Buckeye Partners LP
On Nov, 2, Buckeye Partners completed its strategic review by outside consultants to remedy its Moody’s negative credit outlook and its insufficient cash flow relative to its then current $5.01/yr. distribution.
The result of this review was both good news and bad news. Management announced:
1) It was taking a “non-cash” loss of $300.3 million on its 50% interest in international oil storage facilities run by VITOL, the world’s largest independent oil trader.
The original investment, made only two years ago in 2016, was $1.15 billion, an amount subsequently increased by a $237 million acquisition of additional interests, resulting in a total investment of $1.387 billion.
2) It was taking an additional “non-cash” goodwill writedown, representing the excess of purchase prices over the fair value of net assets acquired (the amount by which they overpaid), of $537 million.
The total chargeoff is a mind-boggling $837.3 million, mitigated only slightly by the fact that Buckeye is a very large partnership. This chargeoff is 8.1% of total 12/17 assets and 17.2% of partners’ capital.
3) Finally, management cut the partnership distribution from $5.01/year to $3.00.
The good news is that despite its mistakes, Buckeye will likely eventually meet its goal of maintaining its investment quality debt rating Add: and could reach its new dividend distribution coverage Its targeted financial metrics, we assume according to Generally Accepted Accounting Principles, are: Leverage less than 4.5X (EBITDA?) and Distribution coverage greater than 1.2x. It is the longer-term that is also concerning, requiring some management reform. The following discusses Buckeye’s industry and the partnership.
Due to the development of the technology of oil fracking, U.S. oil production has grown from slightly more than 5 million barrels/day in 2010 to around 10 million barrels/day currently, see U.S. Energy Information Administration’s Figure 6. 1 The current level of US. production is about equal to Saudi Arabia’s.
A crucial point to note is that the reference case of EIA estimated oil production does not decline in the future. This reference case assumes moderate technological progress, that determines well spacing and production techniques, resulting in a 1% per year decline in drilling costs and a .5% decline in operating costs for tight (i.e. fracked) oil. 2 The EIA then assumes a ± 50% increase or decrease in technological improvements, and illustrates their impacts on production. The maintenance of oil production in the U.S depends upon continued moderate technology improvement. In 12/14 Scotiabank estimated that frackers needed $69/barrel oil to break even. 3 By 10/18 The Economist estimated $46/barrel. 4 Production from fracking wells is highly dependent upon technological progress, because production from a typical well in the Permian will decline to about 10% of its original volume by the third year. 5 At the margin, technological progress makes a lot of difference.
Buckeye’s management has stated that it will concentrate its future endeavors domestically in the Gulf. It estimates annual investments of between $250 -$350 million dollars, at most a likely reasonable 5% of 9/18 net plant and equipment.
For credible crisis management, Buckeye should have:
1) Announced a total $837 million dollar writeoff.
2) Admitted that it messed up, stating the reasons why.
3) Clearly stated that it won’t happen again.
Instead, management clearly obfuscated, describing these losses as “non-cash” and continues (in its jargon) to seek “profit opportunities.” Acting on behalf of the limited partners, management should be seeking stable income and some moderate growth. Instead, it apparently considers Buckeye LP to be a cash cow, for itself. A review of SEC filings indicated that on 2/6/18 the top three managers held 419,992 partnership units valued, at the time, at $21.99 million. Their annual 2017 compensation, as reported on salary.com, was $15.9 million. Management thus has maintained a small stake in the partnership; this the institutional investors should really note. Management should:
1) Invest more heavily in the partnership, eating their own cooking.
2) Stop congratulating themselves, e.g. “Buckeye’s outstanding (2015) fourth quarter and full year financial results further demonstrate the benefits of our diversification strategy and the strength of our position in the market.” and using jargon like, “growth opportunities.”
3) Improve their reporting to investors. The following analysis of third quarter, 2018 distribution coverage is misleading, violating the accounting principle of matching. It erroneously includes in “Adjusted EBITDA, the cash flow from Asset Divestitures” and compares that against the reduced $3.00 partnership distribution. (Footnotes (6) and (7) are also mislabeled.) We assume their financials, audited by Deloitte & Touche, are better.
Add: To somewhat correct the above analysis, we found the third quarter impact of the company’s investment in VTTI, and deducted that from the company’s cash flow (and new distribution) from third quarter, 2018 financials reported to the SEC:
Buckeye Partners Third Quarter 2018 Cash Flow
(dollars in thousands)
Net Reported Loss $ (745,835)
Loss from VTTI Investment 292,387
VTTI 3rd Q EBITDA * (32,255)
Goodwill Impairment 536,964
New Distribution (115,248)
Cash Flow Surplus $ 4,477
* To address VTTI’s cash flow: the inclusion of VTTI's interest expense will decrease this figure and increase Buckeye's cash flow, somewhat.
This reverse financial engineering analysis also indicates what management and its consultants had in mind with this restructuring. Management had the primary goals of maintaining the partnership’s investment grade rating and also maximizing, to the extent possible, the distribution payout. The above indicates that there is no “margin of safety” in this new financial structure, and the company’s capital expenditures will have to be borrowed – so there should be no further mistakes, really.
Buckeye LP is now only 3.1% of our portfolio. For most investors, these limited partnership interests are effectively “one decision” purchases due to the recapture of excess depreciation taken during the holding period, in the event of a sale. We think the economic fundamentals of the company’s industry and its own fundamentals have improved. But we think there are remediable problems that management needs to attend to. A remedy would Add: improve operations and avoid more large writeoffs in the future. Fiduciary institutional investors, who have recommended BPL to their customers, should suggest that the executives of the partnership change the style and some of the substance of the partnership’s financial management. In return, such changes would likely enhance BPL’s price (currently below $32) by better aligning the interests of management with those of the limited partners. 6
1 U.S. Energy Information Administration (EIA); Oil and Natural Gas Resources and Technology; March 2018; p. 10.
2 EIA; Assumptions to the Annual Energy Outlook 2018; Oil and Gas Supply Module; p. 9.
3 National Geographic; “How Long Can the U.S. Oil Boom Last?; 12/19/14.
4 The Economist; “Beyond boom and bust?”; 10/20/18; p. 13.
5 EIA; “Today in Energy”; 2/11/16.
6 Add: How good a job is management doing beyond the finances? Likely, not too bad; this is why our analysis is tempered. The website, glassdoor.com, gives Buckeye an employer rating of 3.3/5. The Department of Transportation compiles the company’s required incidents reports, involving fatalities, injuries, and spills. The following shows that Buckeye’s incidents (2006-2018) relative its miles of pipeline is likely about average: Enterprise Products Operating, LLC 303/26,331 = .0115; Buckeye Partners, LP 187/6310 = .0296; Enterprise Crude Pipeline, LLC 315/3977 = .079. That said, they need to remedy their financial management and closely monitor the profitabilities of their plant expansions.