Author: Ron Hiram
Published: July 10, 2013
Targa Resources Partners LP (NGLS) will report results of operations for 2Q 2013 before the NYSE opens for trading on Thursday, August 1, 2013. A conference call for investors and analysts will take place that day at 10:00 a.m. Eastern Time. This article focuses on some of the parameters that I would look at closely.
NGLS’ revenues are principally derived from percent-of-proceeds (“POP”) contracts under which it receives a portion of the natural gas and/or natural gas liquids as payment for its gathering and processing services. POP contracts share price risk between the producer and processor. Operating income generally increases as natural gas prices and natural gas liquid prices increase, and decreases as they decrease.
Revenues have shown declines in each of the past 4 quarters compared to the same period in the prior year, as shown in the table below. It will be interesting to see if 2Q13 breaks the trend.
| Period: | 1Q13 | 4Q12 | 3Q12 | 2Q12 | 1Q12 | 4Q11 | 3Q11 | 2Q11 |
|---|---|---|---|---|---|---|---|---|
| Sales of commodities | 1,284 | 1,420 | 1,306 | 1,234 | 1,570 | 1,860 | 1,643 | 1,657 |
| Midstream services fees | 114 | 107 | 87 | 84 | 76 | 74 | 70 | 69 |
| Total revenues | 1,398 | 1,527 | 1,393 | 1,318 | 1,646 | 1,933 | 1,713 | 1,726 |
| % Change vs. prior year | -15% | -21% | -19% | -24% | 2% | 27% | 41% | 39% |
Table 1: Figures in $ Millions, except % changes
Another metric of note in Table 1 is the growth in midstream services fee income. This portion of the revenue stream is important because it serves to mitigate the impact of fluctuations in commodity prices on NGLS’ results and to enhance both gross and operating margin percentages. Fee-based operating margin accounted for ~46% of total operating margin in 4Q12 and ~53% in 1Q13. It is expected to continue to increase to 55%-65%+ over next several years.
Gross margin is defined by NGLS as revenues less purchases, while operating margin is defined as gross margin less operating expenses. Table 2 highlights both these margin percentages over the past 8 quarters. It shows that operating margin has declined, in absolute dollar terms, in each of the past 4 quarters compared to the same period in the prior year. It will be interesting to see if 2Q13 breaks the trend.
| Period: | 1Q13 | 4Q12 | 3Q12 | 2Q12 | 1Q12 | 4Q11 | 3Q11 | 2Q11 |
|---|---|---|---|---|---|---|---|---|
| Gross margin % | 18.60% | 17.00% | 17.20% | 18.50% | 15.90% | 13.40% | 13.30% | 14.40% |
| Operating margin % | 5.50% | 5.60% | 4.40% | 6.50% | 6.70% | 5.70% | 4.20% | 5.70% |
| Operating margin $ | 76 | 86 | 61 | 86 | 110 | 110 | 72 | 99 |
| % Change vs. prior year | -31% | -22% | -15% | -14% | 50% | 69% | 48% | 112% |
Table 2: Operating margin in $ Millions, except % changes
EBITDA (earnings before interest, depreciation & amortization and income tax expenses) has also declined in each of the past 4 quarters compared to the same period in the prior year. With the exception of 3Q12, the same is true of Adjusted EBITDA, as shown in Table 3 below:
Table 3: Figures in $ Millions, except % changes
| Period: | 1Q13 | 4Q12 | 3Q12 | 2Q12 | 1Q12 | 4Q11 | 3Q11 | 2Q11 |
|---|---|---|---|---|---|---|---|---|
| EBITDA | 141 | 123 | 105 | 132 | 159 | 160 | 118 | 141 |
| % Change vs. prior year | -11% | -23% | -11% | -6% | 35% | 39% | 29% | 49% |
| Adjusted EBITDA | 132 | 131 | 116 | 123 | 145 | 146 | 107 | 130 |
| % Change vs. prior year | -9% | -11% | 8% | -5% | 35% | 28% | 19% | 38% |
NGLS derives Adjusted EBITDA by adding or deducting to or from EBITDA gains or losses on: a) debt repurchases and redemptions: b) early debt extinguishments; and c) asset disposals. It also excludes non-cash risk management activities related to derivative instruments and, with respect to 1Q13, changes in the fair value of the Badlands acquisition contingent consideration
Management’s 2012 guidance for Adjusted EBITDA was $515-$550 million. NGLS was able to reach the low end of this target. The midpoint of the 2013 Adjusted EBITDA guidance is $625 million, up 10-15% from the midpoint of the initial range of $540-$575 million to take into consideration expected contribution from the Bakken Shale Midstream acquisition (Saddle Butte Pipeline, renamed Targa Badlands). In 2Q12, NGLS reached 52% of the low end of its 2012 Adjusted EBITDA guidance. Reaching 52% of the low end of the 2013 Adjusted EBITDA guidance ($595 million) by mid-year requires ~$177 million Adjusted EBITDA in 2Q13. To the extent this is not achieved, the burden placed on management in 3Q13 and 4Q13 will become much heavier.
