Archive for September, 2008
Saturday, September 27th, 2008
Barron’s published an interesting interview with Jay Rosenberg, manager of the First American Global Infrastructure fund. According to Rosenberg, pipelines and infrastructure related companies are attractive in the current economic environment because they offer stable cash flows. Specifically, Rosenberg says:
…we are generally much more focused on those companies that transport petroleum — both crude refined products — and natural gas. But they do so in a way that is very contractual in nature and where their earnings don’t fluctuate very much based on the volumes that they are shipping. The company that best typifies what I’m talking about would be Enbridge (ENB), in particular because of the contractual nature of its gas load. Another company that we like in is Kinder Morgan …whose institutional shares (KMR) we own. Kinder Morgan has a fantastic portfolio of pipeline assets but also has some of the best unique storage assets in the US…
Related Links:
Barron’s Article (subscription may be required)
Posted in Energy, MLP Investing, Midstream MLPs | No Comments »
Tuesday, September 23rd, 2008
The Master Limited Partnership is a tax efficient, cash generating machine. In the MLP model, the majority of cash generated in a given period is passed directly through to investors. However, some cash is retained in order to fund future projects or growth. Understanding the difference between how much was paid out to investors and how much could have been paid out is key.
Distributable Cash Flow (DCF)
Stock investors typically use a metric called “Free Cash Flow” as a gauge of a company’s ability to generate cash (after adjusting for expenses relating to maintaining its assets). This cash can then be used to fund additional projects or pay out dividends. Similarly, MLP investors use Distributable Cash Flow (DCF) as a measure of cash available to distribute to unitholders or fund growth.
Calculating DCF is fairly simple, and involves working backward from Net Income on the Income Statement and adding back accounting related items. Remember that accounting items like depreciation and amortization are typically subtracted from income to represent the loss of value of different assets over time. However, they don’t really have anything to do with generating cash, so we want to make sure we add them back to net income. The calculation is:
The Coverage Ratio
So, now we know how to calculate Distributable Cash Flow (which represents what we could pay to investors if we wanted to). However, it’s always a smart idea to retain some of the cash generated to fund future growth or as an emergency fund. Thus, the amount actually paid out (the actual distributed amount) will typically be less than DCF. As a general rule, we like to see the ratio of DCF to the actual distribution to be greater or equal to 1.3. This ratio is referred to as the “coverage” ratio and is calculated as:
Coverage Ratio = Distributable Cash Flow / Actual Distributed Cash Flow
In our example above, if we have $225 million in DCF, we would likely actually distribute around $173 million to investors to maintain a coverage ratio of 1.3x.
Posted in MLP Investing, MLP Metrics, MLPs | 1 Comment »
Saturday, September 20th, 2008
One of the largest MLPs in existence today is Houston based Enterprise Products Partners. As measured by enterprise value, EPP is second only to MLP bellwether Kinder Morgan at $21 billion. However, from a liquidity standpoint (the ability to trade LP units on the open market - a key concern of many investors) it bests Kinder Morgan with an average of 560K units traded daily.
Overview
Like many of its peers, EPP is focused on providing midstream energy services to natural gas, natural gas liquids (NGL) and crude oil producers and consumers. Its primary method of doing so is its extensive network of pipelines (both offshore & onshore) which span over 35K miles in length. However, a key differentiator is its ability to tie import / export of NGLs with domestic and international consumers. In fact, NGL has become a very profitable business for EPP, with over half the partnership’s gross operating margin derived from NGL pipelines and services.
The Numbers
Investors like consistency, fiscal conservatism, and cash - and EPP seems to fit the bill with all 3. The partnership has grown cash distributions to LP unitholders at an annual growth rate of 9% per year since 1999, and grew total assets at a 39% CAGR during the same period.
Jan - June 2008 operating margins grew at a double digit pace vs. 2007 with strong performance across all pipeline business segments. Further, distributable cash flow (DCF) grew 41% in 1H ‘08 vs. 1H ‘07 to $730 MM, and the amount of retained DCF grew over 4X to $212 MM. This gives the partnership a comfortable coverage ratio of around 1.47.
In Sum
I don’t issue buy or sell recommendations for any type of security. However, I like EPP and will continue to watch this company as it pursues more projects and grows in the midstream energy space.
Posted in MLP Investing, Midstream MLPs | No Comments »
