Entering text into the input field will update the search result below

Midstream Distributions Are Not Safe: Don't Be Fooled By DCF

Mar. 10, 2020 2:26 PM ETET, UNP, EPD, ENB, OKE, MPLX, MMP, KMI, WMB, ENB:CA121 Comments
Intelligent Walker profile picture
Intelligent Walker


  • Midstream Companies heavily promote Distributable Cash Flow (DCF) as a metric to judge distributions against.
  • DCF vastly overstates a company's true cash generation ability.
  • Don't expect high coverage ratios to protect distributions (or allow for companies to raise them).
  • Article examines FCF and DCF coverage for large midstream names including ENB, EPD, KMI, ET, OKE, WMB, MPLX, MMP.

Midstream companies often tout their cash distributions as a key underpinning in their investment case. As proof that the yields won't be cut, and in fact may be raised, companies point to Distributable Cash Flow ("DCF") coverage. The figures below show DCF coverage (DCF / Distribution) ratios for the largest publicly traded midstream companies for the most recent few years.






Enbridge Inc. (ENB)





Enterprise Products Partners LP (EPD)





Kinder Morgan Inc. (KMI)





Energy Transfer LP (ET)










Williams Cos Inc. (WMB)










Magellan Midstream Partners LP (MMP)





Source: Company press releases and filings. ET is pro forma values provided by ET for consolidated company.

Based on the data in this chart, things look pretty good for midstream companies. Even for the worst capitalized amongst this group (MMP in 2019), DCF could decline by 28% and MMP could still cover its dividend.

However there is a reason why strong DCF coverage doesn't result in dividend increases - because the companies can't afford it. DCF is a non-GAAP metric which for most midstream companies is computed as cash flow from operations (without changes in working capital) minus "maintenance capital expenditures". Some companies use the term "sustaining" instead of "maintenance".

Maintenance capex presents an issue - DCF sounds good, like many an adjusted metric promoted by public companies, but digging deeper it doesn't make much sense. The maintenance capex figure is supposed to be the amount needed to keep current assets operational, e.g. if the company stopped growing and just maintained what it had, maintenance capex is how much it would cost.

This article was written by

Intelligent Walker profile picture
CFA charterholder, NYC based.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You

Comments (121)

With no accounting background, I'm totally confused by this article. Having seen so many CPA disagreed with the author, is there any chart here which is at least useful as a comparison matrix between the various MPLs? I'm invested in EPD which is most frequently mentioned in comments but it doesn't appear to score well in many of the charts such as "Distributions / Free Cash Flow". KMI does better than EPD, if I've not read the metrics wrongly.

Yes, you are reading things correctly. KMI, a C-Corp, pays a lower dividend than EPD's distribution. MLP's usually have higher distributions than corporations.

There are other factors to consider, such as debt to EBITDA. And then there is actually understanding the businesses of the entities. KMI is natural gas pipelines, while EPD is NGL's.
Thanks for clarifying. If this were the case, wouldn't KMI's dividend be safer than EPD, assuming that the future market dynamics for piping NGL and NG are similar and KMI doesn't do another slash like in 2015.

KMI has similar debt to equity ratio as EPD but EPD has higher current and quick ratio as compared to KMI, according to Seekingalpha - seekingalpha.com/...

Since a lot of the metrics are conflicting for the MPLs.

Current and quick ratios are not going to matter for these large investment grade companies (KMI and EPD) with steady revenue streams. The debt ratio that matters for pipelines is debt to EBITDA. Both KMI and EPD score very well at that metric.

KMI does not have a mountainous growth capex backlog to fund to position itself for the shale revolution like it did in 2015. KMI would have no reason to cut its dividend.
Qniform profile picture
Thanks for the article. I'm less concerned about the D&A matching maintenance expenditures than DCF assumptions about terminal value. As you alluded in a comment, these basins are not going to produce economically forever. What will pipelines be worth as stranded assets? Only major trunk lines connected to import/export facilities seem to avoid this fate.
Justin Wiedeman profile picture
So you think that the Operators are simply building billion dollar investments on a whim? Odd reasoning. But in that case, you should not be invested in the sector. Perhaps you sold calls that you don't want to execute?

