Why Boardwalk Pipelines Is An Absolute Steal At $13

This week has been no friend to the long-term unit-holders of Boardwalk Pipelines (BWP) who were greeted with a cash distribution reduction of 81% from $0.5325 to $0.10. And because the appeal of midstream natural gas MLPs is generally the immediate income that they provide, the price of the stock fell almost 50% in reaction to the news, from the mid-$20s to just below $13 per share.

With the double whammy of a dividend cut and share price decrease like that, the only way to remain sensible is to channel your inner St. Lawrence, who reportedly said “Turn me over! I’m done on this side!” when the prefects burned him on the coal gridiron. You might as well accept the pain if you want to act intelligently going forward.

As we get ready to analyze what led Boardwalk to this predicament in which it saw wisdom in substantially eliminating the annual cash payout, it is worth stopping to inventory the moment to understand what led Boardwalk to this position in the first place.

The roots of Boardwalk’s current dilemma can be traced to the first quarter of 2006, when the management team decided to raise the quarterly cash payout from $0.179 per unit to $0.36. At the time, the decision seemed reasonable. With the doubled payout, the pipeline firm was only committing to paying $1.44 of its cash flow per share of $2.53, seemingly giving the management ample room to address its debt, fund some long-term growth using internally generated funds, and even have some margin of safety room to hike the payout ratio in the event that adverse conditions materialized.

Of course, as we now know with the benefit of hindsight, a rapidly growing cash distribution turned out to be a noose rather than a blessing when the financial crisis arrived in 2008 and 2009. This put the Boardwalk team in a tricky position: investors had grown accustomed to a distribution that increased every quarter without fail, but the firm found itself in a true crisis situation in 2009 when the cash payout exceeded the cash flow generated; unit-holders were receiving $1.95 per unit in cash distributions, but the pipelines were only generating $1.90 per unit.

Suddenly, all the options going forward had a Faustian quality: if you slash the payout in the middle of the worst economic situation since The Great Depression, then the already skittish investors will dump the stock, potentially creating a death-spiral in which case it would be impossible to access the credit markets to take on debt or issue additional shares because of a plummeting price.

With the price already depressed in the mid and upper teens, the management team acted intelligently (in my opinion) by holding the share count steady 192.6 million in both 2009 and 2010 as it would have been punitively dilutive to issue additional shares during a period of artificially low prices. With the share count holding steady, and the dividend exceeding the cash flow generated, the company found itself continuing on the path to taking on debt that now stands at north of $3 billion.

Because of the tradition of raising the cash distribution quarterly, and because of the painful commitment (in hindsight) created by the doubling of the cash payout in 2006, Boardwalk Pipelines needed high cash flow per share growth coming out of the financial crisis to re-establish the firm’s footing.

That didn’t happen.

Instead, Boardwalk faced three temporary, but ultimately debilitating, set of circumstances that led to this recent distribution cut. First, the pipelines were steadily generating less cash-in 2010, each unit was producing around $2.63 worth of cash flow. By the end of 2013, that figure had reduced $2.50 per share, which meant that the old $2.13 per share in cash distributions only gave the management team $0.37 per unit to put to use without increasing its already substantial debt load or having a share offering simply to use the capital to address the hemorrhaging.

The last two debilitating factors related to the claims on Boardwalk’s cash: the general partner, Loews (L), had converted its B shares into A shares, which had the net effect of diluting the share count by 10% and entitling them to the payout of $0.5325 instead of the A share payout of $0.30. In short, even though Boardwalk’s distribution had remained steady, the Loews conversion increased the amount of cash necessarily simply to maintain the cash payout at the status quo.

The other problem, of course, is the firm’s debt: total debt crossed the $3.3 billion mark (about half of which is due in the next five years). Within the next year, Boardwalk has debt maturities of $275 and $250 million coming due (Gulf South, and Texas Gas, respectively). If not for the fact that Loews has been willing to step in as Daddy Warbucks and provide Boardwalk with $300 million if needed, it is unlikely that Boardwalk would even be an investment-grade company.

Ultimately, the cash payout cut happened because the debt was overwhelming and the business was unable to achieve near term growth due to the unfavorable headwind of “repricing”. In a nutshell, Boardwalk recently lost $40 million in contract renewals because the oversupply in the natural gas industry in the past three years has led to a narrowing of the forward natural gas pricing curve (which has a detrimental effect on Boardwalk’s bargaining power).

The combination of those factors is what led to Boardwalk to cut the payout.

Looking forward, though, the terms of a Boardwalk investment are much more attractive today than they were a few days ago.

