ETP – A Closer Look at Energy Transfer Partners’ 2Q15 Distributable Cash Flow

ETP’s management uses Adjusted EBITDA, a non-GAAP financial metric, to evaluate the partnership’s overall performance, evaluate business acquisitions, and set incentive compensation targets. Management defines it as earnings before interest, taxes, depreciation & amortization (EBITDA) less various non-cash items (e.g., non-cash compensation expense, gains and losses on disposals of assets, allowance for equity funds used during construction, unrealized gains and losses on commodity risk management activities, non-cash impairment charges, loss on extinguishment of debt, and gain on deconsolidation). Adjusted EBITDA includes amounts for less than 100% owned consolidated subsidiaries based on 100% of the subsidiaries’ results of operations; for unconsolidated subsidiaries it includes ETP’s proportionate ownership of the subsidiaries’ results of operations.

ETP operates and reports in seven business segments. These are described in a prior article. Management uses Segment Adjusted EBITDA to evaluate segment performance, measure a segment’s of core profitability, and allocate capital resources among segments.

Following ETP’s merger with Regency Energy Partners L.P. (NYSE:RGP) in April 2015, RGP’s operations were aggregated into ETP’s existing segments. RGP’s gathering and processing operations were aggregated into ETP’s midstream segment. RGP’s natural gas transportation operations were aggregated into ETP’s intrastate transportation and storage and interstate transportation and storage segments. RGP’s contract services and natural resources operations were aggregated into ETP’s “All Other” segment. Additionally, in June 2015 RGP’s 30% equity interest in Lone Star was transferred to ETP (which now owns 100%).

Adjusted EBITDA by segment, including retrospective adjustments for the RGP merger, is presented in Table 1:

Table 1: Figures in $ Millions, except per unit amounts, % change and units outstanding (million). Source: company 10-Q, 10-K, 8-K filings and author estimates.

Overall, Adjusted EBITDA increased by 6.8% ($95 million) in 2Q15 vs. 2Q14. However, this was accompanied by a 36% increase in the average number of units outstanding due to the 172.2 million ETP units issued to RGP unit holders as part of the merger transaction.

The method used by ETP to derive DCF is shown in Table 2:

Table 2: Figures in $ Millions except units outstanding. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Consolidated DCF in Table 2 includes amounts attributable to Sunoco Logistics Partners LP (NYSE:SXL) and Sunoco LP (NYSE:SUN). The manner in which ETE determines DCF attributable to ETP unit holders and ETP’s coverage ratio is presented in Table 3.

Table 3: Figures in $ Millions, except per unit amounts and ratios. Source: company 10-Q, 10-K, 8-K filings and author estimates.

At 1.03x, ETP’s coverage for the 6 months ended 6/30/14 is thin, but reflects results of the seasonally weak second quarter. A trailing twelve months coverage ratio would have been more meaningful, but retrospective RGP merger adjustments covering 3Q14 and 4Q14 are not yet available.

Distributions declared to the partners of ETP include those to which ETE is entitled by virtue of its ownership positions and general partner’s incentive distribution rights (“IDRs”). The allocation of distributions declared to all the partners of ETP indicates the holders of the limited partner units receive ~56% of the total amount distributed by ETP:

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

The generic reasons why DCF as reported by a master limited partnership (“MLP”) may differ from what I call sustainable DCF are reviewed in an article titled “Estimating sustainable DCF-why and how“. ETP’s definition of DCF and a comparison to definitions used by other MLPs are described in an article titled “Distributable Cash Flow”.

Table 5 provides a comparison between the components of reported and sustainable DCF:

Table 5: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

The principal differences between reported DCF and sustainable DCF in the 6 months ending 6/30/15 and 6/30/14 relate to working capital, risk management and a variety of items grouped under “Other”.

Reported DCF for the 6 months ending 6/30/15 includes $938 million of cash consumed by operating assets and liabilities (i.e., working capital). Under ETP’s definition, reported DCF always excludes working capital changes, whether positive or negative. In contrast, as detailed in my prior articles, in deriving sustainable DCF I generally do not add back working capital used and I exclude working capital generated. Despite appearing to be inconsistent, this makes sense; in order to meet my definition of sustainability the master limited partnerships should generate enough capital to cover normal working capital needs. On the other hand, cash generated from 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. I therefore do not add working capital consumed to net cash provided by operating activities in deriving sustainable DCF.

The risk management line item consists primarily of adjustments for derivative activities relating to interest rate swaps and commodity price fluctuations. These totaled $69 million and $81 million for the 6 months ending 6/30/15 and 6/30/14, respectively; they are excluded from my calculation of sustainable DCF.

Finally, the largest amount under “Other” in the 6 months ending 6/30/14 is a $308 million reversal of charges for “transaction-related income taxes” taken in connection with the transfer of Lake Charles LNG to ETE in exchange for the redemption by ETP of 18.7 million ETP units held by ETE.

Sustainable DCF in the 6 months ending 6/30/15 totaled $1,013 million vs. $1,693 million in distributions. Even if you add to the sustainable number the $233 million of net contribution from non-controlling interests appearing as cash flows from financing activities, coverage on a sustainable basis was below the 1x threshold according to my methodology.

A simplified cash flow statement in Table 6 below demonstrates that, so far in 2015, ETP has funded distributions by issuing debt and/or limited partnership units:

Table 6: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Net cash from operations less maintenance capital expenditures fell short of covering distributions (including distributions to non-controlling interests) by $802 million in the latest 6-month period. Of course, the picture would have been different had working capital, risk management activities and other items, discussed in the context of Table 5, not consumed so much cash.

Table 7 provides selected metrics comparing the MLPs I follow based on the latest available TTM results. Of course, investment decisions should be take into consideration other parameters as well as qualitative factors. Though not structured as an MLP, I include KMI as its business and operations make it comparable to midstream energy MLPs.

Table 7: Enterprise Value (“EV”) and TTM EBITDA figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Note that BPL, EPD, KMI, MMP and SPH are not burdened by general partner incentive IDRs that siphon off a significant portion of cash available for distribution to limited partners (typically 48%). Hence multiples of MLPs without IDRs can be expected to be much higher (see Table 4, column 5). In order to make the multiples somewhat more comparable, I added column 6, a second EV/EBITDA column. I derived this column by subtracting IDR payments from EBITDA for the TTM period. Other approaches can also be used to adjust for the IDRs of the relevant MLPs.

Subsequent to June 30, ETP completed a dropdown of 100% of Susser Holdings Corporation to Sunoco LP in a transaction valued at $1.93 billion. SUN paid ETP approximately $997 million in cash (bolstering ETP’s already high $1.6 billion cash balance at quarter-end), and issued to ETP 22 million SUN units valued at $967 million. There was also an exchange of 11 million SUN units owned by Susser Holdings for another 11 million new SUN units to ETP. In addition, ETP and ETE announced an exchange of 21 million ETP units currently owned by ETE for 100% of the general partner interest (including IDRs) of SUN currently owned by ETP. As part of that transaction, ETE agreed to provide ETP a $35 million annual IDR subsidy for two years. Upon closing, SUN will no longer be consolidated by ETP.

I continue to hold my position and remain overweight on ETE vs. ETP.