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A Distributable Cash Flow Analysis for Magellan Midstream Partners

By Ron Hiram | Thu, 08 November 2012 23:11 | 0

On October 31, 2012, Magellan Midstream Partners, L.P. (MMP) reported results of operations for 3Q 2012. Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for 3Q 2012 and for the trailing 12 months (“TTM”) is summarized in Table 1:

Revenues, operating income, net income and earnings before interest
Table 1: Figures in $ Millions

Product sale revenues in 3Q12 were ~$133 million less than in the prior year period. This reflects a ~$60 million drop in physical sales of petroleum products and a $70 million mark-to-market swing from 3Q11 on positions used to hedge MMP’s commodity price exposure (~$30 million gain in 3Q11 vs. a $43 million loss in 3Q12). Marks-to-market on futures contract that do not qualify for a hedge treatment flow through the revenue and operating margin numbers all the way to the bottom line and therefore also account for the bulk of the drop in operating income, net income and EBITDA. Performance in 3Q12 also compares unfavorable with 2Q12 (which benefitted from ~$28 million of mark-to-market adjustments). This underscores the pitfalls of reviewing just quarterly data. While 3Q12 looks terrible by comparison to 3Q11, revenue and operating profit for the TTM ending 9/30/12 are up vs. the prior year period, as shown in Table 2 below:

Revenues and Operating Profits
Table 2: Figures in $ Millions

MMP’s definition of Distributable Cash Flow (“DCF”) and a comparison to definitions used by other master limited partnerships (“MLPs”) are described in one of my prior articles. Using that definition, DCF for the 12 month period ending 9/30/12 was $492 million ($2.17 per unit), up from $457 million in the TTM ending 9/30/11 ($2.03 per unit). As always, I first attempt to assess how these figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units

The generic reasons why DCF as reported by the MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to MMP results through 2Q 2012 generates the comparison outlined in Table 3 below:

Distributable Cash Flow
Table 3: Figures in $ Millions

The principal differences of between sustainable and reported DCF numbers are attributable to risk management activities in both TTM periods. I do not generally consider cash generated by risk management activities to be sustainable, although I recognize that one could reasonable argue that bona fide hedging of commodity price risks should be included. The MMP risk management activities seem to be directly related to such hedging, so I could go both ways on this.

Coverage ratios appear strong, as indicated in Table 4 below:

Coverage ratios
Table 4

The simplified cash flow statement in the table below gives a clear picture of how distributions have been funded in the last two years. The table nets certain items (e.g., debt incurred vs. repaid) and separates cash generation from cash consumption.

Simplified Sources and Uses of Funds

Simplified Sources and Uses of Funds 2
Table 5: Figures in $ Millions

The numbers indicate solid, sustainable, performance. Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $101 million in the TTM ending 9/30/12 and by $134 million in the comparable prior year period. MMP is not using cash raised from issuance of debt and equity to fund distributions. The excess enables MMP to reduce reliance on the issuance of additional partnership units or debt to fund expansion projects. In over two years (since 3Q 2010), MMP has not issued additional partnership units, a rare achievement in the MLP universe.  It benefits from low cost of capital given there are no general partner incentive distribution rights.

In 3Q12 management raised its 2012 DCF guidance by $5 million, following a $30 million raise in 2Q12. The 2012 DCF target now stands at $525 million, which implied a 4Q12 DCF target of $165 million (a 26% increase over the prior year period). Management reiterated its intention to increase annual distributions by 18% for 2012, double its previous 9% growth target, with the goal of raising distributions an additional 10% for 2013. In terms of net income, actual results ($0.22 per share) did fall significantly short of guidance ($0.38) due to the quarter’s mark-to-market adjustments. This breaks a string of quarters stretching back to 2Q10 in which net income per unit equaled or exceeded distributions per unit, another rare achievement in the MLP universe. However, since mark-to-market adjustments are generally excluded from guidance, management reported a “normalized” EPS for 3Q12 of $0.35, slightly less than the third quarter guidance. The shortfall was primarily due to gasoline that was produced in the third quarter but only sold in the fourth quarter.

Over the last 8 years MMP has spent ~$2.5 billion on acquisitions and organic growth projects. Of the projects currently under way, the conversion of a large portion of the partnership’s Houston-to-El Paso pipeline to crude oil service is of particular note. At $375 million, this is the largest organic growth project ever undertaken by MMP. The reversed pipeline system will transport crude oil from Crane, Texas, to refiners or third-party pipelines in Houston and Texas City, Texas. Pipeline capacity will be 225,000 barrels per day and the entire capacity is fully subscribed with Permian Basin production. Subject to receiving the necessary permits and regulatory approvals, MMP will begin moving at least 75,000 barrels a day of crude oil to Houston in early 2013 and increase to the full 225,000 barrels a day capacity in mid-2013. The reversed pipeline is expected to have a materially favorable impact on MMP’s results of operations beginning in 2013.

MMP currently has over $875 million of organic growth projects underway of which it projects spending approximately $450 million in 2012 with additional spending of approximately $280 million in 2013 to complete these projects. Through 9/30/12, ~$220 million was spent on growth capital expenditures, so roughly $230 million remains to be expended in 4Q12. MMP can fund ~40% of the remaining 2012 growth capital requirements from the ~$100 million cash on hand as of 9/30/12. Long term debt stands at a comfortable 3.2x EBITDA for the TTM ending 9/30/12, so I see no need (barring a major acquisition or signing a definitive agreement with Occidental Petroleum to build the BridgeTex pipeline in which MMP will have a 50% share and which will require it to fund $600 million) for MMP to dilute its unit holders through additional issuances. Management prides itself on being fiscally disciplined and has stated it is unwilling to pay the premiums that other MLPs have been paying for acquisitions.

MMP’s current yield is at the lowest end of the MLP universe. A comparison to some of the MLPs I follow is provided in Table 6 below:

MMP’s current yield
Table 6

For conservative investors MMP’s price may be justified given its performance track record, disciplined management team, portfolio of growth projects, structure (no general partner incentive distributions), excess cash from operations, and proven ability to minimize limited partner dilution.

By. Ron Hiram

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