Energy Transfer LP annual report, Q3 FY2006

Business Context and Reporting Period

Company: Energy Transfer Equity, L.P. (ETE)

Filing Type: Form 10-K (Annual Report)

Period Ended: August 31, 2006

Overview: ETE is a publicly traded limited partnership that operates through its subsidiary, Energy Transfer Partners, L.P. (ETP). The company operates in three primary segments: Midstream (gathering, compression, treating, processing, and marketing of natural gas), Transportation and Storage (intrastate pipelines and storage facilities), and Propane (retail and wholesale distribution). ETE's only cash-generating assets are its direct and indirect investments in ETP, including limited partner interests, general partner interests, and incentive distribution rights (IDRs).

Key Financial Metrics

Metric 2006 (in thousands) 2005 (in thousands)
Total Revenues $7,859,096 $6,168,798
Operating Income $575,540 $297,921
Net Income $107,140 $146,746
Net Income from Continuing Operations $107,140 $100,452
Operating Cash Flow $310,782 $38,133
Capital Expenditures (Maintenance & Growth) $680,164 $196,459
Acquisitions (Cash Paid) $586,185 $1,131,844
Total Debt (Long-term + Current) $3,246,253 $2,315,341
Current Ratio (Current Assets / Current Liabilities) 1.28 1.17

Note: Net Income for 2005 included $46.3 million from discontinued operations (sale of Elk City System). Excluding this, Net Income from Continuing Operations increased by $6.7 million in 2006.

Material Changes vs. Prior Period

  • Revenue Growth: Total revenues increased by $1.69 billion (27.4%) driven by higher natural gas prices, increased transportation volumes, and the acquisition of Titan Energy Partners.
  • Operating Income: Operating income more than doubled to $575.5 million, primarily due to the full-year impact of the Houston Pipeline System (HPL) acquisition, increased fee-based revenues, and favorable derivative positions.
  • Net Income Decline: Reported Net Income decreased by $39.6 million compared to 2005. This decrease is largely attributable to the absence of the $46.3 million gain from the sale of the Elk City System (discontinued operations) in 2005. On a continuing operations basis, income increased.
  • Debt Levels: Consolidated debt increased by approximately $930 million to $3.25 billion, reflecting borrowings to fund the Titan acquisition ($548 million) and the Parent Company's IPO-related refinancing.
  • Acquisitions: Significant activity included the acquisition of Titan Energy Partners (June 2006) for ~$548 million and the remaining 2% interest in HPL. The company also announced the pending acquisition of Transwestern Pipeline for $1 billion (closed November 2006).

Guidance, Outlook, and Risks

Management Commentary and Outlook

  • Strategy: Management continues to pursue a balanced growth strategy through acquisitions (e.g., Transwestern Pipeline) and internal expansion (e.g., 42-inch pipeline project, Johnson County processing plant).
  • Commodity Prices: Natural gas prices decreased significantly after August 2006. Management expects to mitigate this through fee-based contracts and storage arbitrage opportunities.
  • Propane Segment: Expect volume increases in fiscal 2007 due to the Titan acquisition, though warmer weather remains a risk factor.
  • Distributions: ETE increased its quarterly distribution to $0.3125 per unit (announced Sept 2006). ETP increased its quarterly distribution to $0.75 per unit.

Risks and Contingencies

  • Regulatory Inquiries: The company is subject to industry-wide regulatory inquiries regarding natural gas market disruptions during late 2005. Management has accrued an estimated payment to settle these inquiries but cannot predict the final outcome.
  • Commodity Price Volatility: Results are sensitive to natural gas and NGL price spreads. A decrease in prices could adversely affect margins in the midstream segment.
  • Weather Dependence: The propane business is highly seasonal; warmer winters reduce demand and operating income.
  • Debt Covenants: The company is subject to financial covenants (leverage and interest coverage ratios). As of August 31, 2006, the company was in compliance.
  • Environmental Liabilities: Accruals of $1.4 million (general) and $3.0 million (Titan-related) were recorded for potential environmental remediation.

Investor Verification Checklist

  • Continuing Operations Performance: Verify the trend in Net Income from Continuing Operations ($107.1M in 2006 vs. $100.5M in 2005) to assess core business growth independent of one-time gains.
  • Debt Service Coverage: Review the ability to service $3.25 billion in debt, particularly given the variable rate exposure ($1.8 billion) and potential interest rate increases.
  • Transwestern Pipeline Integration: Monitor the closing and integration of the $1 billion Transwestern Pipeline acquisition (closed Nov 2006) and its accretive impact on cash flow.
  • Regulatory Settlement: Track the final resolution of the regulatory inquiries regarding 2005 market disruptions to ensure the accrued liability is sufficient.
  • Propane Weather Sensitivity: Assess the impact of weather patterns on the propane segment's seasonal cash flows and volume growth post-Titan acquisition.
  • Capital Expenditure Execution: Verify the completion and cost management of major internal growth projects, specifically the 42-inch pipeline project (estimated cost increased to $1.0 billion).