A Closer Look At Plains All American Pipeline's Q2'14 Distributable Cash Flow

| About: Plains All (PAA)
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Supply & Logistics segment profits and adjusted EBITDA may continue to compare unfavorably with prior year results for balance of 2014.

DCF coverage of distributions remains strong and sustainable.

Unit price has underperformed peers and MLP index in last 12 months.

Disciplined, cohesive, management team; consistently meet or exceed guidance.

Plains All American Pipeline L.P. (NYSE:PAA) recently reported its results of operations for 1Q 2014. This article analyzes some of the key facts and trends revealed by this and prior PAA reports, evaluates the sustainability of PAA's Distributable Cash Flow ("DCF") and assesses whether PAA is financing its distributions via issuance of new units or debt.

PAA transports, stores and markets crude oil and refined products; it also transports, processes, stores and markets natural gas liquids ("NGL") and owns and operates natural gas storage facilities. PAA's operations are managed through three operating segments:

  1. Transportation Segment: fee-based activities associated with transporting crude oil and NGL on pipelines, gathering systems, trucks and barges;
  2. Facilities Segment: fee-based activities associated with providing storage, terminal and throughput services for crude oil, refined products, natural gas and NGL, NGL fractionation and isomerization services and natural gas and condensate processing services; and
  3. Supply & Logistics Segment: margin-based activities associated with sale of gathered and bulk-purchased crude oil, as well as sales of NGL volumes purchased from suppliers (including the sale of additional barrels exchanged through buy/sell arrangements entered into to supplement the margins of the gathered and bulk-purchased volumes).

Segment profits for recent quarters and the trailing twelve months ("TTM") ended 6/30/14 and 6/30/13 are presented in Table 1 below. Segment profit is one of the key metrics used by management to evaluate performance of its business segments. It is defined as revenues plus equity earnings in unconsolidated entities less a) purchases and related costs, b) field operating costs and c) segment general and administrative expenses. Each of the items above excludes depreciation and amortization. In the TTM ended 6/30/14, Transportation segment profits increased 19%, Facilities segment profits increased 5% and Supply & Logistics segment profits decreased 38% vs. the TTM ended 6/30/13.

Table 1: Segment Profit, excluding "Selected Items Impacting Profitability"; figures in $ Millions (except % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.

Unlike the Facilities and Transportation segments that are predominantly fee-based businesses, a substantial portion of Supply & Logistics is margin based and hence results are more volatile. In a prior article I noted the drivers behind the extraordinary performance generated by this segment in 1Q13. Management rightly predicted infrastructure additions would relieve certain of the transportation constraints that had previously created extremely favorable crude oil margins benefiting Supply & Logistics. Natural gas storage costs incurred to manage delivery requirements in conjunction with the severe cold weather experienced during 1Q14 contributed to the unfavorable comparison to the unusually good results in the prior year period. Overall, there was a 38% decline in that segment's profits in the TTM ended 6/30/14 vs. the corresponding prior year period.

The above-mentioned natural gas storage costs also negatively affected results for the TTM ended 6/30/14 at the Facilities and Transportation segments. But for the latter, the negative impact was offset by favorable results largely due to the continued increase in North American crude oil production and recently completed capital expansion projects.

Earnings before interest, depreciation & amortization and income taxes (EBITDA) and Adjusted EBITDA are shown in Table 2 below. Adjusted EBITDA is another key metric used by management to evaluate its financial results. The adjustments include adding back equity based compensation, inventory and foreign currency revaluations, acquisition related expenses, and derivative gains or losses on commodity transactions. The "return to baseline" at Supply & Logistics in the TTM ended 6/30/14 also explains the declines in Adjusted EBITDA.

Table 2: Figures in $ Millions (except per unit amounts and % change)

Adjusted EBITDA in 1Q14 was $42 million above the mid-point of management's guidance for that quarter, and was $57 million above the mid-point of management's guidance for 2Q14. With the publication of 2Q14 results, management further raised its Adjusted EBITDA guidance for 2014 by $25 million to $2,175 million.

PAA's definition of DCF is presented in an article titled "Distributable Cash Flow." The article also provides definitions used by other master limited partnerships ("MLPs"). Based on this definition, DCF reported by PAA for the TTM ended 6/30/14 was $1,537 million ($4.33 per unit), down from $1,718 million ($5.09 per unit) in the corresponding prior year period, as shown in Table 3 below:

Table 3: Figures in $ Millions (except per unit amounts and % change)

In the TTM ended 6/30/14, distributions grew 10% in the face of a decline in DCF per unit. To me, this usually serves as a note of caution; but not in this case. It too is explained by the "return to baseline" at Supply & Logistics.

Reported DCF may differ from sustainable DCF for a variety of reasons. These are reviewed in an article titled "Estimating sustainable DCF-why and how." Applying the method described there to PAA's results generates the following comparison between reported and sustainable DCF:

Table 4: Figures in $ Millions

Investments in working capital and risk management activities (derivative positions, interest rate and currency hedges) are the largest component of the difference in the TTM ended 6/30/14 between reported and sustainable DCF. Under my definition of sustainable DCF, such items are excluded.

