On Aug. 8, 2012, Energy Transfer Partners, L.P. (ETP) reported results of operations for Q2 2012. Revenues, operating income, net income, and earnings before interest, depreciation and amortization (EBITDA), and income tax expenses were as follows:
Weighted average units outstanding (million)
Table 1: Figures in $ millions except shares outstanding.
Segment contribution to EBITDA was as follows:
Intrastate transportation and storage
NGL transportation and services
Retail propane and other related
Total Segment Adjusted EBITDA
Table 2: Figures in $ millions.
The Intrastate Transportation segment generated lower gross margins both in Q2 2012 vs. Q2 2011 and in the first half of 2012 vs. the first half of 2011. This was partially offset by lower operating expenses.
Volumes transported and Segment Adjusted EBITDA generated by the Interstate segment increased both in Q2 2012 vs. Q2 2011 and in H1 2012 vs. H1 2011. Volumes increased primarily due to additional transported volumes related to the expansion of the Tiger pipeline, which went in service in August 2011, and Segment Adjusted EBITDA increased due to the acquisition of a 50% interest in Citrus on March 26, 2012 ($77 million was attributable to Citrus in Q2 2012 and $81.3 million in H1 2012). The remainder of the increase in Segment Adjusted EBITDA resulted from incremental reservation fees from increased contractual commitments related to the Tiger pipeline expansion and from the 50% interest in the Fayetteville Express Pipeline.
On Jan. 12, 2012, ETP contributed its propane operations, excluding the cylinder exchange business, to AmeriGas Partners, L.P. (APU). ETP received ~$1.46 billion in cash and ~29.6 million APU units, which ETP is obligated to hold until January 2013. APU assumed ~$71 million of debt related to the propane operations. ETP recognized a gain on de-consolidation of $1.06 billion. Investors should note that the propane business is not considered a discontinued operation. Rather, subsequent to the APU transaction propane results are reflected via ETP's investment in APU and are accounted for under the equity method. ETP recorded equity in losses related to APU of $36.4 million and equity in earnings of $3.1 million for the three and six months ended June 30, 2012, respectively. Propane segment results for H1 2012 are harder to understand because they are comprised of 11 days of consolidated propane business activity and ~170 days of propane activity measured using the equity method.
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 present the definition of DCF used by ETP and provide a comparison to definitions used by other MLPs. Using ETP's definition, DCF for the TTM period ending June 30, 2012, was $5.30 per unit ($1,172 million), up 3% from $5.14 per unit ($1,005 million) for the TTM ending June 30, 2011. 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 differs from call sustainable DCF are reviewed in an article titled "Estimating Sustainable DCF - Why And How." Applying the method described there to ETP results through June 30, 2012, generates the comparison outlined in the table:
12 months ending:
Net cash provided by operating activities
Less: Maintenance capital expenditures
Less: Working capital (generated)
Less: Net income attributable to noncontrolling interests
Add: Net income attributable to noncontrolling interests
Working capital used
Risk management activities
DCF as reported
Table 3: Figures in $ millions.
The principal difference between reported DCF and sustainable DCF in the table above relates to ETP's risk-management activities. In deriving its reported DCF, ETP adds back losses from risk management activities. This item totals $179 million in the TTM ended June 30, 2012, the bulk of which is comprised of unrealized losses on interest rate swaps and commodity derivatives, as well as fair value adjustments on inventory. I do not add back these losses when calculating sustainable DCF. I also deducted $44 million to reflect Regency Energy LP's (RGP) interest in Lone Star.
Coverage ratios continue to be below 1.0 as indicated in the table below:
12 months ending:
Coverage ratio based on reported DCF
Coverage ratio based on sustainable DCF
Incentive distributions to Energy Transfer Equity, L.P. (ETE), ETP's general partner are included and accounted for 34.6% of total distributions for the TTM ended June 30, 2012, and 36.3% for the comparable prior-year period. The low coverage ratio of sustainable DCF is a warning signal.
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 ETP.
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)
Other CF from financing activities, net
Cash contributions/distributions related to affiliates & noncontrolling interests
Debt incurred (repaid)
Partnership units issued
Other CF from investing activities, net
Net change in cash
Table 5: Figures in $ millions.
Net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests fell short of covering distributions in both periods. Distributions in both TTM periods were financed with debt and equity.
