Targa Resources Corp. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in millions of dollars unless otherwise noted. Targa gathers and processes natural gas and crude oil, and provides NGL logistics, marketing, storage, fractionation, transportation and export services.
Business context and material changes
On February 17, 2016, Targa completed its acquisition of the public common units of Targa Resources Partners LP (TRP) that it did not already own, issuing about 104.5 million Targa common shares. TRP became a wholly owned subsidiary; its common units ceased trading, while its preferred units remained outstanding. The transaction was accounted for as an equity transaction and created an approximately $944 million deferred tax liability. Comparisons with 2015 are affected by the change in ownership and by Targa’s inclusion of two additional months of TPL operations in the first half of 2016.
Targa reported two segments: Gathering and Processing, and Logistics and Marketing. It commissioned the 100 MBbl/d Cedar Bayou Fractionator Train 5 in June and began commercial operations at the 200 MMcf/d Buffalo processing plant in April.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Total revenue | $1,583.6 | $1,699.4 | $3,026.0 | $3,379.1 |
| Gross margin | $438.4 | $471.3 | $869.8 | $892.5 |
| Operating margin | $299.5 | $325.5 | $598.8 | $625.6 |
| Income (loss) from operations | $66.3 | $112.4 | $101.9 | $250.8 |
| Net income (loss) | $(14.6) | $23.8 | $(15.2) | $59.7 |
| Net income (loss) attributable to Targa | $(23.2) | $15.2 | $(25.9) | $18.6 |
| Net income (loss) attributable to common shareholders | $(52.6) | $15.2 | $(59.1) | $18.6 |
| Basic EPS | $(0.33) | $0.27 | $(0.44) | $0.37 |
| Adjusted EBITDA | $257.1 | $302.4 | $521.7 | $559.0 |
| Distributable cash flow | $169.6 | $210.6 | $347.5 | $398.1 |
Second-quarter revenue fell 7%; first-half revenue fell 10%. Management attributed the declines chiefly to lower commodity prices, along with lower fees and activity in some businesses. First-half operating margin declined 4%, despite additional TPL operations; Logistics and Marketing margin fell 16%, while Gathering and Processing margin increased 10% with the additional TPL period. Adjusted EBITDA and distributable cash flow declined 15% and 19%, respectively, in Q2.
Depreciation and amortization rose 14% in Q2 and 34% in the first half, reflecting growth investments and additional TPL operations. Targa recorded a $24.0 goodwill impairment in Q1, completing the impairment measurement following a $290.0 provisional charge recorded in 2015. It reported no new impairment trigger or charge in Q2.
Cash flow, debt and liquidity
- Cash flow: First-half operating cash flow was $457.5, compared with $484.2 in 2015. Cash outlays for property, plant and equipment were $307.7, versus $436.2. Investing cash use was $305.2, compared with $2,011.8 in 2015, which included Atlas merger cash consideration. Financing activities used $121.6; cash rose $30.7 to $170.9.
- Debt: Consolidated total debt was $5,003.3 at June 30, down from $5,938.1 at year-end 2015. During the first half, TRP repurchased $559.2 principal amount of notes for $534.3, recording a $21.4 net gain. The consolidated debt includes TRP obligations; Targa states it is not responsible for TRP debt payments. Debt covenants were in compliance at June 30.
- Liquidity: At June 30, Targa had $395.0 available on its $670 million revolver; TRP had $1,531.7 available on its $1.6 billion revolver. At July 18, reported liquidity was $455.1 for Targa and $1,666.6 for TRP. Management expected available cash, operating cash flow, credit facilities and capital-market access to fund operations, capital spending, debt obligations, collateral needs and dividends for at least 12 months.
- Capital spending and returns: First-half capital expenditures were $291.8, including $256.6 of expansion spending and $35.2 of maintenance spending. Management estimated about $525 million of net growth capital expenditures for announced 2016 projects. Common dividends were $0.91 per share for each of the first two 2016 quarters; the Q2 dividend was scheduled for payment August 15. Series A preferred stock carries a cumulative 9.5% dividend.
Outlook, risks and unusual items
Management cited sustained low and uncertain commodity prices, weaker customer activity and commodity-price volatility as risks to volumes, margins, cash generation and asset values. It may defer prospective growth projects depending on expected activity, capital needs and returns. The Raptor Eagle Ford plant and associated pipelines were expected to begin operations in early 2017, with estimated Targa investment of about $125 million; the Channelview splitter was expected to be completed by early 2018 at an estimated total cost of about $140 million.
The Series A preferred placement raised $994.1 gross and included detachable warrants exercisable for up to approximately 20.1 million common shares. Preferred shares rank ahead of common stock and may convert after 12 years; warrant exercises and preferred conversion could dilute common holders. Targa also had authority under an equity distribution agreement to sell up to $500 million of common stock and issued about $215.1 million of shares under it in Q2.
Disclosure controls were deemed ineffective because of a previously identified material weakness in controls over valuation of assets acquired in the Atlas mergers. Management had enhanced its control framework but had not yet fully tested its operating effectiveness. Litigation challenging the TRC/TRP merger remained pending in Texas state court; federal disclosure lawsuits were dismissed without prejudice. A New Mexico air-emissions notice of violation was under discussion; the company anticipated a potential sanction above $100,000 but below $300,000. The filing also disclosed a nonmaterial correction to 2015 hedge presentation; total other comprehensive income and previously reported net income were unchanged.
Important facts for investors to verify
- Whether lower commodity prices, customer drilling activity and throughput continue to pressure segment margins and cash generation.
- How the TRC/TRP merger, preferred dividends, warrants and potential preferred conversion affect common-share dilution, dividend capacity and per-share results.
- Whether the projected 2016 growth spending and announced projects meet expected returns and remain on schedule.
- Whether liquidity and capital-market access remain sufficient, including the separate financial obligations and maturities of Targa and TRP.
- Whether remediation of the material weakness is tested successfully, and the outcomes of merger-related litigation and the environmental matter.
- The filing presents adjusted EBITDA and distributable cash flow as non-GAAP measures; investors should review their definitions and reconciliations when assessing cash available for dividends.