Under PAA's definition, reported DCF always excludes working capital changes, whether positive or negative. My definition of sustainable DCF only excludes working capital generated (I deduct working capital consumed). Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability an MLP should generate enough capital to cover its normal working capital needs. On the other hand, cash generated by an MLP through the liquidation or reduction of 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. In the TTM ended 6/30/14 working capital consumed cash amounting to $187 million. Management added back this amount in deriving reported DCF.

PAA's working capital needs can fluctuate significantly due to changes in market conditions. It stores crude oil and NGLs when their prices for future deliveries are higher than current prices (a "contango" market), thus increasing its investment in working capital and reducing net cash generated by operating activities. Conversely, cash flow from operating activities increases during periods such as 1Q14 when PAA collects the cash from the sale of the stored inventory. In periods when the market is not in contango, crude oil and NGLs are typically purchased and sold during the same month, so there is no need to increase the investment in working capital.

PAA's DCF coverage ratios are provided in Table 5 below:

Table 5: $ millions, except coverage ratios

Coverage remains strong, despite dropping from the year-ago level when it was boosted by the above-normal results produced by the Supply & Logistics segment. Based on the midpoint of management's 2014 guidance for DCF and distributions to be paid throughout year, distribution coverage is forecast to be 1.11.

Table 6 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:

Simplified Sources and Uses of Funds

Table 6: Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, exceeded distributions by $121 million in the TTM ended 6/30/14. Clearly PAA is not using cash raised from issuance of debt and equity to fund distributions. On the contrary, the excess cash generated constitutes a significant source of capital for PAA and enables it to reduce reliance on the issuance of additional partnership units that dilute existing holders, or issuance of debt to fund expansion projects. Absent significant acquisition activity, PAA will end 2014 without executing an equity (although $453 million funds will be raised via the continuous equity offering program).

Management's 2014 Adjusted EBITDA guidance is $2,175 million (at mid-point), $117 million below the $2,292 million achieved in 2013. This reflects management's expectation of a "return to baseline" in the Supply & Logistics segment's performance. Negative quarter-over-quarter and year-over-year Supply & Logistics segment profit comparisons for the remainder of 2014 vs. the comparable 2013 periods are expected to continue given that market conditions during 2013 were extremely favorable for PAA.

On the other hand, there are positive factors to consider with respect to PAA. A significant portion of the crude oil and NGL production increases in the U.S. and Canada are concentrated in areas where PAA has significant asset presence. Also, in 2013, unlike the two prior years, PAA invested much more in internal growth than in acquisitions, as shown in Table 7 below:

Table 7: Figures in $ Millions; 2014 forecast based on mid-point of company guidance.

Projects in the Permian Basin, PAA's most active area, are expected to account for $800 million of the amount forecasted for internal growth projects in 2014. The Permian Basin supplies West Texas Sour ("WTS") crude while the bulk of the output from the other shale formations is light and low in sulfur. Since Gulf Coast refineries are set up to process high-sulfur crude, they increasingly need to bring in heavy, sour crude such as WTS from the Permian to balance the growing abundance of low-sulfur oil from shale formations.

Other considerations in PAA's favor include disciplined management (50 consecutive quarters of delivering results in-line or above guidance), conservative leverage (long-term debt over TTM EBITDA at 3.7), and an expected pick up in the natural gas storage business. In regard to the latter, PAA's re-acquisition of the PNG unit previously spun off could prove well timed. The severe winter has depleted inventories and reminded utilities and other customers of the insurance-type value that stored natural gas can provide.

Table 8 below provides selected metrics comparing PAA to some of the other MLPs I follow based on the latest available TTM results. Within this list, I consider PAA, EPD and MMP to be the outstanding performers in terms of the operational results and sustainable DCF coverage they generated. They are a solid choice for more conservative MLP investors.

As of 08/13/14:


Current Yield






Buckeye Partners (NYSE:BPL)






Boardwalk Pipeline Partners (NYSE:BWP)






El Paso Pipeline Partners (NYSE:EPB)






Enterprise Products Partners (NYSE:EPD)






Energy Transfer Partners (NYSE:ETP)






Kinder Morgan Energy (NYSE:KMP)






Magellan Midstream Partners (NYSE:MMP)






Targa Resources Partners (NYSE:NGLS)






Plains All American Pipeline






Regency Energy Partners (NYSE:RGP)






Suburban Propane Partners (NYSE:SPH)






Williams Partners (NYSE:WPZ)






Table 8: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; BPL, BWP, EPD, RGP, and SPH TTM numbers are as of 3/31/14; others as of 6/30/14.

It would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table. Note that BPL, EPD, and MMP are not burdened by general partner incentive distribution rights ("IDRs"); hence their multiples can be expected to be much higher. Also, it would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table.

The IDR burden is somewhat less painful for MLPs such as PAA that rely on organic growth (rather than acquisitions) and generate excess cash flow that reduces their need to issue additional units.

PAA's unit price is 9% higher than where it was one year ago vs. 54% higher for MMP and 27% higher for EPD. It has also underperformed the Alerian MLP Index (up 16.4% vs. 1-year ago). This presents an opportunity to invest in an MLP with a solid management team, a history of conservative guidance, which will have increased distributions by 10% in 2014, and which has a high likelihood of increasing distributions by a further 10% in 2015.

Disclosure: The author is long EPB, EPD, ETP, MMP, PAA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.