BWP – A Closer Look At Boardwalk Pipeline Partners’ 2Q15 Distributable Cash Flow

On February 10, 2014, Boardwalk Pipeline Partners, LP (NYSE:BWP) slashed its quarterly distributions from $0.5325 to $0.10 and drastically reduced its 2014 DCF forecast. This substantially improved Distributable Cash Flow (“DCF”) coverage, but the unit price plummeted in response, dropping from ~$24 to ~$13 in one day. It recovered to a high of $20.36 in August 2014, but is now back to $13.70. This article analyses some of the key facts and trends revealed by 2Q15 results reported by BWP 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 14,625 miles of natural gas pipelines, including 435 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 208 billion cubic feet 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 the 9 most recent quarters are shown below:

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 trailing twelve months (“TTM”) ended 6/30/15 operating income declined 13%, while EBITDA declined 2.5% on an absolute basis and 3% on a per unit basis. When measured vs. the corresponding prior year period, 8 of the 9 most recent quarters showed declines in EBITDA per unit.

Transportation revenues, which account for the bulk of BWP’s revenues, improved in 2Q15 over 2Q14 but until recently presented a significant challenge. Large amounts of contracted transportation capacity expired in 2013 and 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 were not renewed, while others were renewed at lower rates. Remaining available capacity was 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 was another factor driving down transportation revenues because less value was derived from transporting natural gas from one location to another. But in its recent report, management noted transportation demand has been increasing and growing customer interest (especially from electric utilities) in converting interruptible service to firm service.

Declining basis differentials continue to negatively affect Parking and Lending (“PAL”) and storage. Revenues are 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“.

Results in 2Q15 and 1Q15 were positively impacted by the receipt of $6.3 million of proceeds related to a business interruption claim and $5.7 million of additional revenues a rate case. They were adversely impacted by a leak in the Evangeline ethylene pipeline system discovered shortly after its October 2014 acquisition from Chevron Petrochemical Pipeline, LLC. The pipeline was out of service for most of the first half 2015 (the dollar impact of this was not disclosed). Remediation activities requiring ~$25.5 million were completed in June and the pipeline is being returned to service in 3Q15.

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 6/30/15 was $1.58 per unit, down from $2.22 per unit in the prior year period. Changes in DCF per unit measured vs. the corresponding prior year period are shown in Table 2:

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

I use the “DCF per unit” metric as a proxy measure to gauge whether total DCF generated is growing or contracting. 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 2Q14 was distributed to non-controlling interests ($0 in 2Q15).

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 current quarterly distribution rate of $0.10 is at such a low level that calculating coverage ratios becomes superfluous.

The principal differences between reported and sustainable DCF in the two TTM periods are attributable to cash invested in working capital and various items grouped under “Other” (in 2Q14 it consisted mostly of non-cash interest expense).

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 clearly shows that the current low level of distributions can easily be funded from net cash from operations (i.e., not via the issuance of debt or equity).

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

In the TTM period ended 6/30/15 $283 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 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 5: Enterprise Value (“EV”) and TTM EBITDA figures are 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.

The IDRs held by Loews Corporation, BWP’s general partner, kick in above a threshold distribution level of $0.4025 per quarter. At the current rate of $0.10 per quarter there are no IDR payments.

The ratio of long-term debt to EBITDA is significantly higher (5.2x by my calculation) than most peers and the 4x goal set by management for year-end 2014. The current yield is substantially below MLP peers and likely to remain so given the low likelihood that distribution growth will be resumed in the near future. Meaningful growth in EBITDA requires taking advantage of market opportunities; these, in turn, require 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 compelling.