A Closer Look At Regency Energy Partners' 2011 Distributable Cash Flow

| About: Regency Energy (RGP)

In an article titled "Distributable Cash Flow (DCF)" I presented the definition of DCF used by Regency Energy Partners LP (NYSE:RGP) and provide a comparison to definitions used by other MLPs. Using RGP's definition, DCF for 2011 was $1.96, down from $2.05 in 2010. How do these figures compare with what I call sustainable DCF for these periods?

The generic reasons why DCF as reported by the MLP may differs from call sustainable DCF are reviewed in an article titled "Estimating sustainable DCF-why and how". Applying the method described there to RGP results through December 31, 2011 generates the comparison outlined in the table below:

12 months ending: 12/31/11 12/31/10
Net cash provided by operating activities 253.8 169.2
Less: Maintenance capital expenditures (20.3) (14.9)
Less: Working capital (generated) (25.2) -
Less: Net income attributable to noncontrolling interests (1.2) (0.6)
Sustainable DCF 207.1 153.7
Add: Net income attributable to non-controlling interests 1.2 0.6
Working capital used - 6.2
Risk management activities 2.6 (2.6)
Proceeds from sale of assets / disposal of liabilities 10.2 28.5
Other 64.0 48.6
DCF as reported 285.1 234.9

Figures in $ Millions

The principal difference between reported DCF and sustainable DCF relates to RGP's substantial, but non-controlling, stakes in other pipelines (a 49.99% general partner interest in HPC; a 50% membership interest in MEP; and a 30% membership interest in Lone Star). Pursuant to Generally Accepted Accounting Principles (GAAP), the Partnership records its share of the net income in HPC, MEP and Lone Star as income from unconsolidated affiliates in accordance with the equity method of accounting. However, for purposes of calculating DCF, RGP treats these as if they were fully consolidated by deducting its share of net income, adding its share of the earnings before interest, taxes, depreciation & amortization (EBITDA), and further adjusting to take into account its share of interest expense and maintenance capital expenditures.

On the one hand, I can accept classifying RGP's share of cash flows generated from these entities in the sustainable category despite the fact that RGP does not control them (i.e., cannot determine what to do with the cash they generate). This is because they are similar in every other respect to RGP's other pipeline assets and because RGP and/or Energy Transfer Equity, L.P. (NYSE:ETE), RGP's general partner, do exercise a significant degree of influence over them. On the other hand, RGP's share of cash flows generated from these entities (which accounts for the bulk of the $64.0 million and the $48.6 million in the "Other" line item) does not, as of the date of the report, appear on RGP's balance sheet and does not increase RGP's end-of-period cash balance.

Coverage ratios, with and without this line item, are as indicated in the table below:

12 months ending: 12/31/11 12/31/10
Distributions to unitholders ($ Millions) $274.5 $204.7
Coverage ratio based on reported DCF 1.04 1.15
Coverage ratio based on sustainable DCF (including non-consolidated entities) 0.99 0.99
Coverage ratio based on sustainable DCF 0.75 0.75

These are thin coverage ratios. Moreover, they are calculated based on distributions actually made during the relevant period. RGP recently increased its distributions by ~3.4% (from $1.78 to $1.84 per unit on an annual basis), so coverage ratios could fall further unless there is an increase in cash from operating activities. On the other hand, RGP's 6.93% distribution yield is somewhat higher than the average of 5.89% for all master limited partnerships (MLP). Assuming 7% per annum growth, it would take ~2.5 years for the average MLP to reach the distribution level currently provided by RGP.

I find it helpful to look at a simplified cash flow statement by netting certain items (e.g., acquisitions against dispositions) and by separating cash generation from cash consumption.

Here is what I see for RGP:

Simplified Sources and Uses of Funds

12 months ending: 12/31/11 12/31/10
Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions (41.0) (50.4)
Capital expenditures ex maintenance, net of proceeds from sale of PP&E (362.1) (121.2)
Acquisitions, investments (net of sale proceeds) (593.8) (261.8)
Cash contributions/distributions related to affiliates & noncontrolling interests - (47.0)
Other CF from financing activities, net (17.6) (55.4)
(1,014.5) (535.8)
- -
Cash contributions/distributions related to affiliates & noncontrolling interests 20.9 -
Debt incurred (repaid) 549.5 107.9
Partnership units issued 435.7 427.5
1,006.1 535.4
Net change in cash (8.4) (0.4)

Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests did not cover distributions in both periods, although the shortfall was reduced to $41 million in 2011 from $50.4 million in 2010. These shortfalls occur despite the fact that RGP's reported DCF exceeded the amount distributed. The reason, as previously noted is that reported DCF included items that never make it into the cash flow statement (i.e., cash flows from the non-consolidated pipelines and some other adjustments). Note also that absent the $25.2 million of cash generated from working capital in 2011, the shortfall would have increased vs. the prior year period.

For a further drill-down that reviews the breakdown by quarter of the 2010-2011 numbers in this report, click here.

RGP expects to increase 2012 spending on organic growth projects by ~$290 million vs. 2011. Spending on NGL infrastructure (via Lone Star, a joint venture with Energy Transfer Partners, L.P. (NYSE:ETP) in which RGP has a 30% stake) is expected to grow from ~$90 million in 2011 to ~$250 million in 2012, and spending to develop assets in emerging shale plays located near existing assets requiring gathering and processing infrastructure is projected to increase from $200 million to $290 million. These investments will begin to have a meaningful impact only in 2013-2014.

In 2012, a meaningful increase in cash from operating activities can be expected if drop-downs resulting from the merger of Energy Transfer Equity, L.P., RGP's general partner, with Southern Union Gas (NYSE:SUG) materialize in short order. When, to what extent, and under what terms such dropdowns occur remains to be seen. The terms will be important since ETE is entitled to 48% of any increase in RGP's current distributions. Whether an investment in ETE is a better way to participate in the RGP story from a risk-reward perspective requires a separate analysis.

Disclosure: I am long ETP, ETE.