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Enterprise's shift on cash flow reflects 'metamorphosis' of US pipeline firms

While several major U.S. energy pipeline companies spent 2018 shedding cash-leaking habits and forging a more conventional financial structure as stocks languished, adopting reporting practices that are more accessible to the investing public could be a gradual process for the industry, if it takes flight at all.

Enterprise Products Partners LP, the biggest pipeline master limited partnership, took a step in that direction when it emphasized free cash flow — interpreted broadly as cash flow from operations minus capital expenditures — and de-emphasized distributable cash flow as the primary way to illuminate how much money it has available to pay out to investors and for debt reduction.

"The incremental value of investment is from more traditional funds, institutional investors that are not accustomed to our MLP language," President and CFO Randall Fowler said during the company's Jan. 31 earnings conference call. "We need to talk their language."

Enterprise's move was a public acknowledgment of a trend away from the sometimes opaque financial reporting of MLPs in recent years. S&P Global Market Intelligence spoke with several industry analysts, who conveyed that whether other partnerships follow suit, and whether the MLP structure itself can coexist with more conventional metrics, are open questions.

"It's very much limited to the blue-bloods in midstream," BMO Capital Markets analyst Danilo Juvane said in an interview. "We think [Plains All American Pipeline LP] is in a position to do it this year, and [Oneok Inc.] will have enough powder to do it next year. ... It's a metamorphosis."

While FCF subtracts all capex from cash flow for operations, the DCF metric does not account for growth capex, a key avenue MLPs use to continually expand their income-earning infrastructure systems. DCF also typically accounts for incentive distributions rights payments MLPs make to their general partners, a practice that has become increasingly rare as MLPs streamline.

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Justin Jenkins, a financial adviser with Raymond James & Associates Inc., agreed that while the pipeline sector is migrating toward talking the language of free cash flow, the amount of capital companies plan to spend on new projects this year makes it less attractive for them to start using it now. "I think 2019's going to be another elevated year of growth spending, so the free cash flow metrics themselves ... may not look all that great," the midstream analyst said in an interview.

Facing high capital costs and required payments to general partners that have drained coffers and helped limit stock prices, most midstream companies either eliminated the payments or abandoned the MLP structure altogether. Most, however, still use MLP-specific metrics like DCF for measuring earnings that institutional investors cannot use to compare their investments in the midstream energy sector to other industries.

This means any capital put toward growing the business, including debt and equity issuances, is unaccounted-for in determining how much cash is left over. "The marketplace ... was ignoring the concept that growth capital associated with driving future distributable cash flow is also shareholder capital," Brian Nelson, president of investment research firm Valuentum Securities Inc., wrote in a September 2018 note to clients. "It becomes questionable whether distributable cash flow, because it does not deduct for growth capital spending, is a useful measure at all."

MUFG Securities Inc. midstream analyst Barrett Blaschke, on the other hand, is adamant that the DCF metric is still useful for reformed MLPs that declined to ditch the partnership structure because of their history as yield-focused investments. "I'm still a believer in distributable cash flow because these are income vehicles," Blaschke said. "I don't know how far FCF will go. ... I have a hard time getting to that as an absolute necessity just yet."

MLPs tend to generate high yields distributions to investors as a percentage of the stock price — which are bolstered by the exclusion of growth capital expenditures from the DCF equation, especially now that most partnerships no longer make incentive distribution rights payments.

Enterprise's pivot may not be enough to compensate for its complicated tax status. MLPs' ability to pass on taxes to their shareholders long gave them an advantage over corporate equity as an investment vehicle, an edge that was dulled after the 2017 federal tax overhaul slashed the corporate tax rate that partnerships avoid to 21% from 35%.

"[Enterprise] is going to remain challenged in terms of attracting 'generalist' investors, not because of how it talks, but because of its structure as an MLP," CBRE Clarion Securities analyst and MLP expert Hinds Howard said. "With the increasing number of midstream companies structured as corporations or taxed as corporations, generalists seeking exposure to the theme of midstream have other options."