A Closer Look At Boardwalk Pipeline Partners' Q2'14 Distributable Cash Flow

| About: Boardwalk Pipeline (BWP)
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The 2014 DCF forecast is likely to be met or exceeded.

The leverage target (4x Debt-to-EBITDA) is unlikely to be reached by year-end.

Operating income and EBITDA trends in recent quarters and the TTM period are not encouraging.

Valuation multiple lower than peers, but so is current yield. The likelihood of significant distribution growth in the next 2-3 years is low.

BWP is well-positioned to benefit from increased demand to transport gas and NGLs from north to south. But this will require significant capital investments and time.

Boardwalk Pipeline Partners, LP (NYSE:BWP) substantially improved its Distributable Cash Flow ("DCF") coverage when, on February 10, 2014, the partnership slashed its quarterly distributions from $0.5325 to $0.10 and drastically reduced its 2014 DCF forecast. The latter was set at approximately $400 million, a $159 million decrease from 2013. The price per unit plummeted in response, dropping from ~$24 to ~$13 in one day. It has since made a substantial recovery to $20.36. This article analyses some of the key facts and trends revealed by the Q2'14 results reported by BWP, evaluates whether recent results indicate the DCF forecast and the leverage target set by management (4:1 Debt-to-EBITDA ratio) are likely to be met, and examines the sustainability of BWP's DCF.

BWP is a midstream master limited partnership ("MLP") that transports, stores, gathers, and processes natural gas and natural gas liquids ("NGLs") for its customers. It operates approximately 14,450 miles of natural gas pipelines, 255 miles of NGL, olefins, and brine pipelines, and offers the most extensive ethylene distribution system in Louisiana. BWP has underground storage caverns with an aggregate working gas capacity of approximately 207 billion cubic feet ("Bcf") and liquids capacity of approximately 18 million barrels. The assets are located near shale gas supply sources with significant reserves (e.g., Barnett, Eagle Ford, Fayetteville, Hayensville, Woodford). Its general partner, Loews Corporation (NYSE:L), is well-capitalized, and has historically aided in financing acquisitions and projects.

Revenues, operating income, net income and earnings before interest, depreciation & amortization, and income tax expenses ("EBITDA") for recent quarters and the trailing 12 months ("TTM") ending 6/30/14 and 6/30/13 are summarized in Table 1:

Table 1: Figures in $ Millions, except % change and per unit amounts. Source: Company 10-Q, 10-K, 8-K filings, and author estimates.

The trends are not encouraging. In the TTM ended 6/30/14, operating income declined 15%. EBITDA declined 8% on an absolute basis and 22% on a per unit basis. When measured vs. the corresponding prior-year period, there have been 7 consecutive quarterly declines in EBITDA per unit. Based on the latest results, I calculate the ratio of long-term Debt-to-EBITDA to be 4.8x. The 4x goal set by management is unlikely to be reached by year-end.

Transportation revenues, which account for the bulk of BWP's revenues, present a significant challenge. Large amounts of contracted transportation capacity expired in 2013 and have, or will have, expired in 2014. Increased production in the Marcellus and Utica shale formations reduces demand for gas to be transported to the Northeast on BWP's Texas Gas system. Therefore, some of BWP's transportation contracts have, or are, not being renewed, while others are being renewed at lower rates. Remaining available capacity is marketed and sold on a short-term firm or interruptible basis, which is also at lower rates.

Declining basis differentials across BWP's pipeline system is another factor driving down transportation revenues, because less value can be derived from transporting natural gas from one location to another. The same factor also negatively affected Parking and Lending ("PAL") and storage. Revenues were lower because less value can be derived from moving natural gas delivery dates between time periods. For a brief description of what are firm and interruptible transportation services, as well as PAL, see "Glossary of MLP Operational Terms".

Higher operating expenses in the latest quarterly and TTM periods also contributed to the decline in operating income. These were driven by significant impairment charges related to goodwill and the cancellation of the Bluegrass Pipeline project. The TTM ended 6/30/13 was favorably impacted by $17 million from gains on the sale of storage gas, making the latest figures appear even more unfavorable by comparison.

In an article titled "Distributable Cash Flow", I present BWP's definition of DCF, and also provide definitions used by other MLPs. Based on this definition, BWP's DCF for the TTM ending 6/30/14 was $2.23 per unit, down from $2.40 per unit in the prior-year period. Changes in DCF per unit measured vs. the corresponding prior-year period are shown in Table 2 below:

Table 2: Figures in $ Millions (except % change). Source: Company 10-Q, 10-K, 8-K filings, and author estimates.

