Buckeye Partners LP
12/1/18
On Nov 2,
Buckeye Partners completed its strategic review by outside consultants, to
remedy Moody’s negative credit outlook and its insufficient cash flow to pay
the 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.
Industry
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.
Partnership
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)
Depreciation 68,464
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.
Conclusion
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.