Following the $5.3 billion acquisition of Sunoco, Inc. (SUN), ETP will further reduce its dependence on natural gas and become a transporter of heavier hydrocarbons like crude oil, NGLs, and refined products. However, in an article dated May 3, 2012, I noted that I cannot understand how the SUN acquisition could be immediately accretive to ETP. Ray Merola, a fellow contributor, initiated a conversation with management representatives and published a well-written article dated July 27 concluding that the transaction was accretive to the tune of $88 million. Having adjusted my numbers to reflect input from that article, and having incorporated recent data from the 10-Q reports for June 30, 2012, filed by SUN and SXL, I can see that, under certain assumptions, the acquisition can be accretive and present my analysis in Table 7.
A quick recap is in order before proceeding to Table 7. Acquisition consideration consists of $25.00 of cash and 0.5245 ETP common units for each of the ~106 million fully diluted SUN shares. So the cash portion at $25 per SUN share comes to $2,650 million (50% of the announced $5.3 billion price tag). In addition, ETP will assume SUN's debt which, as of June 30, 2012, amounted to ~$990 million, net of the debt owed by Sunoco Logistics Partners L.P. (SXL).
Another key parameter to keep in mind before the reviewing the analysis presented in Table 7 is the manner in which DCF is apportioned between the partners and the holder of Incentive Distribution Rights (IDR). ETE receives distributions both as a partner (it holds a general partner interest and limited partner interests) and as the sole owner of the IDRs. Based on my reading of agreements, ETE is entitled to IDR distributions according to the waterfall chart shown in Table 6. The chart is applied to the current distribution rate of $0.89375 per quarter ($3.575 per annum):
Click to enlarge images.
Table 6: Figures in $ except for percentages.
To support the issuance of an additional LP unit that receives distributions of $0.89375 per quarter ($3.575 per annum), ETP must generate, by my calculations, an additional $1.4138 per quarter ($5.655 per annum) of DCF. Hence, the cash required by ETP to support distributions for the 71.1 million additional shares depicted in Table 7 totals $402 million, of which $148 million is for the IDRs (before the IDR give-back).
Table 7: Figures in $ millions.
I noted above that, under certain assumptions, the acquisition can be accretive. For example, if proceeds of the recent 15.5 million share equity issuance were deemed allocated for other purposes (i.e., not the SUN acquisition) and the $680 million gap would be funded by additional debt at a 6% interest rate, the numbers would swing from $24 million dilution to a $23 million accretion. But it seems to me that in any event the accretion from this transaction will be minimal. Not only that, but operational results will have to show substantial improvement to make up the $70 million shortfall that will arise when ETE's $210 million of aggregate IDR relinquishment expires in three years.
In addition to my discomfort with the SUN acquisition, the Q1 2012 and Q2 2012 results, and the fact that distributions are being funded with debt and equity, I am also troubled by the sheer complexity of the ETP story. It has announced acquisitions in excess of $10 billion over an 18-month period, it will own a retail gasoline business, which is non-strategic and does not fit well structure-wise because it is a corporation and is subject to corporate taxes, and it must dispose of aging refineries. The complexities created by using ETP for some acquisitions and ETE for others need to be untangled and, in attempting to do so, additional structures are being created. I find it difficult to follow the logic, economics and implications of the recent transaction, announced June 15, 2012, whereby ETE and ETP agreed that following the closing of the SUN acquisition:
- ETE will contribute its interest in Southern Union into an ETP-controlled entity in exchange for a 60% equity interest in the new entity, to be called ETP Holdco Corporation ("Holdco"); and
- ETP will contribute its interest in Sunoco to Holdco and will retain a 40% equity interest in Holdco.
I am also unsure about the logic, economics and implications of:
- SUN contributing its interests in SXL to ETP in exchange for 50.7 million Class F Units representing ETP limited partner interests plus an additional number of such to be determined based upon the amount of cash contributed to ETP by SUN at the closing of the merger; and
- the Class F Units entitlement to 35% of the quarterly cash distributions generated by ETP and its subsidiaries other than Holdco, subject to a maximum cash distribution of $3.75 per Class F Unit per year.
As of Aug. 17, 2012, ETP's current yield of 8.17% was higher than almost all the other MLPs I cover: the 4.55% for Magellan Midstream Partners (MMP), 4.71% for Enterprise Products Partners L.P. (EPD), 4.85% for Plains All American Pipeline (PAA), 5.96% for Kinder Morgan Energy Partners (KMP), 6.18% for Williams Partners (WPZ), 6.20% for El Paso Pipeline Partners (EPB), 6.31% for Targa Resources Partners (NGLS), 7.87% for Buckeye Partner (BPL), and 7.89% for Boardwalk Pipeline Partners (BWP).
I am long both ETP and ETE, but in light of the low coverage ratio, the Q1 2012 and Q2 2012 results, and my sense of discomfort with the structural complexity, I have already reduced -- and may further reduce -- my ETP position.