Magellan Midstream Partners' Distributable Cash Flow As Of Q2 2012

Aug.16.12 | About: Magellan Midstream (MMP)

On Aug. 1, 2012, Magellan Midstream Partners, L.P. (NYSE:MMP) reported results of operations for the second quarter of 2012. Revenues, operating income, net income, and earnings before interest, depreciation and amortization (EBITDA), and income tax expenses were as follows:

Period:

Q2 2012

Q2 2011

H1 2012

H1 2011

Revenues

450

383

943

826

Operating income

167

129

290

245

Net income

138

103

231

193

EBITDA

198

159

352

305

Adjusted EBITDA

177

153

343

305

Weighted average units outstanding (million)

113

113

113

113

Click to enlarge

Figures in $ millions.

Strong performance was exhibited by all segments:

Period:

Q2 2012

Q2 2011

H1 2012

H1 2011

Petroleum Pipeline System

372

314

787

685

Petroleum Terminal

72

64

145

130

Amonia Pipeline System

7

6

13

13

eliminations

(0)

(1)

(1)

(2)

Total revenues

450

383

943

826

Petroleum Pipeline System

176

146

302

273

Petroleum Terminal

43

35

91

75

Amonia Pipeline System

4

2

8

6

eliminations

(3)

1

(3)

1

Total operating margin

220

185

398

355

Click to enlarge

Figures in $ millions.

Results for Q2 2012 are inflated by a ~$28 million gain from a futures contract that does not qualify for a hedge treatment and therefore flows through the revenue and operating margin numbers all the way to the bottom line. Comparisons across quarterly periods can therefore be difficult to make. Net income per limited partner unit was $1.22 in Q2 2012 and would have been $1.01 had the gain been excluded. Still, even absent this gain, Q2 2012 numbers would have exceeded management's due to improved gasoline and crude oil transportation volumes and higher commodity sales.

MMP's definition of Distributable Cash Flow (DCF) and a comparison to definitions used by other master limited partnerships ((MLPs)) are described in one of my prior articles. Using that definition, DCF for the 12-month period ending March 31, 2012, was $468 million ($4.14 per unit), up from $432 million in the TTM ending March 31, 2011, ($3.89 per unit).

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," I present the definition of DCF used by EPD and provide a comparison to definitions used by other MLPs. Using MMP's definition, DCF for the TTM period ending June 30, 2012, was $485 million ($4.29 per unit), up from $449 million in the comparable prior-year period ($3.99 per unit). As always, I first attempt to assess how these figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units

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 MMP results through Q2 2012 generates the comparison outlined in the table below:

12 months ending:

6/30/12

6/30/11

Net cash provided by operating activities

698

429

Less: Maintenance capital expenditures

(77)

(49)

Less: Working capital (generated)

(94)

-

Sustainable DCF

527

380

Working capital used

-

57

Risk management activities

(26)

20

Proceeds from sale of assets / disposal of liabilities

-

-

Other

(16)

(8)

DCF as reported

485

449

Click to enlarge

Figures in $ millions.

The principal differences of between sustainable and reported DCF numbers are attributable to working capital consumed (TTM ending June 30, 2011) and risk management activities (both TTM periods). As detailed in my prior articles, I generally do not include working capital generated in the definition of sustainable DCF, but I do deduct working capital invested. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the master limited partnerships should, on the one hand, generate enough capital to cover normal working capital needs. On the other hand, cash generated from working capital is not a sustainable source and I therefore ignore it. Over reasonably lengthy measurement periods, working capital generated tends to be offset by needs to invest in working capital. I therefore do not add working capital consumed to net cash provided by operating activities in deriving sustainable DCF.

Risk management activities present a more complex issue. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. The MMP risk management activities seem to be directly related to such hedging, so I could go both ways on this.

Coverage ratios appear strong, as indicated in the table below:

12 months ending:

6/30/12

6/30/11

Distributions to unitholders ($ Millions)

$366

$338

Reported DCF per unit

4.29

3.99

Sustainable DCF per unit

4.66

3.38

Coverage ratio based on reported DCF

1.33

1.33

Coverage ratio based on sustainable DCF (including risk management)

1.37

1.18

Coverage ratio based on sustainable DCF

1.44

1.12

Click to enlarge

The simplified cash flow statement in the table below gives a clear picture of how distributions have been funded in the last two years. The table nets certain items (e.g., debt incurred vs. repaid) and separates cash generation from cash consumption.

