How Safe Is BreitBurn's Distribution?

Oil and gas partnership BreitBurn (NASDAQOTH: BBEPQ  ) reported its first-quarter earnings last week. One metric, the distribution coverage ratio, came in a lot lower than investors were expecting, so low in fact that it could be cause for concern. Let's drill down into BreitBurn's distribution coverage ratio to make sure it's still safe.

Behind the numbers
Fresh on the heels of announcing a 4% distribution increase, BreitBurn CEO Hal Washburn noted on the company's earnings call that its distribution coverage ratio had slipped to just 0.67 times. A coverage ratio of 1.0 means the company is paying out 100% of its income to investors so anything below that means the company is paying out more than its making. Further, the current ratio is well short of the 1.1-1.2 times the company is targeting.

As an asset class, upstream oil and gas MLPs are faced with more difficulty in maintaining steady cash flow from quarter to quarter. Midstream MLPs like Enterprise Products Partners (NYSE: EPD  ) have a much easier task – the majority of its cash flow is locked into fee-based contracts. In fact, 81% of Enterprise's gross operating margin is secured by long-term, fee-based contracts. Upstream MLPs try to replicate this income safety by hedging production for several years, but they are not always successful in locking in enough cash flow to cover the distribution from quarter to quarter. 

In BreitBurn's current quarter the coverage ratio was mostly affected by lower realized commodity prices. Part of this is due to the fact that BreitBurn does not hedge 100% of its production like peer LINN Energy (NASDAQOTH: LINEQ  ) . Instead, the company hedges 80% of its current-year production and then it steps it down over time so that it's only 50% hedged in the fifth year, whereas LINN is typically 100% hedged that far out. That unhedged volume can be affected by lower commodity prices, which can be both positive and negative.

One other factor playing a role in the current quarter's ratio is that the company issued units earlier this year and paid down its credit facility. It now has just $100 million outstanding on the facility, which gives it excellent liquidity. However, that came at a cost – without the equity offering, the distribution coverage ratio would have come in at 0.83 times this quarter. While that's still under its target, it did make a noticeable impact.

Looking ahead
BreitBurn is planning to spend $261 million to drill high-margin oil projects this year. As these wells come on line throughout the year it'll have a significant impact on the company's distribution coverage ratio. The company believes that these projects alone are enough to get that ratio into a more comfortable 1.1-1.2 times by the fourth quarter, even taking into account the recent distribution hike.

However, the company's strong liquidity picture has it planning to be very active, yet disciplined, on the acquisition front this year. Its goal is to complete at least $500 million in acquisitions this year, which will really move the needle. For example, a hypothetical deal at its desired metrics could add as much as $0.21 in distributable cash flow per unit. So, given these numbers, that distribution is very safe and has the potential to go even higher this year if the company can secure the right deal.

Foolish bottom line
While BreitBurn's distribution isn't the safest in its space from quarter to quarter, there certainly is nothing to worry about in the near term. The coverage ratio will slowly make its way back above the target ratio over the course of the year, and a highly accretive acquisition or two can move the needle further into positive territory. I see no reason why BreitBurn can't keep up the growth of its best-it-class distribution for the foreseeable future. 

If, on the other hand, you are worried that at some point it will be hard for the company to grow its way out of commodity price volatility, then you might want to consider the safety of Enterprise's distribution instead. Enterprise Products Partners, with its superior integrated asset base, can profit from massive bottlenecks in takeaway capacity by taking on large-scale projects that is peers cannot afford to fund. To help investors decide whether Enterprise Products Partners is a buy or a sell today, click here now to check out The Motley Fool's brand-new premium research report on the company.

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Comments from our Foolish Readers

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  • Report this Comment On May 08, 2013, at 9:38 AM, zorro6204 wrote:

    Well done, I think you got that just right. The coverage was alarming, but getting all worked up about results from quarter to quarter is just going to give you an acid stomach if you're holding this.

    I don't rate BBEP as the best managed MLP out there, they've been digging out from a real mess they caused, resulting in the suspension of the distribution. I think they could have structured the capital/debt situation more artfully to keep the distribution stable, but I'll judge that this time next year. In the meantime the big dump is probably a buying opportunity.

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