Partners, L.P. (NASDAQ:BKEP) 5.09 0.1450 11.39 61.05 58.00 -9.43 -4.27 -84.38 -16.22 11.76 3.94 -38.60
Boardwalk Pipeline Partners, LP (NYSE:BWP) 18.07 0.1000 2.21 22.22 20.00 39.21 40.76 10.00 0.89 1.69 0.00 400.00
Columbia Pipeline Partners LP (NYSE:CPPL) 14.83 0.1875 5.06 92.59 70.09 -15.16 -13.01 -10.78 -16.07 -10.00 11.94 -14.29
Dominion Midstream Partners (NYSE:DM) 28.46 0.2245 3.16 71.27 59.47 -7.18 -5.71 1.64 -1.60 7.69 28.29 -0.71
Genesis Energy LP 37.23 0.6700 7.20 75.07 71.28 1.33 4.98 -22.07 -18.80 -10.75 12.61 0.00
Holly Energy Partners L.P. (NYSE:HEP) 35.61 0.5750 6.46 87.12 83.33 14.35 18.05 8.52 9.83 -0.38 6.98 0.00
Martin Midstream Partners LP (NASDAQ:MMLP) 22.96 0.8125 14.16 100.93 97.89 5.81 13.29 -25.00 -28.25 -4.17 0.00 -50.00
NuStar Energy L.P. (NYSE:NS) 51.26 1.0950 8.54 92.41 90.87 27.83 33.29 1.78 3.47 -3.66 0.00 -42.86
TC PipeLines, LP (NYSE:TCP) 56.18 0.8900 6.34 79.46 74.32 13.02 16.60 8.59 44.23 -1.32 5.95 -10.00
Tallgrass Energy Partners, LP (NYSE:TEP) 46.25 0.7050 6.10 81.03 64.38 12.23 15.65 -8.16 -9.64 -1.14 45.36 10.00
Transmontaigne Partners L.P. (NYSE:TLP) 40.24 0.6800 6.76 74.52 69.92 50.37 55.46 -16.38 37.50 0.27 2.26 11.11
Small Cap Average 7.03 76.15 69.05 12.04 15.92 -12.39 0.49 -0.91
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GEL is up 1.33% while the sub-sector average is up 12.04% and the Alerian MLP index as measured by the ETN AMJ is up 8.97%. Price performance strongly follow with the changes in the DCF projection - and the projection for GEL is down 10.75% for the year. Price targets takes their directional clues from DCF projection changes. The GEL target has fallen almost 19%. This cynic believes the market is clueless about MLPs because the earnings metrics are relatively obfuscated and the diligence needed to have clear perceptions is higher than the market is willing to do. Thus it blindly follows the valuation suggestions of the analysts. GEL provides evidence that the market has been obedient in 2016. That obedience has led to under performance. And - completing the unbroken circle - that performance is merited by changes in the DCF projection. Given that the current and decrement 2016 projection is in line with my run rate number, the beginning projection evidently had some unneeded optimism in it.

Now that we have reviewed recent market history and also have a good DCF - let's move on the CAGRs - or a five year forward "Compound Annual Growth Rate" projection of the distribution.

Long term metric trends
The average calculation for growth is for ten years - for 2006 through 2015
The first average is the sum of changes for each individual year over ten year period - with that result divided by 10
The 2nd average is the difference between the current and beginning number, divided by the beginning number - with that result divided by 10
The distributions shown are annualized first quarter distributions

Company 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 average average CAGRs PI-CAGRs
GEL DCF 1.48 1.36 2.21 1.94 2.16 2.00 2.27 2.25 2.64 3.16 3.57 3.76 My 9.00% RRR-yield 6.30%
growth -8.1% 62.5% -12.2% 11.3% -7.4% 13.5% -0.9% 17.3% 19.7% 13.0% 5.3% 11.41% 14.12% Last5 10.89% P/DCF Ratio 3.18%
Dist. 0.68 0.84 1.14 1.32 1.44 1.60 1.76 1.94 2.14 2.38 2.62 Broker1 8.60% Broker2 0.00%
growth 23.5% 35.7% 15.8% 9.1% 11.1% 10.0% 10.2% 10.3% 11.2% 10.1% 14.71% 28.53% Broker3 0.00% Broker4 10.30%
Dist/DCF 46% 62% 52% 68% 67% 80% 78% 86% 81% 75% 73% 72.16%

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My median 2018 DCF projection for GEL is $3.93 and the median 2019 projection is $3.97. Presuming a 80% payout of the 2019 DCF of $3.97, the distribution would be $3.18 - and that would average (318/262 . . divided by 3 years) 7.12% distribution growth per year. I show the high brokerage projection at 10.3% and the low one at 8.6%. I want conservative CAGRs. My 8% CAGR is low on the conservative attribute - but it is under the company guidance. Given the current 7.20% yield, the market is putting a valuation (averaging my two PI-CAGRs of 6.30 and 3.18 to get 4.74%) on GEL that is well under that projection. This low valuation is why GEL shows up on a few buy lists provided by the brokerages.

