A Closer Look At El Paso Pipeline Partners' Distributable Cash Flow

On August 3, 2012, El Paso Pipeline Partners, L.P. (EPB) provided its quarterly report on Form 10-Q for 2Q12. This is EPB’s first 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:


Note that the 2012 operating income numbers for 2012 (the second quarter and first half of this year) are lower than those provided in my July 31 article which were based on EPB’s July 18 press release. The recent 10-Q includes a $29 million increase in expenses over the amount reported in EPB’s second quarter 2012 earnings release issued on July 18, 2012. This expense is attributable to non-cash severance costs allocated to EPB from El Paso Corporation as a result of the merger between KM and El Paso; however, EPB has stated it does not have any obligation, nor has it paid, any amounts related to this expense.

On May 24, 2012, contemporaneously with KMI’s acquisition of El Paso Corporation, 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., which owns Cheyenne Plains Gas Pipeline Company, L.L.C. The 2Q12 numbers reflect the contributions from CIG and Cheyenne Plains Gas from May 24 through June 30. Despite that, revenues and operating income were down for the quarter and the 6 months ending 6/30/12.Revenues in 2Q 2012 declined 5.9% vs. the prior quarter and 4.2% vs. 2Q 2011 (by comparison, revenues in 1Q 2012 decreased 0.8% vs. 4Q 2011 and were flat vs. 1Q 2011O.

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 6 months ended 6/30/12 and 6/30/11 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:

The DCF number originally reported by EPB in its Form 10-Q filed on 8/4/11 for the 6 months ending 6/30/11 was $298 million, substantially higher than the $256 million for the same period appearing in the recent filing dated 8/3/12. The differences are due to “certain items” totaling $32 million (an $18 million adjustment related to Cheyenne Plains Gas Pipeline and a $14 million project cancellation payment) and a $10 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 6 months ending 6/30/12, management added back to net cash from operations $75 million of working capital used (of which ~$70 million attributable to the termination of the accounts receivable sales program). 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 6 month period ending 6/30/12 also includes numerous adjustments that reduce reported vs. sustainable DCF by $107 million. The principal components of these are the general partner’s share of net income (~$55 million) and non-cash severance costs (~$29 million). Adjustments relating to net income attributable to non-controlling interest are decreasing due to the acquisition of additional interstate natural gas transportation and terminal facilities (e.g., the remaining 49% interest in each of Southern LNG Company (SLNG) and Elba Express in November 2010, the 28% interest in CIG in June 2011, the remaining 40% interest in SNG in March and June 2011, and the remaining 14% interest in CIG in May 2012).

Coverage ratios are as indicated in the table below:

The coverage ratio in Table 3 for the 6 months ended 6/30/12 may be overstated because of the low level of maintenance capital expenditures, as indicated in Table 2, and because the increased distribution recently announced for 2Q12 (from $0.51 to 0.55 per quarter) is not yet reflected. These factors further reduce the safety margin.

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

Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $57 million in the 6 months ended 6/30/12 and by $189 million in the prior year 6-month period. EPB is not using cash raised from issuance of debt and equity to fund distributions. The excess cash reduces the need to issue equity, as witnessed by the fact that the CIG and Cheyenne Plains Gas Pipeline acquisitions have been financed principally with debt and cash on hand. Management expects to end 2012 with excess coverage of $80 million and has stated that these acquisitions will be immediately accretive to EPB’s DCF.

EPB closed at $34.65 on 8/3/12 and, with a $2.20 per annum current rate of distributions per unit, the yield is 6.35%. EPB expects total distributions declared in 2012 to reach $2.25 per unit (i.e., $1.19 per unit in 2H12 vs. $1.06 in 1H12) 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.