Targa Resources Corp. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unless noted, financial amounts are in millions of dollars. Targa gathers and processes natural gas, and handles NGLs, crude oil and refined products through its Gathering and Processing and Logistics and Marketing businesses.
Financial performance and liquidity
- Q3 revenue: $1,652.3, up 1% from $1,632.1 a year earlier. Commodity sales rose 6% to $1,398.7, while midstream-service fees fell 18% to $253.6.
- Q3 earnings: Gross margin was $429.6, down 8%; operating margin was $286.6, down 12%; operating income was $51.6, down 55%. Net loss was $3.2, compared with net income of $20.8 in Q3 2015. Targa-attributable loss was $10.7, and common-shareholder loss was $39.4, or $0.23 per share, including preferred dividends and deemed dividends.
- Nine-month performance: Revenue was $4,678.4, down 7%; operating margin was $885.5, down 7%; net loss was $18.4 versus net income of $80.6 in 2015. Targa-attributable loss was $36.6 and common-shareholder loss was $98.6, or $0.68 per share.
- Cash generation: Operating cash flow for the first nine months was $560.7, down from $695.5. Investing cash outflow was $422.0, compared with $2,208.2, largely because 2015 included cash consideration for the Atlas mergers. Financing cash outflow was $137.8 versus inflow of $1,534.6 in 2015. Cash ended the period at $141.1.
- Non-GAAP measures: Q3 Adjusted EBITDA was $245.3, down 21%, and distributable cash flow was $168.3, down 24%. For nine months, Adjusted EBITDA was $767.1, down 11%, and distributable cash flow was $516.0, down 16%. These are company-defined non-GAAP measures.
- Debt and liquidity: September 30 total debt was $4,950.9, including $225.0 under the accounts-receivable securitization facility; long-term debt was $4,725.9. The filing says the company and Partnership complied with debt covenants. October 17 reported consolidated liquidity was $1,962.6, including cash and available facility capacity, after outstanding borrowings and letters of credit. Consolidated debt includes Partnership obligations, for which Targa Resources Corp. says it does not itself have the obligation to make interest or principal payments.
- Balance sheet: Current assets were $976.7 and current liabilities $948.8. Deferred income taxes, net, increased to $1,141.7 from $177.8, primarily reflecting the taxable TRC/TRP merger and its preliminary deferred-tax accounting. Total assets were $13,055.6 and total owners’ equity was $5,876.9.
Changes versus the prior comparable period
- Results are affected by the February 17, 2016 merger through which Targa acquired the TRP common units it did not already own, issuing 104.5 million common shares. TRP’s common units ceased public trading. The merger changes ownership attribution and makes comparisons with periods before the merger less directly comparable.
- Q3 operating-margin decline reflected lower Logistics and Marketing results and lower commodity-hedge settlement revenues, partly offset by improved Gathering and Processing margins. Gathering and Processing operating margin rose 6% to $149.4; Logistics and Marketing fell 23% to $126.0.
- For the first nine months, Gathering and Processing operating margin increased 9% to $404.1, while Logistics and Marketing fell 18% to $424.5. Management attributed the nine-month revenue decline mainly to lower commodity prices, partly offset by two additional months of TPL operations in 2016.
- Depreciation and amortization increased 11% in Q3 and 26% for nine months, primarily due to growth investments and, year to date, additional TPL operations. The company recorded a $24.0 goodwill impairment in Q1, finalizing the prior-year provisional impairment; no Q3 impairment trigger was identified.
- During the first nine months, the Partnership repurchased $559.2 of senior-note book value for $534.3 cash, recording a $21.4 net financing gain. The Series A preferred financing and common-stock sales also materially changed the capital structure and share count.
Outlook, commentary, risks and unusual items
- Capital projects: Management estimated approximately $525 million of net growth capital expenditures for announced projects in 2016. Buffalo, a 200 MMcf/d Permian processing plant, began commercial operations in April; Cedar Bayou Fractionator Train 5 added 100 MBbl/d of capacity in June. The Raptor plant was expected to begin operations in early 2017, and the Channelview splitter was expected to be completed by early 2018. The filing also describes projects announced in November 2016, after quarter-end, including restarting Benedum and constructing additional WestTX capacity.
- Funding outlook: Management believed operating cash flow, revolver and securitization availability, and access to debt and equity markets would be sufficient for operations, capital spending, debt obligations, collateral needs and dividends for at least the next 12 months, assuming anticipated operations and no disruptive events. This is subject to commodity prices, customer activity, credit markets and other risks.
- Post-quarter debt actions: In October, the Partnership issued $1.0 billion of senior notes and used the proceeds, together with revolver borrowings, to fund tenders for $1,138.3 principal amount of existing notes. It expected to record a $59.2 loss on extinguishment in Q4. It also announced redemptions of $146.2 principal amount of remaining notes for $151.1 plus accrued interest, with an expected additional Q4 extinguishment loss of $9.7. The Partnership extended its $1.6 billion revolver maturity from October 2017 to October 2020.
- Distributions and dilution: Common dividends declared were $0.91 per share per quarter during the periods shown. Series A preferred stock carries a cumulative 9.5% dividend and senior distribution and liquidation preferences; holders may have conversion rights after 12 years, creating potential dilution. Warrants were exercised and net settled for 3.2 million common shares through September, with further exercises after quarter-end.
- Commodity and other risks: Management cited persistent low and volatile oil and gas prices and associated risks to producer activity, volumes, demand and asset values. Commodity hedges reduce some cash-flow volatility but can limit receipts when prices rise; derivative valuations and earnings may also be volatile. The company disclosed interest-rate, counterparty and customer-credit risks and $33.9 of surety bonds outstanding.
- Goodwill and contingencies: Goodwill was $393.0 after cumulative impairments attributed primarily to lower commodity prices and higher industry cost of capital; further deterioration could lead to additional impairment. A merger-related unitholder lawsuit seeks damages and fees; the company says it believes the case is without merit and intends to defend it. A New Mexico environmental matter was expected to result in a monetary sanction above $0.1 but below $0.3.
- Controls: Management concluded disclosure controls were not effective at September 30, 2016 because of material weaknesses in controls over acquisition fair-value measurements and interim income-tax provisions. Remediation was underway; the filing states the weaknesses had not yet been fully remediated or tested for operating effectiveness.
Most important facts for investors to verify
- How the TRC/TRP merger affects year-over-year comparability, ownership attribution, share count and the preliminary deferred-tax liability.
- Whether lower Logistics and Marketing margins, commodity prices and customer activity persist, and whether Gathering and Processing growth offsets them.
- Cash-flow and dividend coverage against debt service, preferred distributions and planned capital spending; distinguish reported debt from obligations directly payable by TRC.
- Completion, cost and expected returns of announced growth projects, and the effects of the October–November 2016 refinancing, tenders and redemptions.
- Progress in remediating the disclosed material weaknesses, and any further goodwill or asset impairments, legal or environmental developments, or preferred-stock dilution.