Boardwalk expects to generate $400 million in distributable cash flow this year, with the negative re-pricing factors included. Boardwalk has always been a cash generating machine-even in 2009, possibly the worst environment we’ll see in our lifetimes (knock on wood), Boardwalk still pumped out net profit of $162 million. It’s not that the underlying company is bad-the cash generated has always been impressive since the company went public in 2005, it’s just that the dividend had become a straightjacket for management, and the debt load had been quite high.

The terms going forward are quite different: before the cut, Boardwalk was set to generate $400 million in distributable cash flow while paying out over $500 million to unit-holders. You can see the problem there. Now, the cash payout commitment is only a shade above $100 million, which gives the company huge breathing room to lower its debt burden and use that internally generated cash to fund growth projects without being entirely at the mercy of the credit markets to fund growth.

The current cash payout is not indicative of Boardwalk’s earnings power. My guess is that Boardwalk cut the dividend much more than necessary so that it could follow the “General Electric model” of dividend cuts. You make the cut one-time and draconian, and thereafter, you create a huge gap that allows you to change the storyline by giving lofty dividend increases going forward.

It shows a preference for sharp, quick pain over a drawn-out, moderate pain. From a management perspective, it is more enjoyable to spend the next 5-10 years announcing quarterly cash payout raises rather than freezes and moderate cuts.

For those of you looking to take a page out of the Graham playbook, this is your chance. The profits that Boardwalk generates are real and substantial. But now the cash payout only accounts for $100 million out of the $400 million in distributable cash flow. The spread can tackle debt and fund growth, making the company’s balance sheet healthier, and earnings power stronger.

If the Bluegrass plans materialize, you could realistically find yourself in the situation ten years from now in which the company is generating $4 per unit in cash flow and paying out over $3 per unit in cash distributions. The volatility risk is high-with the distribution yield support temporarily out of whack, there is nothing to stop the share price from falling to $5-but the long-term earnings power potential is great. There aren’t a whole lot of situations out there in which you can make an investment today that has a realistic shot of paying you an annual cash yield of over 23% in 2024 in relation to the cash you set aside in 2014. To earn those lucrative returns, you will have to tolerate severe volatility in the near term, and cash flow per unit figures that may take two or three years before showing meaningful growth.

Originally posted 2014-02-13 01:51:01.

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8 thoughts on “Why Boardwalk Pipelines Is An Absolute Steal At $13

  1. joelo says:

    Yea the price and starting yield as of now arent bad at all considering the payout ratio. I’m considering it for my taxable account. Are you going to make an imvestment in the company? Saw no disclosure so I assume you havent yet. Im on the fence of going in now or seeing how the hext few days/weeks turnout

  2. EricRasbold says:

    This is the kind of event that I like. Like the song says. “They want to toss it and leave it….and I pull up quick to retrieve it!” 
    Sell, Mortimer!!!!  So I can buy cheap – after I check their asset map first and then the flows….

    Good Luck and May Your Dow Never Jones.

  3. scchan_2009 says:

    Panic sell off isn’t anything new anyway. Just look at what happened to Mattel a couple of weeks ago. Nowadays it is just too easy to click sell, and a lot of these big price drops are caused by algorithm trading that automatically short the shares whenever there is bad news.

  4. ipahophead says:

    I am in at an average cost basis of $13.35 yet I must admit very unsettled that $BWP can turn around. I’ve read many opinions

  5. ipahophead says:

    The continued drifting lower in the last week has been painful; another -2% today. Two contributions:

    1) On February 18, 2014 Thomson Reuters/Verus upgraded BOARDWALK PIPELINE PARTNERS LP (BWP) from SELL to HOLD.
    2) In case anyone is tuned in… my notes from SA article:
    few weeks ago, the stock fell nearly 50% on heavy volume after the company lowered its distribution by a massive 81% to $0.10 per unit per quarter. This was clearly an unmitigated disaster as Boardwalk Pipeline Partners was before widely seen as a “safe” investment due to the fee-based nature of its incomeHowever, compared to the conference call, Boardwalk Pipeline Partners’ recently filed 10-K really does provide some valuable insights into why the company needed to lower its payout.For natural gas transportation, the company is seeing much narrower natural gas differentials, which has the direct result of lowering rates as well as future contract terms. Indeed, these factors have had a materially adverse impact on transportation revenues for the company this year.In other words, as soon as these existing contracts expire, the company will basically have to settle for lower rates or not have that capacity on its systems. Once again, this is expected to have a materially adverse impact on both cash flow and revenues.As can be clearly seen, Boardwalk Pipeline Partners is seeing much worsening fundamentals for both its natural gas transportation and storage segments. This is a major issue for the company as essentially 95% of its TTM operating revenues comes from these two segments.Even when looking forward, Boardwalk Pipeline Partners is not expecting the situation to improve, The company is expecting that it may not be able sell capacity and or extend expiring contracts at attractive rates which will hurt future cash flows and revenues.CommentsFeel the company at this level though is oversold. Taking a stab as it falls to the 12.30 level for a bouncealways a questionable statagey, trying to catch a falling knifeTisch will either sell the P/L or take it private as other of his companies are nowThis entire area is overextended with ridiculous P/Es. Investors (or speculators) are buying solely on distribution yields without regard to earnings. A good portion of the distributions are returns of capital with GPs highly incentivized to keep distributions high since to benefit their IDRs. I actually admire BWP’s move and it is now trading at a much more reasonable PE. Loews is foregoing incremental returns on IDRs in favor of establishing a more secure future for the company (which by the way they own the majority of).In general, I am not going to buy a MLP with problems – even if currently “cheap” but rather the best of them: KMI. Much more diversified pipelines. Diversified transport too (even with tankers now). I like a couple others too, like PAA.The management is taking a conservative and prudent approach to leverage in the face of growing uncertainty, which though difficult for shareholders in the near term is the prudent course of action. Here are what BWP has going for it, a deep pocketed general partner. The luxury of management to think longer term. Contracts that still will give good operational cash flow for another 4-5yrs with opportunities to redeploy that cash into future profitable expansion/new projects. At current prices, the risk and rewards are fairly balanced IMHO. Were Loews not behind them, I’d be a seller right here, but I think there exists a reasonable opportunity to profit handsomely if things don’t work out like a doomsday scenario.  But it is not risk free and their assets are at least partially impaired.I think at these discounted prices, it offers a good margin of safety and potential for small distribution increases.

  6. ipahophead says:

    Just providing another summary of a SA article re: BWP. This author uber unimpressed. I’ll admit that I’m beyond waffling. Outside of this positive article on which I keep commenting, very few are pro-BWP. That either makes for a perfect “greedy/scared” set-up or it is time to fold.
    part of an effort to investigate a potential dirty value opportunity I will analyze Boardwalk’s recent troubles, its future growth prospects and whether or not there is anything here for long-term investors to salvage.On the surface the small declines in revenues and DCF make the size of the distribution cut seem excessive, but there is good reason why management took such drastic action.Midstream pipeline partnerships such as Boardwalk are typically very stable and reliable sources of distributions because of long-term (typically 10 year) contracts that reduce exposure to commodity risk. This is because the partnership’s contract states a guaranteed volume and payment for use of its pipes to transport oil and gas. The only risk is if commodity prices have greatly changed for the worse when the contract is up for renewal and renegotiation.The important thing to understand about Boardwalk is that it is incredibly non-diversified. 95% of its income comes from the transport and storage of natural gas and natural gas liquids.They initially made very lucrative contracts during the early years of the fracking boom when natural gas prices dropped in some areas and not in others. This resulted in lucrative decade long contracts that ensured solid cash flow and high distributions. Later, the nationwide fracking boom drove natural gas prices to historical lows and demand for storage was very high.The next few years look bleak for Boardwalk for several reasons.1. Wrong assets in the wrong places and 2. Highly levered balance sheetCurrently Boardwalk’s debt is $3.3 billion and its Debt/EBITDA is 4.6x. Anything above 4.5 is alarmingly high and management is both guiding for lower EBITDA in 2014 and has stated a long term goal of debt/EBITDA of 4.Given that the entire reason for owning an MLP is for high yield and consistent distribution growth, the current state of Boardwalk Pipelines Partners is nothing less than disastrous.With its yield slashed and its prospects of future distribution increases all but eliminated, in the short-medium term the investment thesis for Boardwalk Pipeline Partners has completely collapsed.Meanwhile, Boardwalk’s competitors Magellan Midstream, Kinder Morgan and Plains All American continue to execute well, cover distributions and grow consistently.CommentsI agree with you on BWP, it is a stay away. EPD, PAA, MMP, and KMP, KMI are much better and safer.BWP sure has a rough road ahead. I actually think more downside is likely, especially if the bluegrass pipeline is nixed.Has the company really lost 50% of its true value, or is it a case of ignoring the pipes and only valuing the immediate cash? I am a long term owner of L and a short term (post collapse) owner of BWP.But for BWP holders there is no real premium from here so it would be far better for you to buy into a high quality GP of an MLP for that same 3% yield but lever into higher growth or buy a high growth rate MLP that will have a higher yield than BWP.As for BWP, I don’t see why anyone would buy BWP here when EPB trades at the same EV/EBITDA valuation and has superior assets, better fundamentals, a much stronger balance sheet, superior management, a fully-covered dividend of 8.8% this is projected (by a management team with excellent credibility/track record) to be secure and some excellent projects in the pipeline with a likely return to distribution growth in a couple of years. No-brainer.

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