A Closer Look At El Paso Pipeline Partners' Distributable Cash Flow As Of 1Q 2012

| About: El Paso (EPB)

Revenues in 1Q 2012 declined 0.8% vs. the prior quarter and were flat vs. 1Q 2011 (by comparison, revenues in 1Q 2011 increased 4% vs. 4Q 2010 and were up 10% over 1Q 2010). However, earnings before interest expense and income taxes (EBIT) in 1Q 2012 increased 4% vs. the prior quarter and 17% over the prior year period. The increase in EBIT over the prior year period was primarily driven by the acquisition of incremental interests in Colorado Interstate Gas Company (CIG) and Southern Natural Gas Company (SNG) and the completion of organic growth projects in 2011, partially offset by lower revenues due to non renewal and restructuring of expiring contracts and higher operating expenses.

Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review trailing 12 months ("TTM") numbers rather than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.

In an article titled Distributable Cash Flow ("DCF") I presented the definition of DCF used by El Paso Pipeline Partners, L.P. (NYSE:EPB) and provide a comparison to definitions used by other master limited partnerships ("MLPs"). Using EPB's definition, DCF per unit for the TTM ending 3/31/12 was $2.91, essentially unchanged from the prior year period ($2.92 for the TTM ending 3/31/11). 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 EPB's results for the TTM ending March 31 generates the comparison outlined in the table below:

12 months ending: 3/31/12 3/31/11
Net cash provided by operating activities 725 776
Less: Maintenance capital expenditures (90) (103)
Less: Working capital (generated) (2) -
Less: Net income attributable to non-controlling interests (38) (206)
Sustainable DCF 595 467
Add: Net income attributable to non-controlling interests 38 206
Working capital used - 3
Other (41) (224)
DCF as reported 592 451
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Table 1: Figures in $ Millions

Results for the TTM ending 3/31/12 present a very clean picture. There is no appreciable difference between reported DCF and what I term sustainable DCF. Net income attributable to non-controlling interest decreased vs. the prior year TTM period primarily due to the acquisition of additional interstate natural gas transportation and terminal facilities (the remaining 49% interest in each of Southern LNG Company (SLNG) and Elba Express in November 2010, the 28% interest in CIG in June 2011 and the remaining 40% interest in SNG in March and June 2011).

Coverage ratios are as indicated in the table below:

12 months ending: 3/31/12 3/31/11
Distributions to unitholders ($ Millions) 460.0 279.5
Coverage ratio based on reported DCF 1.29 1.61
Coverage ratio based on sustainable DCF 1.29 1.67
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Table 2

Investors should, however, note the decrease in maintenance capital expenditures indicated in Table 1. This is seems to stem from an unusually low number in 1Q 2012 vs. 1Q 2011 ($9 million vs. $20 million). So the coverage ratios in Table 2 for the TTM ending 3/31/12 may be slightly overstated.

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 EPB:

Simplified Sources and Uses of Funds

12 months ending: 3/31/12 3/31/11
Capital expenditures ex maintenance, net of proceeds from sale of PP&E (131) (288)
Acquisitions, investments (net of sale proceeds) (745) (2,292)
Cash contributions/distributions related to affiliates & non-controlling interests (34) (54)
(910) (2,634)
Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions 175 393
Cash contributions/distributions related to affiliates & non-controlling interests - 58
Debt incurred (repaid) 361 543
Partnership units issued 501 1,599
Other CF from investing activities, net (7.0) 1.0
1,030.0 2,594.8
Net change in cash 120 (39)
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Table 3: Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $175 million in the TTM ended 3/31/12 and by $393 million in the prior year. EPB is not using cash raised from issuance of debt and equity to fund distributions. The excess enables EPB to reduce its reliance on the issuance of debt and/or equity to fund expansion projects.

In addition to the above-mentioned organic growth projects and acquisition of additional interstate natural gas transportation and terminal facilities, recent transactions expected to support distribution growth include, the April 2012 proposal from EP to purchase the remaining 14% interest in CIG and a 100% interest in Cheyenne Plains Investment Company, L.L.C., which owns Cheyenne Plains Gas Pipeline Company, L.L.C. The transaction is expected to close contemporaneously with KMI's acquisition of EP and be immediately accretive to EPB's DCF. The amount required for these purchases and the portions to be funded by debt and equity are not yet known.

The October 2011 announcement by Kinder Morgan Inc. (NYSE:KMI), the general partner of Kinder Morgan Energy Partners (NYSE:KMP), of its acquisition of El Paso Corp. (EP) resulted in a marked decline in EPB's unit price (price declined from $38 on October 14 to $32.17 on December 15, 2011). EPB's current yield is ~6.15% vs. ~5.5% as of March 2, 2012, the date of my prior report. At that time, the unit price had recovered to $36.26. The current yield may not be at the high end of the MLP universe but it is very sustainable and net cash from operations easily covers maintenance capital expenditures and distributions.

The price per unit is now below the 12-month low, closing at $33.05 on May 10, 2012. For investors not fearful of the market downturn we are currently in the midst of, the current price level should be attractive given the solid distribution coverage and the 9% per annum anticipated growth in distributions. While the distribution growth rate is slowing (distributions grew 19% in the TTM ended 3/31/12 vs. the comparable prior year period), it is still quite substantial.

Disclosure: I am long EPB.