Revenues generated by Regency Energy Partners LP (RGP) in 1Q 2012 decreased 3.2% vs. the prior quarter and were up 12.8% vs. 1Q 2011 (by comparison, revenues in 1Q 2011 decreased 1.7% vs. 4Q 2010 and were up 4.1% over 1Q 2010). Earnings before interest expense, depreciation & amortization and income taxes (EBITDA) increased 23.4% in 1Q 2012 vs. the prior quarter and were up 47.6% over the comparable prior year period. RGP's definition of Distributable Cash Flow ("DCF") and a comparison to definitions used by other master limited partnerships ("MLPs") are described in an article titled Distributable Cash Flow ("DCF"). Using that definition, DCF for the trailing 12 months ("TTM") period ending 3/31/12 was $329 million ($2.18 per unit), up from $247 million ($1.96 per unit) in the comparable prior year period.
As always, I first attempt to assess how these DCF figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows.
The generic reasons why DCF as reported by the MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to RGP's results through 1Q 2012 generates the comparison outlined in the table below:
12 months ending:
Net cash provided by operating activities
Less: Maintenance capital expenditures
Less: Net income attributable to noncontrolling interests
Add: Net income attributable to non-controlling interests
Risk management activities
Proceeds from sale of assets / disposal of liabilities
DCF as reported
Table 1: 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; a 30% membership interest in Lone Star; and a 33.3% interest in the Ranch JV). Pursuant to Generally Accepted Accounting Principles (GAAP), the Partnership records its share of the net income in these other pipelines 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 and amortization, 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. (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 $88 million and the $54 million in the "Other" line item) does not, as of the date of the report, appear on RGP's balance sheet and does not increase RGP's end-of-period cash balance.
Coverage ratios, with and without this line item, are as indicated in the table below:
12 months ending:
Distributions to unitholders ($ Millions)
Weighted average units outstanding
Coverage ratio based on reported DCF
Coverage ratio based on sustainable DCF (including non-consolidated entities)
Coverage ratio based on sustainable DCF
These are thin coverage ratios. However, on June 5, 2012, RGP's distribution yield was ~8.4% (up from ~6.9% as of my February 28 article ), significantly higher than yields offered as of the same date by some of the other MLPs I have covered. For example: 4.9% for Magellan Midstream Partners (MMP); 5.3% for Enterprise Products Partners (EPD); 5.4% for Plains All American Pipeline (PAA); 6.0% for Williams Partners (WPZ); 6.2% for El Paso Pipeline Partners (EPB); and 6.9% for Targa Resources Partners (NGLS).
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:
Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions
Capital expenditures ex maintenance, net of proceeds from sale of PP&E
Acquisitions, investments (net of sale proceeds)
Cash contributions/distributions related to affiliates & noncontrolling interests
Other CF from financing activities, net
Debt incurred (repaid)
Partnership units issued
Net change in cash
Table 3: 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. The shortfall was $59 million for the TTM ending 3/31/12 and $46 million for the comparable prior year period. Table 3 therefore shows that distributions in both TTM periods were partially financed by issuing equity and debt, despite the fact that RGP's reported DCF exceeded the amount distributed (as shown in Tables 1 and 2). 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).
Capital expenditures in 2012, including capital contributions to RGP's unconsolidated affiliates (i.e., the non-controlling, stakes in other pipelines), are expected to total ~$800 million, of which less than $70 million was expended in 1Q 2012. Long term debt stands at ~4.2x EBITDA for the TTM ending 3/31/12, so a portion of the expenditures (up to ~$300 million by my rough estimate) can be financed with debt and by cash on hand (~$66 million). But that still leaves a fairly significant amount that will have to be financed through additional equity issuances in 2012. The projects will begin to impact RGP's results 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 (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, via its incentive distribution rights ("IDRs"), to 48% of any increase in RGP's current distributions. RGP is at a significant disadvantage in terms of cost of capital compared to MLPs who are at a lower threshold or have eliminated IDRs altogether. At current unit price levels an incremental project must generate ~16.2% cash return of which ~7.8% (48%) would be distributed to ETE and ~8.4% to the limited partners. Energy Transfer Partners, L.P. (ETP) is also burdened with a high hurdle rate.
For investors seeking current yields in excess of 8%, prepared to take the commensurate risks, I prefer RGP to Boardwalk Pipeline Partners (BWP) with its current yield of ~8.3%, Suburban Propane Partners (SPH) with its current yield of ~9.5%, and Inergy L.P. (NRGY) with its current yield of ~8.9%. More conservative investors willing to add to their positions on pullbacks such as the one that we are currently seeing should consider other MLPs.