The 2Q13 EBITDA and Adjusted EBITDA numbers should also be reviewed on a per unit basis, especially given the significant increase in the number of units shown in Table 4 below:
| Period: | 1Q13 | 4Q12 | 3Q12 | 2Q12 | 1Q12 | 4Q11 | 3Q11 | 2Q11 |
|---|---|---|---|---|---|---|---|---|
| Average units o/s | 102 | 94 | 89 | 89 | 88 | 85 | 85 | 85 |
| % Change vs. prior year | 16% | 11% | 5% | 5% | 7% | 12% | 18% | 25% |
Table 4: Figures in millions, except % changes
The impact is shown in Table 5 below:
| Period: | 1Q13 | 4Q12 | 3Q12 | 2Q12 | 1Q12 | 4Q11 | 3Q11 | 2Q11 |
|---|---|---|---|---|---|---|---|---|
| EBITDA per unit | $1.38 | $1.30 | $1.18 | $1.48 | $1.80 | $1.89 | $1.39 | $1.66 |
| % Change vs. prior year | -23% | -31% | -15% | -11% | 26% | 24% | 10% | 19% |
| Adjusted EBITDA p/ unit | $1.30 | $1.39 | $1.30 | $1.38 | $1.65 | $1.73 | $1.27 | $1.53 |
| % Change vs. prior year | -21% | -20% | 3% | -10% | 26% | 14% | 1% | 11% |
Table 5: Figures in millions, except % changes
In a prior article I noted that NGLS was acquiring Targa Badlands at an expensive EBITDA multiple and that the effect would be dilutive. Distributions in 2013 are projected to increase by 10%-12%, so the combination of hard-to-achieve EBITDA targets and higher unit counts will cause distribution coverage to drop.
Management expects 2Q13 distribution coverage could be somewhat lower than the 0.94x reported for 1Q13 due to historic seasonality in the downstream business. It projects distribution coverage will average ~0.9x in the first half of 2013, but will increase significantly thereafter and end up averaging 1.0x for the entire year. Results for 2Q13 will provide additional insight on how hard it will be to avoid sharper declines in coverage ratios.
Table 6 below shows how NGLS’ current yield of 5.23% compares with some of the other MLPs I cover:
| As of 7/09/13: | Price | Quarterly Distribution | Yield |
|---|---|---|---|
| Magellan Midstream Partners (MMP) | $54.65 | $0.51 | 3.71% |
| Enterprise Products Partners (EPD) | $63.77 | $0.67 | 4.20% |
| Plains All American Pipeline (PAA) | $55.00 | $0.59 | 4.27% |
| Targa Resources Partners (NGLS) | $53.35 | $0.70 | 5.23% |
| El Paso Pipeline Partners (EPB) | $43.91 | $0.62 | 5.65% |
| Buckeye Partners (BPL) | $70.51 | $1.05 | 5.96% |
| Kinder Morgan Energy Partners (KMP) | $86.19 | $1.30 | 6.03% |
| Williams Partners (WPZ) | $51.63 | $0.85 | 6.57% |
| Boardwalk Pipeline Partners (BWP) | $31.83 | $0.53 | 6.69% |
| Regency Energy Partners (RGP) | $27.40 | $0.46 | 6.72% |
| Energy Transfer Partners (ETP) | $51.38 | $0.89 | 6.96% |
| Suburban Propane Partners (SPH) | $48.19 | $0.88 | 7.26% |
| Inergy (NRGY) | $15.92 | $0.29 | 7.29% |
Table 6
The report being issued on August 1 will not contain sufficient information to enable an analysis of Distributable Cash Flow (“DCF”). A comparison of reported to sustainable DCF will be possible a few weeks later, once NGLS issues its quarterly report on Form 10-Q. I will then undertake a DCF analysis.
In the meantime, my concerns regarding NGLS remain centered on the expensive acquisition, the low coverage ratio, the high cost of the IDRs, the increased debt level, and the still significant exposure to commodity prices. I also believe developing the infrastructure for the Bakken shale is more risky than the Texas shale plays and the Marcellus shale. I will complete a DCF analysis once NGLS issues its quarterly report on Form 10-Q.