Targa is steady in an uncertain commodity market

When money is cheap, one of the most important things to look for in an energy master-limited partnership is a pipeline of attractive investment opportunities.

By Jim J. Jubak Feb 21, 2013 11:07AM
Natural gas plant (© Kevin Burke/Corbis)Not surprisingly, Targa Resources Partners (NGLS) has shown a little weakness recently after the Feb. 14 date (record date Jan. 28) for paying the master limited partnership’s fourth-quarter dividend.

What’s surprising is how small the retreat has been. I suspect that this strength in a dividend-paying stock after the dividend payout is a sign that investors are feeling a little less aggressive and a little more conservative at the market's current high.

The retreat wasn’t very large -- from $41.88 on Feb. 14 to $41.04 on Feb. 20 -- but the decline pattern is normal for stocks and master limited partnerships (MLPs) that pay hefty dividends. (Targa showed a projected dividend yield of 6.5% at the Feb. 14 price.) Some holders, having collected the quarterly dividend, sell with the idea of buying something else about to pay a dividend and maybe returning to hold Targa closer to its next payout.

The fourth-quarter dividend of 68 cents per unit ($2.72 per unit on an annual basis) is a 3% increase from the third quarter and a 13% increase from the fourth quarter of 2011. The partnership continues to project a 10% to 12% increase in distributions for 2013.

If you believe those projections, and I think they’re reasonable, then that $2.72 in dividends turns into $2.99 to $3.05 a share at the end of 2013. And that would equate to a $45 a unit price and a 6.8% yield at end of the year. (Which is -- $45 by December 2013 -- what I’m going to set as my new target price for Targa in my Jubak’s Picks portfolio.)

On Feb. 14, Targa reported financial results for the fourth quarter of 2012 and for full-year 2012. (The results of the acquisition of assets in the Bakken oil shale play aren’t included in these numbers since that deal didn’t close until Dec. 31, 2012.) EBITDA (earning before interest taxes, depreciation, and amortization) came to $131 million in the quarter against $146 million in the fourth quarter of 2011. Transaction costs for the Bakken deal came to about $6 million in the period. The partnership also wrote off $15.4 million in damage from Hurricane Isaac and recorded a $12.8 million loss on debt redemption.

For the fourth quarter, the partnership had distributable cash flow of $86.4 million, or roughly equal to the $90.9 million in distributions just paid on Feb. 14.

In a period when money is cheap, one of the most important things to look for, in my opinion, in an MLP is a pipeline of attractive investment opportunities. (An MLP borrows money to invest in new projects, and makes it money on the spread between the cost of that money and the returns on new investments.)

Targa’s pipeline of organic investment opportunities adds up to $1.7 billion in announced projects scheduled to come on line in 2013 and 2014, with $1.1 billion of that front-loaded to go into service in 2013. In addition, the Bakken acquisition opens up opportunities for the company in a new production area that's more weighted to oil than to Targa’s current focus on natural gas liquids. The company expects the Bakken acquisition to be accretive to EBITDA in 2014.

But the size of a partnership’s project pipeline isn’t the only important criteria for judging an MLP in an era of cheap money. There’s also the question of how a partnership's revenue stream is structured. Targa transports, mostly, natural gas liquids. Where revenues are linked to commodity prices, weak prices for natural gas liquids (because of fast-growing supply) hurt.

Targa’s revenues that come from fee-based services such as logistics hold up rather well even if commodity prices are under pressure. On this front, Targa has been moving in the right direction. Revenue over the last 12 months was only 37% fee-based, but the partnership’s newer projects have been fee-based. That should result in 55% of revenues coming from fee-based projects by the end of 2013 and 60% by the end of 2014.

That gives Targa’s cash flow and distribution growth good predictability in an uncertain commodity market.

My December 2013 target price of $45 and the current yield of 6.5% add up to a projected total return of 18.9% from the Feb. 20 closing price.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund
did not own shares of any company mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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