Targa Resources Corp. — Q1 2016 Form 10-Q
Business context and period. This unaudited filing covers the three months ended March 31, 2016, with comparisons to Q1 2015. Targa gathers and processes natural gas and handles NGLs, crude oil and refined products through its Gathering and Processing and Logistics and Marketing segments. On February 17, 2016, Targa acquired the public common units of Targa Resources Partners LP (TRP) it did not already own, issuing about 104.5 million TRC shares. The merger materially changed ownership and reporting; Q1 2015 includes only about one month of Atlas operations, versus a full quarter in 2016.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Revenue | $1,442.4 million | $1,679.7 million | Down 14%; lower commodity prices were the primary factor |
| Gross margin | $431.4 million | $421.1 million | Up 2% |
| Operating margin (non-GAAP) | $299.3 million | $300.0 million | Essentially flat |
| Income from operations | $35.5 million | $138.2 million | Down $102.7 million, reflecting higher D&A and goodwill impairment |
| Net income (loss) | $(0.7) million | $35.7 million | TRC-attributable loss was $2.7 million; common-shareholder loss was $6.5 million after preferred dividends |
| Adjusted EBITDA (non-GAAP) | $264.7 million | $258.0 million | Up 3% |
| Distributable cash flow (non-GAAP) | $179.7 million | $188.4 million | Down 5% |
| Operating cash flow | $241.3 million | $271.3 million | Down $30.0 million |
- Cash and cash equivalents were $114.5 million at March 31, 2016, down from $140.2 million at year-end. Cash outlays for capital projects were $190.1 million; capital expenditures were $176.9 million, including $161.9 million for expansion and $15.0 million for maintenance.
- Consolidated debt was $5.071 billion, including $150 million under the receivables securitization facility; total debt was $5.938 billion at December 31, 2015. Targa reported compliance with debt covenants. The filing distinguishes TRC and Partnership obligations: TRC is not obligated to make payments on Partnership debt.
- As of April 19, 2016, TRC reported $391.6 million of liquidity and the Partnership reported $1.673 billion. Management said available cash, operating cash flow and borrowing capacity should fund operations, capital spending, debt obligations, collateral needs and dividends for at least 12 months, absent disruptive events.
- TRC’s March 2016 private placement raised $994.1 million gross through 9.5% Series A preferred stock and detachable warrants; net proceeds were $970.4 million. The preferred stock is senior to common stock for distributions and liquidation and carries potential conversion dilution. Targa used proceeds for debt repayment, note repurchases and general corporate purposes.
Material changes and management commentary
- Commodity sales revenue fell $231.2 million as lower prices reduced both sales and product purchases. Management attributed improved gross margin primarily to a full quarter of TPL operations, increased throughput from expansions and other offsets to weaker commodity prices.
- Gathering and Processing operating margin rose to $115.6 million from $87.0 million, while Logistics and Marketing operating margin declined to $157.0 million from $191.3 million. The latter faced lower fractionation and LPG export margins, lower terminaling and storage throughput, and the absence of certain 2015 contract-renegotiation fees.
- Plant natural gas inlet volumes increased 36% and gross NGL production increased 47%, mainly reflecting the full-quarter contribution of Atlas assets. Average realized prices declined: natural gas 34%, NGLs 29% and condensate 37% year over year.
- Depreciation and amortization rose to $193.5 million from $118.6 million. Targa recorded a further $24.0 million goodwill impairment, finalizing the 2015 provisional impairment; goodwill was $393.0 million at quarter-end. The filing cites depressed commodity prices and a higher industry cost of capital, and warns that prolonged weakness could cause further impairment.
- Debt repurchases of $357.7 million face value cost $330.6 million and generated a $24.7 million net gain. Interest expense was $52.9 million. The reported tax expense of $3.1 million reflected interim tax calculations amid a forecast full-year tax loss and a small book loss, despite quarterly pretax income.
- For announced 2016 projects, management estimated net growth capital expenditures of $525 million or less. Cedar Bayou Fractionator Train 5 was expected to be completed in Q2 2016, with net project and related infrastructure cost of about $340 million. The Buffalo plant began commercial operations in April 2016; the Raptor plant was expected to begin operations in early 2017. The Channelview splitter was expected by early 2018 at an estimated cost of about $140 million. Targa said it could defer potential projects depending on activity and returns.
Risks, contingencies and unusual items
- Disclosure controls and procedures were reported ineffective due to a material weakness in valuation controls for assets acquired in the Atlas mergers. Management had enhanced controls but had not yet tested their operating effectiveness; testing was expected during the 2016 goodwill impairment process.
- Commodity-price and customer activity exposure, access to capital, collateral requirements, counterparty performance, interest rates and further asset impairment are key risks. The company reported no interest-rate hedges; a 100-basis-point rate increase would raise annual interest expense by an estimated $4.4 million for TRC and $1.5 million for the Partnership.
- Litigation challenging the TRC/TRP merger remained pending in Texas state court, with plaintiffs seeking rescission and attorneys’ fees. Related federal disclosure lawsuits were dismissed without prejudice on April 20, 2016. The company said it believed the state case was without merit and intended to defend it.
- A New Mexico environmental notice alleged air-emissions violations at the Monument Gas Plant; the Partnership estimated a possible monetary sanction above $100,000 but below $300,000. The filing also describes other ordinary-course proceedings.
- Targa corrected prior-year presentation of commodity-hedge activity in other comprehensive income. It said the errors were not material and did not affect previously reported net income, total comprehensive income, cash flows or financial position.
Important facts for investors to verify
- How much of the reported year-over-year volume and margin change reflects the Atlas assets’ longer inclusion period, and how underlying throughput and customer activity are trending.
- Whether liquidity, cash generation and the planned capital program remain consistent with management’s at-least-12-month funding assessment, including debt maturities and distributions.
- The effect of the preferred stock’s 9.5% dividend, redemption and conversion terms, warrants and associated potential dilution on common shareholders.
- Progress in remediating and testing the material weakness, and whether commodity weakness leads to further goodwill or property impairments.
- Developments in the state merger litigation, environmental matter, and execution, timing and cost of major growth projects.