Can't make sense out of this comment.
JamesSutton profile picture
What about export?
In the Total Capex / D&A calculation probably a lot of those capex spends are for expansion rather than maintaining existing infrastructure.

I bought ENBL midstream because it's yield allows for a dividend cut of 50% and would still have an 18% dividend yield at $3.50. Yes the dividends will get cut if this low oil/gas environment keeps up. but also when oil and gas recover (which they eventually will) the share prices will move up in a big way.

So much short term thinking in the market creates very good opportunities if you're willing to hold for 3-5 years
I own ENBL too (at much higher levels, $7ish).

I remodeled it this a m. If you haircut the selling prices by 5%, reduce volumes by 15%, and take one turn off the current EBITDA multiple (take it down from 6x to 5x) the equity is a doughnut.

But who knows, I'll ride it to zero rather than sell at these prices.
I own BPMP and CNXM. Both have been steadily increasing distributions, although that may stop with these depressed O&G prices.
It is always darkest just before dawn, or so they say. Right now it is pretty darn dark!!!! Likely will get darker as 2020 progresses, but with MLP's collapsing by 50%+ I think it is okay to nibble at various positions. I have a long time frame and set it all to DRIP.
@clrodrick - down another 26% today. Ouch. No more buying for me until I see some stabalization
can they go below zero? . . . asking for a friend
PipelineDancer profile picture
If a MLP goes bankrupt, you need to google CODI right quick and get out. You can owe taxes greater than your investment. Lots of seeking alpha articles written on it. But I don't see a lot of MLPs that I think could go bankrupt anytime soon, except maybe SMLP. Just be careful. I'm a big buyer of MLPs here.
Edward Strover profile picture
You've written a very helpful article. My question: isn't D&A what you are allowed to offset against taxable income to account for the depreciation of the asset - and maintenance capex what you actually have to spend to maintain it? Surely, if the taxman allows you to charge off more than you have to spend this is a good thing? However, if your argument is that they are under-spending compared to the what's required to maintain the asset in a serviceable condition then that's a very different thing. What do you think?
Intelligent Walker profile picture
Thanks for your question. Yes, D&A is a non-cash expense and maintenance capex is a cash cost. The point of my piece is that companies' "maintenance capex" figures understate the amount to actually maintain the assets, and so DCF is a flawed metric that overstates the safety of midstream distributions. It is very hard to know what true maintenance capex is, but I used D&A as a proxy to try and make a point. Clearly a number of readers in the comments have gotten very hung up on D&A, but the piece really isn't about D&A. It is about these companies cash spending and actual ability to maintain their assets and pay / raise their distribution.
ChuckXX profile picture
Wish you would have included HESM in your analysis.
Of course nothing is certain. I'd rather be here than in a lot of other places!
Charlie Munger would agree with you. EBITDA is bull****. The yield pigs are getting slaughtered.
I would prefer to look at the long term safety of the distributions by looking at the type of assets the midstream is investing and invested in and the balance sheets ability to support them over a short term downturn. For example, moving product from a refinery to a plastics company is not the same as moving LGNs to other countries which is totally different than moving oil from a well to a refinery. The ones I am invested in have proven records of over 20 years of being smart about where to invest and they maintain strong balance sheets and credit ratings.
Charles1w profile picture
LongT888, Which one's are you invested in now?
EPD has take or pay contracts with strong companies. Yes, this is so extreme even the best balance sheets in the industry are in question.

BUt it is backed by an extremely high coverage ratio. Also a low debt ratio and solid credit rating.

Low oil prices could result in the rich natural gas basins going back into production. As the associated oil natural gas and ngls dries up.