Simplified Sources and Uses of Funds

12 months ending:

6/30/12

6/30/11

Capital expenditures ex maintenance, net of proceeds from sale of PP&E

(118)

(173)

Acquisitions, investments (net of sale proceeds)

(22)

(407)

Other CF from financing activities, net

(7)

(1)

(147)

(581)

Net cash from operations, less maintenance capex, less net income from non-controlling interests, less distributions

255

42

Cash contributions/distributions related to affiliates & noncontrolling interests

1

4

Debt incurred (repaid)

111

255

Partnership units issued

-

258

Other CF from investing activities, net

2

-

368

559

Net change in cash

221

(22)

Click to enlarge

Figures in $ millions.

The numbers indicate solid, sustainable, performance. Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $255 million in the TTM ending June 30, 2012, and by $42 million in the comparable prior year period. MMP is not using cash raised from issuance of debt and equity to fund distributions. The excess enables MMP to reduce reliance on the issuance of additional partnership units or debt to fund expansion projects. Since Q3 2010, MMP has not sold partnership units, a rare achievement in the MLP universe. It benefits from low cost of capital given there are no general partner incentive distribution rights.

Management raised its 2012 DCF guidance by $30 million to approximately $520 million and announced its intention to increase annual distributions by 18% for 2012, double its previous 9% growth target, with the goal of raising distributions an additional 10% for 2013. Net income per limited partner unit is estimated to be $3.90 for 2012, with third-quarter guidance of $0.76. In fact, MMP's net income has equaled or exceeded distributions in each quarter since Q2 2010, another rare achievement in the MLP universe. Based on past performance, there is certainly no reason to doubt management's ability to achieve its targets.

Over the last eight years MMP has spent ~$2.5 billion on acquisitions and organic growth projects, and currently has $700 million of organic growth projects underway of which it projects spending approximately $500 million in 2012 with additional spending of approximately $200 million in 2013 to complete these projects. Of particular note is the conversion of a large portion of the partnership's Houston-to-El Paso pipeline to crude oil service. At $375 million, this is the largest organic growth project ever undertaken by MMP. The reversed pipeline system will transport crude oil from Crane, Texas to refiners or third-party pipelines in Houston and Texas City, Texas. Based on a successful open season, the capacity is being expanded from approximately 135,000 to 225,000 barrels per day and the entire capacity is fully subscribed with Permian Basin production. The reversed pipeline is expected to be operational by early 2013 and to have a materially favorable impact on MMP's results of operations beginning in 2013.

In H1 2012 ~$97 million was spent on growth capital expenditures, so roughly $400 million remains to be expended during 2012. MMP has been retaining an extraordinarily high level of cash on its balance sheet since Q3 2011. Cash and cash equivalents increased from $13 million as of June 30, 2011, to ~$210 million at year-end and to $234 million as of June 30, 2012. Thus, MMP can fund over 50% of the remaining 2012 growth capital requirements from cash on hand. Long term debt stands at a comfortable 3.1 times EBITDA (2.8 times if the cash is netted out) for the TTM ending June 30, 2012, so I see no need (barring a major acquisition) for MMP to dilute its unit holders through additional issuances. Management prides itself on being fiscally disciplined and has stated it is unwilling to pay the premiums that other MLPs have been paying for acquisitions.

MMP's current yield of ~4.64% (as of Aug. 15, 2012) is at the lowest end of the MLP universe. Enterprise Products Partners L.P. (NYSE:EPD) yields ~4.82% and Plains All American Pipeline (NYSE:PAA) ~4.91%, but almost all the other MLPs I cover yield significantly more. For example: ~5.95% for Kinder Morgan Energy Partners (NYSE:KMP), ~6.18% for Williams Partners (NYSE:WPZ); ~6.24% for El Paso Pipeline Partners (NYSE:EPB); ~6.37% for Targa Resources Partners (NYSE:NGLS); ~7.87% for Buckeye Partner (NYSE:BPL); ~7.83% for Boardwalk Pipeline Partners (NYSE:BWP), and ~8.15% for Energy Transfer Partners (NYSE:ETP).

For conservative investors MMP's price may be justified given its performance track record, disciplined management team, portfolio of growth projects, structure (no general partner incentive distributions), excess cash from operations, and proven ability to minimize limited partner dilution.

Disclosure: I am long EPB, EPD, ETP, PAA, WPZ.