Has Boardwalk Pipeline Partners Lost its Way?

Boardwalk taking an axe to its distribution may have surprised some, but its last 10-Q foretold its current woes.

Feb 18, 2014 at 11:04AM

Midstream Master Limited Partnerships, which operate pipelines and terminals that treat and transport oil and gas, are extremely popular. Since their tax structures require them to distribute the vast majority of their cash flow through to investors, they often offer tantalizing yields of 6% or higher. And, thanks to the oil and gas boom in the United States, higher demand for pipelines and storage facilities means greater volumes (and consequently, cash flow) for these MLPs.

Unfortunately, not all midstream MLPs are created equal. As is the case with any investment opportunity, it's critical to analyze an MLP's underlying business to make sure its hefty yield is sustainable and covered by sufficient cash flow. A deteriorating core business is why Boardwalk Energy Partners (NYSE:BWP) recently slashed its distribution by 81%, and lost nearly half its market value in a single day.

Too much debt, declining cash flow
Boardwalk reported distributable cash flow fell 12% in 2013, which includes the impact of its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) collapsing 34% in the fourth quarter due to lower volumes. Boardwalk's management sought to maintain a 4-to-1 debt to EBITDA ratio. As its cash flow declined, its debt-to-EBITDA ratio rose to unhealthy levels. Management could simply no longer distribute as much cash flow through to investors to maintain proper cushioning against its debt requirements.

It's common for midstream MLPs to use that ratio as a benchmark to ensure a proper balance between a healthy balance sheet and tapping reasonable levels of debt to finance infrastructure investments. That's why Kinder Morgan Energy Partners (NYSE:KMP) maintains a debt-to-EBITDA ratio of 3.8-to-1. In addition, Kinder Morgan's core business is much healthier than Boardwalk's. Kinder Morgan Partners generated $22 million in cash flow above its distribution last year.

Particularly disturbing is that Boardwalk warned investors at the end of the last quarter that not all was well. Boardwalk's third-quarter 10-Q document held some concerning statements that served as a huge red flag.

Management stated that, "Transportation rates that we can charge customers we serve through interconnects with third-party pipelines are heavily influenced by current and anticipated basis differentials. Basis differentials, generally the difference in the price of natural gas at receipt and delivery points across our natural gas pipeline system, influence how much customers are willing to pay to transport gas between those points. As a result of the new sources of supply and related pipeline infrastructure, basis differentials on our pipeline systems have narrowed significantly in recent years, reducing the transportation rates we can typically negotiate with our customers on contracts due for renewal for our firm transportation services."

Put simpler, Boardwalk's assets were no longer seeing the same level of demand. The company's transportation agreements were being renewed at sharply lower rates. In addition, any remaining natural gas capacity that the company couldn't contract has been sold at severely lower rates. In some cases, remaining capacity isn't sold at all.

By contrast, Enterprise Product Partners (NYSE:EPD) has very positive things to say in its own most recent 10-Q. The company notes rising sales and increasing gross operating margins, which management attributes specifically to rising volumes. For example, through the nine month period ended September 30, Enterprise Product Partners reported its gross operating margin rose to $3.53 billion, from $3.23 billion generated in the same period the year prior. In percentage terms, that represents a very healthy growth rate of more than 9%.

Those are the things midstream MLP investors need to see in order to feel comfortable with the company's financial standing. This is why reading through a company's 10-Q can be so valuable. Management has no choice but to offer an unblemished view of upcoming business conditions.

Boardwalk's 10-Q held the truth
Boardwalk slashing its distribution and seeing its market value plummet is a cautionary tale to review SEC documents carefully before investing. Periodic reports from a company itself will often contain only a cursory review of its core business. SEC documents, such as the 10-Q, force a company to reveal not just what it wants to say, but what it has to say. Boardwalk notified investors that its services were seeing less demand. Management foresaw the extremely difficult market conditions up ahead, and its statements served as a major red flag.

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Bob Ciura owns shares of Kinder Morgan Energy Partners LP. The Motley Fool recommends Enterprise Products Partners L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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