What Can Turn Around This Dog of an MLP?

From the time it debuted on the market in November of 2012 until May of this year, Southcross Energy Partners (NYSE: SXE  ) had been a total dog. Despite growing revenue, the gathering and processing master limited partnership couldn't cover its distributions, let alone offer investors an increase. Now, on the heels of a deal at its general partner, units have popped 28% and Goldman Sachs has upgraded the MLP from sell to neutral.

Are all of its problems suddenly behind it? Today, we're taking a closer look at Southcross Energy Partners.

Thumbs up or all thumbs at Southcross? Source: Flickr/Charles LeBlanc.

Quick background 
Southcross has an asset footprint in the Eagle Ford, Alabama, and Mississippi -- with the primary focus of the partnership squarely on South Texas. All told, the partnership's operations consist of 2,800 miles of gathering pipe, 385 million cubic feet per day in processing capacity, and 27,300 barrels per day in fractionation capacity. Compare that to the pipeline mileage of its peer Access Midstream Partners (NYSE: ACMP  ) at 6,400 miles, or Eagle Rock Energy Partners (NASDAQ: EROC  ) at 8,100 miles, and you get a sense for how small Southcross really is.

Financially, despite lower volumes in its processed gas segment, the partnership beat its own guidance for adjusted EBITDA in its most recent quarter. A boat hit one of its pipelines in March, and the effects of the ensuing pipeline rupture will continue to impact EBITDA in the second quarter. That's to be expected given the size of this partnership: If something goes wrong with any one asset, there will be some pain. Even though first-quarter EBITDA outpaced expectations, it fell short of 2013 fourth-quarter EBITDA. 

And again, there was no distribution increase, and the partnership sported a coverage ratio of about 0.62 times payouts. While it appears healthier than Eagle Rock Energy Partners, it pales in comparison to the 1.4 times coverage ratio at Access Midstream.

Southcross is a partnership expected to grow, which in theory will lead to more cash flow and stronger financial metrics. That said, as a gatherer-processor, its growth is first dependent on the successful endeavors of exploration and production companies, and second on the contracts it signs with these companies. Fortunately for Southcross, the Eagle Ford is hot right now, and producers are quite focused on increasing production there in the near future.

The question that remains for investors is whether or not the partnership's planned growth will result in a healthy Southcross Energy Partners. So, what is it about this recent deal that has analysts convinced a new day has dawned at Southcross?

The deal
Last week, Southcross announced its holding company planned to merge with TexStar Midstream Services, creating Southcross Holdings LP. EIG Global Energy Partners, Charlesbank Capital Partners, and Tailwater Capital will split ownership of the new entity.

This will benefit Southcross Energy Partners via dropdowns from TexStar, which has a substantially greater processing and fractionation footprint than Southcross.

TexStar has a processing plant capacity of 300,000 cubic feet per day, a fractionation capacity of 63,000 barrels per day, and 885 miles of pipeline. Approximately two-thirds of this asset footprint will be available for dropdown to Southcross Energy Partners going forward.

As part of the deal, Southcross will immediately acquire a rich gas system from TexStar for $450 million in cash and units issued to the new holding company. It's a great pick-up right off the bat because the system is 100% supported by fee-based contracts. The other Southcross assets are about 76% fee-based right now.

Bottom line
The new deal gives investors a comfortable level of transparency for the partnership's growth outlook, and Southcross leadership has said it wants to increase distributions by the first quarter of 2015, once it has achieved 1.0 times distribution coverage. Investors might want to follow Goldman Sachs' lead and stay neutral on Southcross Energy Partners until management proves it can actually do that.

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