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Ron Hiram

Ron Hiram

Ron Hiram currently manages investment portfolios and assists earlier stage companies in their capital raising efforts. His articles analyzing results reported by master limited partnerships…

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El Paso Pipeline Partners' Distributable Cash Flow Analysis

On October 30, 2012, El Paso Pipeline Partners, L.P. (EPB) provided its quarterly report on Form 10-Q for 3Q12. This is EPB’s second report since the May 24, 2012, acquisition of EPB by Kinder Morgan, Inc. (KMI) (on that date, EPB’s parent, El Paso Corporation, was acquired by KMI). Revenues, operating income and net income were as follows:

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

On May 24, 2012, contemporaneously with KMI’s acquisition of El Paso Corporation (EP), EPB acquired the remaining 14% interest in Colorado Interstate Gas Company, L.L.C. (“CIG”) and all of Cheyenne Plains Investment Company, L.L.C. (“CPI”), which owns Cheyenne Plains Gas Pipeline Company, L.L.C. (“CPG”). The 3Q12, 3Q11 and 9M 2011 numbers have been retrospectively adjusted to reflect reorganization of entities under common control and change in reporting entity due to the May 24, 2012 transactions. Specifically:

a)    Pre-acquisition earnings of CPI were allocated solely to EPB’s general partner. The retrospective consolidation of CPI increased 3Q12, 3Q11 and 9M 2011 net income attributable to EPB by $22 million, $9 million and $27 million, respectively;
b)    3Q11, 9M 2012 and 9M 20111 include CPI pre-acquisition EBDA of $21 million, $34 million and $64 million, respectively;
c)    9M 2011 includes $17 million of revenue related to cancellation of a third party’s commitment on an expansion project, offset by a $3 million charge to operating expenses related to the write off of project development costs incurred in conjunction with this project;
d)    9M 2012 includes an $11 million charge to operating expenses associated with a canceled software implementation project and a $6 million non-cash adjustment related to environmental liabilities for certain CIG environmental projects; and
e)    3Q12 and 9M 2012 numbers include non-cash severance costs of $3 million and $32 million, respectively, allocated from EP as a result of KMI’s acquisition of EP (however, EPB does not have any obligation nor did it pay any amounts related to this expense).

Average throughput volumes on EPB’s pipelines increased 6.98% in 3Q12 vs. 3Q11 and 7.37% in 9M 2012 vs. 9M 2011. Despite that, revenues were essentially flat. EBDA and operating income were up for the quarter and essentially flat in 9M 2012 vs. the comparable prior year period.

In 3Q 12 EBDA increased ~$43 million vs. 3Q11. Approximately $25 million of that is associated with acquisitions, primarily CPI/CPG, and about $22 million is associated with the assets owned during both periods, primarily expansions at Southern Natural Gas Company LLC (“SNG”) and increased demand from natural gas-fired electric generation facilities on both SNG and CIG.

The generic reasons why distributable cash flow (“DCF”) as reported by master limited partnerships (“MLPs”) may differ from what I call sustainable DCF are reviewed in an article titled “Estimating sustainable DCF-why and how”. EPB adopted a new definition of DCF following its acquisition by KMI and its reported DCF numbers for the 3 and 9 months ended 9/30/12 and 9/30/11 are based on this mew definition. In an article titled Distributable Cash Flow (“DCF”)  I present this new definition and provide a comparison to definitions used by other master limited partnerships MLPs. After restating the 2011 numbers to conform to this new format, the comparison between reported and sustainable DCF is as follows:

comparison between reported and sustainable DCF
Table 2: Figures in $ Millions

The DCF number originally reported by EPB in its Form 10-Q filed on 11/7/11 for the 9 months ending 9/30/11 was $435 million, substantially higher than the $369 million for the same period appearing in the recent filing dated 10/30/12. The differences are due to “certain items” totalling $66 million (consisting principally of a $41 million adjustment related to CPI/CPG, a $14 million project cancellation payment, and a $14 million adjustment related to non-controlling interests). These adjustments reduced the reported DCF in the past periods and make the current period reported DCF look better by comparison. However, sustainable DCF for the current period has not improved by much over the prior year, and would have shown deterioration but for maintenance capital expenditures being much lower. Management expects maintenance capital expenditures to total $55-60 million in 2012 vs. ~$100 million actually spent in 2011 and ~$94 million actually spent in 2010. Whether this lower level is sufficient is an open question.

In the first half of 2012 and of 2011, the major differences between reported and sustainable DCF are attributable to working capital, non-controlling interests and other items. In deriving reported DCF for the 9 months ending 9/30/12, management added back to net cash from operations $75 million of working capital used. I generally do not add back working capital used, but do deduct working capital generated, from net cash from operations in deriving sustainable DCF. Despite appearing to be inconsistent, this makes sense because in order to meet my definition of sustainability the MLP should generate enough capital to cover normal working capital needs. On the other hand, cash generated by the MLP through the liquidation or reduction of 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 used to net cash provided by operating activities in deriving sustainable DCF.

Reported DCF for the 9 month period ending 9/30/12 also includes numerous adjustments that reduce reported vs. sustainable DCF by $142 million. The principal components of these are ~$94 million of distributions or allocations to the general partner (~$8 million allocated on account of the 2% interest and ~$86 million of incentive distributions) and non-cash severance costs (~$32 million).

The coverage ratio I calculate compares total DCF to total distributions to all unit holders (including the general partner). DCF as reported by EPB is after distributions made to the general partner. A comparison of reported vs. sustainable coverage should therefore also include the reported number had it been calculated pre distribution to the general partner, as shown on the third line of the table below:

total DCF to total distributions
Table 3

The coverage ratios in Table 3 for the 9 months ended 9/30/12 may be overstated if the current levels of maintenance capital expenditures prove unsustainably low. As indicated in Table 2, EPB has cut maintenance capital expenditures from $68 million in the 9 months ending 9/30/11 to just $29 million in the 9 months ending 9/30/12. Maintenance capital expenditures for 2012 are expected to total $48 million compared to $101 million in 2011.

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 EPB:

Simplified Sources and Uses of Funds

Simplified Sources and Uses of Funds 1
Table 4: Figures in $ Millions

Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $95 million in the 9 months ended 9/30/12 and by $280 million in the prior year 9-month period. EPB is not using cash raised from issuance of debt and equity to fund distributions.

EPB closed at $35.55 on 10/26/12 and, with a $2.32 per annum current rate of distributions per unit, the yield is 6.53%. Distributions for the first 9 months of 2012 total $1.64. EPB expects total distributions declared in 2012 to reach $2.25 per unit (i.e., $0.61 per unit in 4Q12) and to reach ~$2.67 by 2015 (growth of ~ 9% per annum from 2011).

In summary, despite some signs of weakness I continue to hold EPB.

By. Ron Hiram

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