Ron Hiram

Research analyst, dividend investing, oil & gas, mid-cap
Ron Hiram
Research analyst, dividend investing, oil & gas, mid-cap
Contributor since: 2011
Thank you for your suggestion. I calculate sustainable DCF (a metric probably similar to your CAD) in absolute and per unit terms each quarter and include these numbers in the reports I write. I do not include them in my last table simply because it takes several weeks for me to analyze the results for all the MLPs I follow and cannot provide comparisons for a given period until my last MLP analysis is completed. Once all my 4Q15 reports are done, I will prepare a table with a Price/CAD column and submit it for publication.
Long asset lives is a unique feature of the business of midstream energy MLPs. The physical life of a pipeline is considered virtually unlimited given proper maintenance, repair & replacement programs. Pipeline companies make dividend or distributions payments based on their DCF, a metric that excludes most capital expenditures and is derived from operating cash flows. In contrast, dividend paying corporations generally pay their shareholders using FCF, a metric based on cash remaining after funding all capital expenditures. You seem to be saying this is a suitable metric for EPD. I differ precisely because the capital investments made by pipeline companies have such long useful lives and think it is appropriate to fund these by issuing long-term debt or equity. Requiring them to cover the payments via FCF as if they had 5 or 10 year lives is, in my view, too onerous and overly conservative. Even under current market conditions, EPD's cost of capital does not appear to have increased to the point where significant cutbacks in growth cap ex are necessary.
The numbers you refer to are that portions of maintenance expenses that are capitalized. The portion that is less visible is the portion that is expensed. EPD refers to the sum of the two as "integrity costs" and, in 2014, 2013 and 2012 they totaled $99.0 million, $128.0 million and $150.0 million, respectively. The total for 2015 has not yet been published, but EPD did project integrity costs would be approximately $128.0 million (i.e., higher than 2014).
I am long ETE and ETP. Both are small positions, but as between the two I am overweight on ETE for reasons described in my articles.
I share your concerns. My position in ETP is too small to worry about. But I should have been more disciplined and sold it all.
Thanks to Fred L. for providing the schedule. i would only add that I estimate debt maturing beyond 2019 totals ~$19.3 billion. EPD has been extending maturities and lowering the interest on its debt since 2009. I am not concerned at this time about their ability to roll over debt.
I am long both (mostly ETE). There was no change.
Everything depends on how you structure your overall portfolio (% in cash, CDs, ST bonds or bond funds, LT bonds or bond funds, broad-based equity funds/ETFs, etc.) Individual equity picks are at the riskier part of the scale (the more so if they are concentrated on one industry) and their allocation should reflect your age and risk tolerance. If you are unable to sleep at night it is probably an indication for you to reduce your allocation to these investments.
Hi Ray
If I understand it correctly, the "return" part of your calculation ignores depreciation. True, for the most part the assets have very long lives, but zero depreciation may be too generous. At the very least, the return you calculate should not ignore the capitalized portion of expenditures on maintenance.
Another factor that inflates the "return" part of your calculation are earnings generated by less than wholly-owned subsidiaries. These are recorded as though Energy Transfer owned 100%, even though it owns less.
Other items that may affect the usefulness of EBIT as a performance measurement metric are gains and losses on disposals of assets, unrealized gains and losses on commodity derivatives, inventory write-downs and other impairment charges, and losses on extinguishments of debt.
If I understand it correctly, the "invested capital" part of your calculation ignores current maturities of LT debt. Also, you take non-controlling interests out of the denominator but include the income therefrom in the nominator.Finally, averaging BOP and EOP numbers may be more indicative than end of period numbers.
Hope this is helpful.
BWP tried doing just that. Results show this route is not without its challenges.
For MMP, that is indeed the case (which is one of the reasons I own the units). But that is not the case for most other MLPs I follow.
As some readers noted, PAA could borrow to continue distributions at the current rate (by tapping credit lines or borrowing from the PAGP via IDR relinquishments). But these are not long-term solutions to what may be problems that will not be resolved in the short term. Given the high cost of capital imposed by the IDRs, a merger seems to make sense, unless management sees a reasonable chance of improved business conditions in the next 2 years or so. A merger could take either form, i.e., PAA buys PAGP or vice versa. The former implies significant dilution for LPs, the latter implies adverse tax consequences for those LPs with low basis in the units but possibly not for those who purchased their units more recently.
As mentioned, I sold.
You may be right. But precisely because of the public ownership of PAGP, suspending IDRs is much riskier. As we have seen, distribution cuts are not well received by public shareholders.
Keeping distributions flat is the more likely scenario for PAA in my view.
SPH is in an entirely different business. For my thoughts on SPH see article dated around August 27. In general, I favor strong coverage over high current yield.
Still long ETE, still overweighed on ETE vs. ETP
I doubt that there will be a repeal of the legislation granting MLPs their special status. Based on 2Q15 reports, I do not see significant pipeline volume reductions.
