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Submitted by Ron Hiram of Wise Analysis using our Trefis Contributors tool.

On November 2, 2012, Buckeye Partners L.P.  ( BPL ) reported results of operations for 3Q 2012. Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) for 3Q 2012 and for the trailing 12 months ("TTM") are summarized in Table 1:

Table 1: Figures in $ Millions, except units outstanding

The decrease in 3Q12 revenues vs. the prior year period is primarily attributable to a 21.5% decline in sales volume for the Energy Services segment which was partially offset by an increase in revenues in the Pipelines & Terminals segment and from incremental capacity coming on the line, combined with higher ancillary revenues, in the International Operations segment.

The favorable comparison of operating income and net income numbers for 3Q12 and the TTM ended 9/30/12 primarily result from a $170 million goodwill impairment charge for the Lodi acquisition in 3Q11 and a $21 million equity plan modification expense in 4Q10. But even absent these write-offs, 3Q12 and the TTM ended 9/30/12 show an improvement in operating income over the corresponding prior year periods. This is due to improved margins on product sales and natural gas storage services, and also because the TTM period ending 9/30/11 does not include contributions from Perth Amboy (acquired in 2012) and only partial contributions from acquisitions made during 2011.

Adjusted EBITDA improved significantly in 3Q12 compared to the prior year period and 2Q12 ($120 million). Contributions to Adjusted EBITDA by segment are presented in Table 2:

Table 2: Figures in $ Millions

Improved 3Q12 operating performance was primarily driven by increased throughput at the Pipelines & Terminals segment where volumes increased ~4% compared to the prior year quarter and ~1% sequentially over 2Q12. The Energy Services business, a wholesale distributor of refined petroleum products in the Northeastern and Midwestern United States, was adversely impacted by volatility and continued market backwardation (see Glossary of Terms ) that reduced sales and inventory value but recently has been less of a drag on performance. A summary of the prior 6 quarters is presented in Table 3 below:

Table 3: Figures in $ Millions

Pipelines & Terminals segment performance in 3Q12 compares favorably with prior quarters also because of a $10.6 million benefit in the third quarter related to the successful resolution of a product settlement allocation matter (the full 2012 impact of this one-time item is $7.8 million).

Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review TTM numbers rather than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows. The definition of DCF used by BPL is described in an article titled Distributable Cash Flow ("DCF").  That article also provides, for comparison purposes, definitions used by other master limited partnerships ("MLPs"). Using BPL's definition, DCF for the TTM ending 9/30/12 was $340 million, up from $310 million in the TTM ending 9/30/11, but DCF per unit declined to $3.53 from $3.96.

The generic reasons why DCF as reported by the MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF-Why and How. Applying the method described there to BPL results through 9/30/12 generates the comparison outlined in Table 4 below:

Table 4: Figures in $ Millions

There are no appreciable differences between reported and sustainable DCF. The risk management item reflects large fluctuations in the value of derivatives used to hedge exposure to commodity prices and interest rates. In certain quarters, BPL's results are significantly impacted by these fluctuations. For example, there was a $79 million loss on derivatives in 1Q11, a $82 million loss on derivatives in 3Q11 and an $84 million gain the following quarter. For the most part, these gains and losses are not reflected in BPL's statement of operations. Rather, they increase or reduce total equity through the statement of comprehensive income. Losses on derivatives reported in this manner totaled $29 million in the 9 months ending 9/30/12 and $92 million in the corresponding prior year period. These losses have a real cash impact and I find their size troubling when considered as a portion of cash generated by operating activities. Coverage ratios for are presented in Table 5 below:

Table 5

While overall DCF level, both reported and sustainable, increased in the TTM ended 9/30/12, this was more than offset by a ~19% increase in the number of units outstanding. BPL therefore continues to exhibit low coverage ratios. Management reported 1.19x distribution coverage for 3Q12 but in its calculation a ~$135 million outflow used to increase working capital is ignored. I prefer to look at coverage ratios over longer periods and not to add back working capital deployed.

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 BPL:

Simplified Sources and Uses of Funds

Table 6: Figures in $ Millions

Table 6 indicates $149 million of net cash from operations remained after deducting maintenance capital expenditures and distributions in the TTM ending 9/30/12. But as can be seen from Table 4, there would have been a shortfall absent risk management gains of $101 million and $67 million generated by liquidation of working capital.

BPL's current yield is at the high end of the MLP universe and the highest among the MLPs I follow, as shown in Table 7 below:

Table 7

BPL expects to spend a total of ~$270 million on expansion and cost reduction projects in 2012, of which $197 million has been spent in the 9 months ending 9/30/12. BPL has not been generating excess cash which could help fund these capital expenditures and must therefore fund them with debt, equity or asset sales. BPL has only $2.9 million cash on the balance sheet and long-term debt that, at $2.7 billion (up from $2.3 billion as of 6/30/12), is already at 5.3x Adjusted EBITDA on a TTM basis (up from 4.7x as of 6/30/12). I believe it is likely BPL will issue additional equity, further diluting current limited partners (in February 2012, it issued 4.3 million units). Otherwise I don't see how it can fund expansion and cost reduction projects in 4Q12 and the significant capital expenditures in 2013. Sale of the Natural Gas Storage business will reduce the amount of equity required to be raised but management reports no progress on this front and it is not possible to predict whether, and at what price, a sale will occur.

Also of concern is the Federal Energy Regulatory Commission (FERC) order of March 30, 2012, that disallowed proposed rate increases on the Buckeye System that would have become effective April 1, 2012. The proposed rate increases were expected to increase BPL's annual revenues (and, I presume, EBITDA) by approximately $8 million. But if forced to resort to FERC's generic rate setting mechanism, the adverse impact goes well beyond forgoing this increase and could have a substantial adverse affect on BPL because it would lower tariffs on pipelines that account for ~70% of BPL's revenues. This is a major issue overhanging this MLP.

I held BPL units for many years and eliminated my position in light of the issues highlighted in my prior articles (for example, see article dated December 19, 2011, another article dated February 13, 2012, and a third article dated April 19, 2012 ). Thirty two consecutive quarterly increases in distributions per unit ended in 1Q12 with distribution unchanged at $1.0375 per unit. This is also the amount declared for 2Q12 and for 3Q12. Despite positives such as an 8.6% yield and the absence of general partner incentive distribution rights, I am not currently considering reestablishing a position because of concerns discussed in this and prior articles. These include low distribution coverage, expensive acquisitions, past and prospective unitholder dilution, as well as the FERC risk.

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