Readers of my prior articles on Buckeye Partners (BPL), Plains All American Pipeline, (PAA) and Enterprise Products Partners (EPD) may choose to skip the three following paragraphs since they contain general information relating to my approach with which they may already be familiar.
As an investor seeking the high yields being offered by MLPs, I look carefully at what portion of the distributions being received are really ?earned? and generally seek to avoid or reduce positions in MLPs that fund distributions with debt or through issuance of equity (i.e., sale of additional partnership units). Since money is fungible and the MLP financial statements are voluminous and not always easy to read, ascertaining whether you are genuinely receiving a yield on your money (rather than of your money) can be a complicated endeavor.
In addition, it is important for a conservative investor to understand how safe is the current return before tackling the question of what are the MLP?s growth prospects. Sustainable distributions provide some protection in that under a downside scenario those MLPs that cannot maintain their distribution rates are likely to suffer significantly greater price deterioration.
In prior articles regarding Buckeye Partners, L.P., Plains All American Pipeline and Enterprise Products Partners, L.P., I noted that ?sustainability? is not a clearly defined term and one has to settle on a subjective measure that one is comfortable with. My approach begins with the requirement that to be considered sustainable, an MLP?s net cash from operations should at least cover maintenance capital expenditures plus distributions over a 6-9 months measurement period.
Energy Transfer Partners (ETP) has not raised distributions to its limited partners since 2Q 2008 but offers a high (~7.80%) yield relative to some other large cap MLPs. How does the sustainable DCF generated by ETP compare with its level of distributions? My analysis is provided in the table below:
9 months ending 9/30/11 | 9 months ending 9/30/10 | |
Net cash provided by operating activities | 1,030.2 | 1,102.9 |
Less: Maintenance capital expenditures | (80.5) | (70.3) |
Less: Working capital (generated) | (195.0) | (344.7) |
Less: Net income (loss) attributable to non-controlling interests | (17.7) | - |
Sustainable DCF | 737.0 | 688.0 |
Add: Net income (loss) attributable to non-controlling interests | 17.7 | - |
Working capital (generated) used | - | - |
Risk management activities | 63.5 | 56.2 |
Proceeds from sale of assets | 3.2 | 0.2 |
Other | 5.2 | 0.8 |
DCF as reported | 826.6 | 745.2 |
Figures in $ Millions.
By my calculation, sustainable DCF for the 9 months ending 9/30/11 was $737 million. The principal difference vs. the $827 million reported DCF is attributable to $63.5 million of cash generated by risk management activities and $17.7 million of net income attributable to non-controlling interests. In my view, the latter item does not qualify in the distributable category, let alone as sustainable DCF, because the cash generated by that income is not cash that limited partners are entitled to. It will be distributed to others (RGP, to be precise, for its 30% interest in Lone Star, which is included in ETP?s consolidated financials).
The $63.5 million of cash generated by risk management activities presents a more complex issue. Generally I do not consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonably argue that bona fide hedging of commodity price risks should be included. The problem I run into is that risk management activities encompass many kinds of items, including: (i) net changes in fair value of derivatives; (ii) amortization of net losses related to monetization of derivative instruments; (iii) currency hedges and valuations; (iv) unrealized gains on non-hedged interest rate derivatives; (v) unrealized gains and losses on commodity risk management activities; (vi) gains and losses on non-hedged interest rate derivatives; and (vii) proceeds from termination of interest rate derivatives. In the case of ETP, the $64 million appears to be principally related to floating-to-fixed swaps used to hedge interest rates associated with anticipated note issuances. I would not consider this a sustainable item. Since I have not yet developed a methodology for reliably differentiating between the various risk management items, I therefore exclude them from my analysis.
The impact on coverage ratios is shown in the table below:
9 months ending 9/30/11 | 9 months ending 9/30/10 | ||
Distributions to unitholders ($ Millions) | 863.5 | 794.8 | |
Coverage ratio based on sustainable DCF | 0.85 | 0.87 | |
Coverage ratio based on reported DCF | 0.96 | 0.94 | |
Since distributions substantially exceed sustainable DCF, I have concerns regarding ETP. Short term, sustainable DCF may be further reduced due to the $2.9 billion sale of ETP?s propane operations to AmeriGas Partners, L.P. (APU) and if in 2012 ETP will consume, rather than generate cash from, working capital. The concerns are somewhat mitigated by prospective drop-downs resulting from the merger of ETE, ETP?s general partner, with Southern Union Gas.
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
9 months ending 9/30/11 | 9 months ending 9/30/10 | |
Net cash from operations, less maintenance capex, less distributions, less net income from non-controlling interests | - | - |
Capital expenditures ex maintenance, net of proceeds from sale of PP&E | (870.5) | (966.6) |
Acquisitions (net of operating unit sale proceeds) | (1,964.9) | (142.6) |
Cash contributions/distributions related to affiliates & noncontrolling interests | - | (6.0) |
Debt incurred (repaid) | - | (197. 7) |
Other CF from investing activities, net | - | - |
Other CF from financing activities, net | (12.3) | (23.3) |
(2,847.6) | (1,336.3) | |
Net cash from operations, less maintenance capex, less distributions, less net income from non-controlling interests | 86.2 | 237.8 |
Cash contributions/distributions related to affiliates & noncontrolling interests | 391.8 | - |
Debt incurred (repaid) | 1,638.7 | - |
Partnership units issued | 799.3 | 1,095.9 |
Other CF from investing activities, net | 18.4 | 12.0 |
Other CF from financing activities, net | - | - |
2,934.3 | 1,345.8 | |
Net change in cash | 86.69 | 9.52 |
Figures in $ Millions
The period-to-period analysis for ETP shows a marked deterioration, although net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests did cover distributions. But it did so only thanks to cash generated from working capital and the $86.2 million excess should be viewed with that in mind. The $237.8 million excess in the prior year period is also due to reductions in working capital. Working capital may not be a reliable source with which to fund distributions. As a reminder, in 2009, ETP?s working capital consumed, rather than generated, cash and the amount was significant ($320 million).
Disclosure: I am long ETP, BPL, ETE, EPD, PAA.
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