Nor are low oil prices a reason to stop the massive investment in petrochemical assets due to deeply discounted ngls. Taking market share form other naptha base competition in communist China.
EPD and A little in Kinder Morgan
distr cut seems obvious. cant expect 20% yields.
CapVandal profile picture
Roger that. Or, it is possible the units increase.
I'm hoping they dont increase distribution levels. Reinvesting at 11% or even 6% is just fine.
The accounting for depreciation and amortization actually is not linked accurately to asset life. It is an often arbitrary accounting attempt to allocate capital costs to some period of time to "match revenue and expense." Maintenance capital expenditures -- expenditures to keep capital assets in good working condition -- and depreciation have no necessary connection , other than that maintenance capital can be expected to keep an asset running beyond its depreciable accounting lifetime. The analysis appears to me to be based upon a false premise.

What DCF tells one is how much cash is available for a variety of undertakings -- capital investment, dividends, stock buybacks, etc. When a company tells investors up front that the DCF is not sufficient for additional capital investment and that such an investment must be met by either borrowing or debt in addition to DCF remaining after distributions, it is basically another way of describing FCF as, potentially, a negative number. Using either metric really should get you to virtually the same analytical space.

One can argue about how much cash flow from assets should go to debt reduction -- if depreciation were the same as the time in which an asset wears out and becomes uneconomic or unusable, perhaps we should see entities (corporations and MLPs) aligning debt repayment for each capital asset with its corresponding depreciable life. But that does not appear to be done by any class of entity, probably because actual useful life and the depreciable life set by accounting rules are the same only in the rarest of circumstances.
Pipelines that have high utilization do not depreciate when you actually go to sell them...they appreciate...bottom line. Do you think the Transco pipeline has gone down in value? Is the colonial pipeline worth less today? Did Kinder Morgan take a loss on the sale of their Cochin pipeline or their Transmountain pipeline. Will DAPL be worth less 10 years from now?

There are pipelines that serve oil and gas basins with declining utilization rates. These companies will take impairment charges on these assets as market dynamics change. These companies will dramatically slash their future growth capex. Ultra low interest rates, dirt cheap stock prices, and mid double digit cash flows will be a nice set up for high distributions, share buy backs, and no more projects.
Power Hedge profile picture
This article shows a very misinformed idea of how midstream works.

Depreciation & Amortization is not a cash expense. It's a tax writeoff. Your car loses 1/3-2/3 of its value the second you drive it off the lot. Does that mean you're paying somebody $10-$20k to maintain it in the first year or two? Basically, D&A is just a tax reduction that the IRS says that you can take to reduce your taxes but it doesn't mean that money is leaving your bank account and its substantially more than it actually costs to maintain these assets.

Free cash flow is cash flow from operations minus capital expenditures (excluding companies like TSLA that make up their own definitions). CapEx for these companies is NOT just the money needed to maintain their existing assets. Every company that you listed is investing heavily to construct new pipelines and other infrastructure because the customers have demanded it and have already signed contracts to pay for it.

None of the companies that you mentioned is at any risk of bankruptcy or a distribution (midstream partnerships do not pay dividends) cuts barring massive bankruptcies upstream. This is a possibility, and that's why we need to look at the financial strength of their counterparties. This article does not do that.
CapVandal profile picture

But what about current PE's? These are GAAP.numbers, using GAAP D&A. They are mid single digit for several of your examples, and lower than 10 for most. So the firms are cheap on that basis, including full depreciation. Arguing about yesterdays management metrics is hardly news.

Everyone now knows the market is demanding FCF break even, heavily punishing asset investment. There is blood in the streets here. No one wanting a boring SWAN should bother. But if someone needs this article to tell them there is risk with anything involving O&G....they should be somewhwew else.
OMG, another poorly informed author that knows not of what he speaks. Depreciation is NOT a cash cost, particularly with long lived assets. How do these people get published?
Depreciation is a very real cost that these guys are ignoring in order to pay higher distributions. You are the one who is misinformed. Please google Charlie Munger and his opinion of EBITDA. Hint: He calls it “bull****” earnings.
A total waste of time, nothing but a bunch of gibberish!
Just a reminder about what the bulls said about upstream MLPs a few years ago...
Wow, what an ignorance! You cannot understand even the meaning of depreciation or its practical impact on cash (see $0) or the difference between D&A and maintenance capex --and you are a contributor on SA! Wow
Disagree with this article? Submit your own. To report a factual error in this article, . Your feedback matters to us!
To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.