Each year you are taxed only on your pro-rata portion of the MLP’s pretax income. Each year your tax basis increases by your pro-rata portion of the MLP’s pretax income and decreases by the amount of distributions you received. Because an MLP's income is typically less than its distributions, primarily because of depreciation deductions: a) your current taxes are low relative to the cash you receive; and b) your tax basis is reduced. Therefore, when you ultimately dispose of the investment your basis has been lowered and therefore your tax bill will be high relative to the cash you receive. At the end of the day, the tax benefit of owning an MLP is tax deferral, not tax reduction. However, deferred taxes increase your rate of return because you gain the time value of money (cash outflow at a later date is better than the same amount of outflow at an earlier date).
I think your assessment is overly harsh. First, proceeds from the increase in debt of ~$2B and issuance of equity of ~$2.6B were used to fund ~$5B in acquisitions, expansions and contributions to equity investments in 1H15. So the base of EBITDA producing assets has also increased. Second, I calculate sustainable DCF coverage for the 9 months ending 6/30/15 at 0.96, so if business conditions do not deteriorate KMI is close to 1x coverage. Third, additional assets will be placed into service in the remainder of 2015, in 2016 and beyond. I think the real issue is whether business conditions will be sufficiently favorable to meet the projected 10% per annum dividend growth target without blowing through coverage ratios.
I would describe the distributions from MLPs as tax deferred rather than not non-taxable. NGLS and SPH are in totally different businesses and i would not expect their growth patterns to be correlated. Both are sensitive to oil prices, but not in the same way. As I pointed out in the article, SPH benefited from lower prices. Past patterns of distribution increases notwithstanding, further increases may be tougher for NGLS to achieve on a sustainable basis. SPH may be in a better position to maintain its distribution in the face of further sharp declines in oil prices.
1) KMI and other MLPs calculate DCF differently from the way I do, but also differently from each other. I calculate sustainable DCF in the same way for KMI and all the other MLPs I follow.
2) The EBITDA number I use in the comparison table is the number supplied by management (=Adjusted EBITDA). The debt number I use in the comparison table is not supplied by management; it comes directly from the balance sheets. For my own purposes, I also look at the ratio using strict EBITDA (i.e., not Adjusted) in the numerator, but inserting another column would be overkill and explaining the differences could be too time consuming.
I suggest you also read my response to NC Investor.
KMI already filed its 2nd quarter 10-Q and paid the dividend. My analysis will not impact its distribution policy.
See my response to HighOnDividends
The physical life of a pipeline is considered virtually unlimited given proper maintenance, repair & replacement programs. Pipeline companies and partnerships make dividend or distributions payments to their shareholders or unit holders from “adjusted OCF” (i.e., reduced or increased by various amounts deemed appropriate by management). The rationale is that because the capital investments they make have such long useful lives, it is appropriate to pay for them by issuing long-term debt or equity and that requiring them to cover the payments via FCF as if they had 5 or 10 year lives is too onerous and overly conservative. If you buy into that theory, the simple answer regarding KMI is that it is in the pipeline business and that is what really matters – not whether it is structured as a company or MLP. But it is not really a simple answer because KMI’s dividends are covered by “adjusted OCF”, not OCF. The distinction is important because there is no strict definition of what these “adjustments” should include. That means management has wide latitude to decide and it is exceedingly difficult to make comparisons. Worse, even for items on which there is consensus for inclusion, there is no standard measurement method. For example, one of the two major issues around maintenance capital expenditures is whether amounts classified as expansion cap ex should really have been classified as maintenance cap ex. Correct classification can have a huge impact on DCF and on coverage ratios. But there is no reliable, consistent and standard method of determining into which bucket (expansion vs. sustaining) a capital investment should be placed. I don’t see a way of finding out if management inappropriately allocated more than it should have to the expansion bucket, and is thus overstating an MLP’s DCF and its DCF coverage ratio.
I did not get additional information on this variance.
Management contacted me after seeing the article on SA.
The DD&A ($338m), Certain Items ($107m) and Other ($347m) are absent from KMI's cash flow statement. I do not include them in DCF. As I noted, if the cash is not there, how can it be distributed? In other words, I stand behind the analysis in the August 2 article and behind the conclusion that KMI fell a little short of sustainable DCF coverage in the 9 months ended 6/30/15.
KMI's management includes the 3 items because it sees things differently. I believes management's assessment is that inclusion provides investors a more representative, accurate, and/or realistic picture of DCF.
I realize some consider my definition of sustainable DCF overly conservative. It is based on the premise that: a) cash consumed by working capital is not available to be distributed and therefore my calculation, unlike reported DCF, does not add it back; b) cash generated by liquidating working capital is not a sustainable source of DCF (here my treatment does not differ from reported DCF).
In any event, I always look at both reported DCF and what I call sustainable DCF.
Supply & Logistics accounts for $41m of the total $114m of adjustments that are added to "Total Segment Profit" in order to derive "Adjusted Segment Profit". The principal components of the additional $114m are $60m of derivative losses added back and $65m of losses related to the spill that are added back. I did not see a breakdown of the adjustments by segment, so I cannot give a breakdown by segment of the $114m.
For Supply & Logistics, the $84m Adjusted number is the lowest quarterly level I have seen in a while. The TTM number, including 2Q15, is $629m. Management's $525m mid-point forward guidance is substantially below that.
Distribution growth is a much bigger factor in GP valuation models than it is for the underlying limited partnerships. The negative effect of slower or zero growth on unit price is therefore much greater at the GP unit level than at the LP unit level.