Note that I use the "DCF per unit" metric as a proxy measure to gauge whether total DCF generated is growing or contracting. I generally do not use it to calculate DCF coverage, and it does not imply that the limited partners are the only stakeholders in that DCF. Indeed, they may not be, because non-controlling interests and/or the general partner may have claims against a portion of that DCF. In the case of BWP, $7 million of the $124 million DCF in Q2'14 was distributed to non-controlling interests, and Loews Corporation also has a claim to a portion of the DCF by virtue of incentive distribution rights ("IDRs"). However, below a threshold distribution level of $0.4025 per quarter, the IDR obligations do not kick in. The current quarterly distribution rate of $0.10 (a 1.96% yield) is at such a low level that calculating coverage ratios becomes superfluous.

Year-to-date, DCF totals $286 million, so it seems that the $400 million guidance for 2014 will be met or exceeded, even taking into consideration that in Q3'14, BWP plans to spend approximately $15 million in base gas purchases for operational purposes.

But the question of whether, and understanding why, BWP's reported DCF differs from its sustainable DCF is still relevant. The generic reasons why reported DCF may differ from sustainable DCF are reviewed in an article titled "Estimating sustainable DCF-why and how". For BWP, the comparison is as follows:

Table 3: Figures in $ Millions. Source: Company 10-Q, 10-K, 8-K filings, and author estimates.

The principal differences between reported and sustainable DCF in the two TTM periods are attributable to various items grouped under "Other" (the largest component of which is non-cash interest expense) and to cash invested in working capital.

The simplified cash flow statement in Table 4 below nets certain items (e.g., debt incurred vs. repaid), separates cash generation from cash consumption, and gives a clear picture of how distributions have been funded in the last two years.

Simplified Sources and Uses of Funds

Table 4: Figures in $ Millions. Source: Company 10-Q, 10-K, 8-K filings, and author estimates.

Cash distributions were reduced to $327 million in the TTM ended 6/30/14, from $506 million in the corresponding prior-year period. As a result, after funding maintenance capital expenditures, in the latest TTM period, $143 million of cash flow generated by operations was available to reduce BWP's reliance on issuance of debt and/or equity to fund growth capital expenditures.

Table 5 provides selected metrics comparing BWP to some of the other MLPs I follow:

As of 08/22/14:


Current Yield






Buckeye Partners (NYSE:BPL)






Boardwalk Pipeline Partners






El Paso Pipeline Partners (NYSE:EPB)






Enterprise Products Partners (NYSE:EPD)






Energy Transfer Partners (NYSE:ETP)






Kinder Morgan Energy Partners (NYSE:KMP)






Magellan Midstream Partners (NYSE:MMP)






Targa Resources Partners (NYSE:NGLS)






Plains All American Pipeline (NYSE:PAA)






Regency Energy Partners (NYSE:RGP)






Suburban Propane Partners (NYSE:SPH)






Williams Partners (NYSE:WPZ)






Table 5: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; TTM numbers are as of 6/30/14. Source: Company 10-Q, 10-K, 8-K filings, and author estimates.

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 IDRs; hence their multiples can be expected to be much higher. IDRs are far less of an issue with respect to BWP. As previously noted, its IDR obligations kick in at the threshold distribution level of $0.4025 per unit per quarter, far enough above the current $0.10 level to ignore IDRs going forward.

Computing the EV/TTM EBITDA multiples in Table 7 on an IDR adjusted basis would increase BWP to 12.3x (reflecting the lingering effects of IDR payments prior to the drastic cut in distributions). This is a little lower than SPH's 12.4x (SPH is also not burdened by IDRs), and at least 2 points lower than the multiples all the other MLPs in Table 7 would show, were they also computed on an IDR-adjusted basis. This is a positive factor to be taken into consideration when assessing an investment in BWP. Add to that the increased interest in pipeline capacity seen by BWP resulting from the combination of increased demand for natural gas and NGLs in the Gulf Coast (e.g., from customers looking to build large-scale petrochemical facilities, power plants, and LNG export facilities) and the need of producers in the Marcellus and Utica shale plays to access the Gulf Coast, since production from their basins is now exceeding regional demand.

There are, however, several negative factors to take into consideration. Given that long-term Debt-to-EBITDA is significantly higher (4.8x by my calculation) than the 4x goal set by management, I think it is unlikely that distribution growth will be resumed in the near future. The current yield is likely to remain substantially below MLP peers. Also, taking advantage of the market opportunities requires BWP to invest significant amounts in growth projects that will make parts of its system bi-directional and utilize idle pipeline capacity, in order to take advantage of an increase in demand to transport gas and NGLs from north to south, instead of south to north. Considering the lead times need for regulatory approvals and construction, most of these projects will not be placed into service and begin generating revenues for another two to three years.

On balance, I believe BWP's value proposition is not as compelling as some of the other MLPs I cover, and remain on the sidelines.

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.