Now that I have arrived at a growth projection with which I can have a fair amount of confidence - it is time to make a numeric risk assessment.

When it comes to historical DCF projection accuracy - GEL is a little below average. When it comes to credit ratings - GEL is a little below average for the sub-sector and well below average compared to the large caps. When it comes to credit metrics - GEL is temporarily ugly. When it comes to distribution coverage - it is above average. I want to slightly increment the risk of owning GEL due to relatively high growth projections. Because of the sum of all attributes, I assess GEL with a 13.5% Required Rate of Return ("RRR" or risk assessment). Low RRRs are in the 10s and mainly go to BBB+ rated companies. RRRs for well covered distributions are in the 11s and mainly go to BBB rated companies. Uncovered distributions result in RRRs in the 12s and mainly go to BBB- rated companies. BB rated companies with good coverage ratios have RRRs in the 13s. Sky high CAGRs are extremely ugly credit metrics result in RRRs in the 14s or higher.

And with that - you should be sufficiently prepped for the ending spreadsheet that compares valuations:

Company

Q2-16 Consensus Total Bonds DCF My Total Rtn Consensus Price Implied CAGR Distrib Price
Yield CAGR Return Ratings Accr RRRs - RRR Ratings RRR-Yld P/DCF / DCF / DCF
Small Cap Midstream
Blueknight Energy Partners, L.P. BKEP 11.39% 3.50% 14.89% none 4.00 14.50 0.39 2.3 3.11 -3.53% 61.05 5.36
Boardwalk Pipeline Partners, LP BWP 2.21% 5.00% 7.21% BBB- 4.50 11.00 -3.79 2.2 8.79 -1.59% 22.22 10.04
Columbia Pipeline Partners LP CPPL 5.06% 12.00% 17.06% none 2.50 15.00 2.06 2.5 9.94 18.66% 92.59 18.31
Dominion Midstream Partners DM 3.16% 14.00% 17.16% none 1.50 15.00 2.16 2.2 11.84 25.72% 71.27 22.59
Genesis Energy LP GEL 7.20% 8.00% 15.20% BB- 3.00 13.50 1.70 2.2 6.30 3.18% 75.07 10.43
Holly Energy Partners L.P. HEP 6.46% 4.50% 10.96% BB 1.00 11.50 -0.54 2.5 5.04 3.28% 87.12 13.49
Martin Midstream Partners LP MMLP 14.16% 0.50% 14.66% B+ 5.00 14.00 0.66 2.7 -0.16 0.22% 100.93 7.13
NuStar Energy L.P. NS 8.54% 2.00% 10.54% BB+ 3.30 11.20 -0.66 2.8 2.66 0.02% 92.41 10.81
TC PipeLines, LP TCP 6.34% 4.50% 10.84% BBB- 1.00 11.00 -0.16 2.8 4.66 2.54% 79.46 12.54
Tallgrass Energy Partners, LP TEP 6.10% 11.00% 17.10% BB+ 1.50 13.50 3.60 2.0 7.40 7.90% 81.03 13.29
Transmontaigne Partners L.P. TLP 6.76% 3.00% 9.76% none 1.00 11.00 -1.24 1.3 4.24 0.04% 74.52 11.02

Average 7.03% 6.18% 13.22% 2.32 5.80% 5.13% 12.27
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GEL is relatively risky as shown by its lower than average credit ratings and its higher than average earnings projection volatility. At the same time, the distribution coverage and company guidance leads me to come to a relatively strong distribution CAGR projection.

GEL is one of six MLPs where my "Yield + CAGR - RRR" numbers are higher than zero. Four out of six of those MLPs have Yahoo Finance sourced analyst "consensus ratings" that are lower (or better) than average. GEL has a slightly better than average analyst rating number. GEL is currently priced for a lower growth projection or a higher risk assessment. Based on the numbers, GEL is a buy.

This is a time where MLPs with superior safety attributes have relatively high valuations. This is a relatively good time to purchase riskier assets.

Conservative investors should want to invest predominantly in stocks where they have "faith and confidence" in the DCF and CAGR projections - and in equities that have investment grade rated debt. That label does not fit GEL. That attribute should strongly influence any weighting decision you would make on a GEL purchase.

Disclosure: I am/we are long EPD, GEL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.