A Closer Look At Williams Partners Distributable Cash Flow As Of 2Q 2012

On March 19, 2012 Williams Partners, L.P. (WPZ) announced the $2.5 billion Caiman acquisition and upped its estimate of 2012 capital expenditures from ~$2.9 billion to $5.4 billion. The following day the price per unit immediately dropped from $61 to $56 on investor concerns regarding dilution.

On July 23, 2012, WPZ lowered Distributable Cash Flow (“DCF”) guidance for 2Q12 (to ~ $289 million, down from $475 million in 1Q12 and $397 million in 2Q11) and for 2012-2014 as follows:

In response, the price per unit dropped from $55.21 to $53.70. On a positive note, distribution growth guidance was maintained at 8% for 2012 and 9% (midpoint) per annum for 2013-2014, growth in WPZ’s fee-based business is expected, and WPZ announced an agreement to a acquire an 83.3% interest in the Geismar Olefins-Production Facility from Williams Companies, Inc, (WMB), WPZ’s general partner, which is expected to be accretive (this is not yet reflected in the current guidance) and to shift ethane price exposure to ethylene. WMB owns 68% of WPZ (66% in the form of limited partner interests and a 2% general partner interest).

The weak results announced August 1 for 2Q12 primarily reflect a sharp decline in prices for natural gas liquids (“NGL”) and are secondarily due to higher maintenance expenditures. WPZ’s Midstream segment provides natural gas gathering and processing services under fee contracts (volumetric-based), keep-whole agreements and percent-of-liquids arrangements. Under keep-whole and percent-of-liquid processing contracts (see glossary of terms), the Midstream segment retains the rights to all or a portion of the NGLs extracted from the producers’ natural gas stream and recognizes revenues when the extracted NGLs are sold and delivered; hence lower NGL prices mean lower revenues, as well as lower segment profits and operating income, as seen below:

The definition of DCF used by WPZ is described in an article titled Distributable Cash Flow. That article also provides, for comparison purposes, definitions used by other master limited partnerships. Using WPZ’s definition, DCF for trailing 12 months (“TTM”) period ending 6/30/12 was $1,580 million ($5.20 per unit), up from $1,413 million ($5.03 per unit) in the TTM period ending 6/30/11.

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 WPZ results through March 31, 2012 generates the comparison outlined in the table below:

The gaps between reported DCF and sustainable DCF in Table 3 relate mostly to “other” and are comprised principally of adjustments for earnings from unconsolidated subsidiaries and certain acquisition-related adjustments (e.g., management added back to DCF $26 million of Caiman-related transaction costs in 2Q12). But overall, the differences between reported and sustainable DCF are not huge.

Coverage ratios are indicated in the table below:

The lower coverage ratios reflect, in addition to the performance issues discussed above, growth in the number of units outstanding as a result of issuing equity to partially finance large acquisitions.

It is 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 WPZ:

Simplified Sources and Uses of Funds

In 2Q12 net cash from operations, less maintenance capital expenditures, less net income from non-controlling interests, did not cover distributions. This is highly unusual for WPZ and has not occurred in the prior 10 quarters even once. For the TTM ending 6/30/12, the excess net cash was $452 million, down from $560 million for the TTM ending 3/31/12, but higher than the $418 million for the TTM ending 6/30/11.

Another note of caution relates to the balance sheet which, in 2Q12, saw an increase of $724 million in goodwill and ~$1 billion in other intangible assets vs. the prior quarter. Based on recent performance, management may conclude that the carrying value of the goodwill exceeds its implied fair value and recognize an impairment loss in the amount of the excess.

Price per unit continues to languish and has dropped further since the July 23 announcement to close on 8/3/12 at $52.18 with a yield 6.08%. Despite some signs of weakness I have been adding to my WPZ position on such pullbacks and such as the one that we are currently seeing.