Targa Resources Corp. — Q3 2017 Form 10-Q
Business context and reporting period. Targa is a midstream energy company providing natural gas gathering and processing, NGL logistics and marketing, crude oil gathering, and related services. This unaudited filing covers the quarter and nine months ended September 30, 2017; financial amounts are in U.S. dollars unless otherwise noted.
Financial performance and position
- Revenue: Q3 revenue was $2.132 billion, up 29% year over year; nine-month revenue was $6.112 billion, up 31%. Commodity sales drove the increase, principally through higher prices. Q3 midstream service fees rose 3% to $260.3 million, while nine-month fees fell 5% to $759.0 million.
- Profit and margins: Q3 operating loss was $323.6 million, including a $378.0 million noncash impairment. Net loss was $155.1 million; loss attributable to Targa common shareholders was $197.0 million, or $0.91 per diluted share. For nine months, operating loss was $235.9 million, net loss was $195.0 million, and common-shareholder loss was $317.1 million, or $1.56 per diluted share. Non-GAAP Q3 operating margin was $313.2 million, up 9%, and gross margin was $468.7 million, up 9%. Adjusted EBITDA was $276.5 million, up 13%; distributable cash flow was $186.6 million, up 11%. For nine months, adjusted EBITDA was $811.1 million, up 6%, and distributable cash flow was $576.7 million, up 12%.
- Segment trends: Q3 Gathering and Processing operating margin increased 33% to $198.3 million; Logistics and Marketing margin decreased 8% to $115.9 million. Nine-month margins were $549.3 million for Gathering and Processing, up 36%, and $358.5 million for Logistics and Marketing, down 16%.
- Cash flow and investment: Nine-month operating cash flow was $531.9 million versus $560.7 million in 2016. Cash outlays for capital projects were $866.6 million; investing cash flow was negative $1.458 billion, including $570.8 million for acquisitions. Cash ended the period at $114.1 million. Gross capital expenditures were $987.7 million.
- Debt and liquidity: Total debt obligations were $4.897 billion at September 30, compared with $4.881 billion at year-end 2016. Current debt obligations were $528.4 million. Targa reported compliance with debt covenants. As of October 31, consolidated liquidity was $2.097 billion, including cash and net available revolver and securitization capacity. Management stated available liquidity and expected cash flows should fund operations, capital spending, obligations, collateral needs, and dividends for at least 12 months.
- Dividends and equity: Common dividends declared were $0.91 per share for each of the first three quarters. The 9.5% Series A preferred stock carries quarterly dividends; $22.9 million was accrued at quarter-end for payment in November. Common shares outstanding increased materially amid 2017 public offerings and ATM sales.
Material changes and notable items
- Q3 included a $378.0 million impairment of North Texas gathering and processing assets. Management cited projected Barnett Shale production declines as producers pursue opportunities in other basins.
- A $126.8 million Q3 gain, and $125.6 million for nine months, resulted from a reduction in the estimated fair value of Permian Acquisition earn-out obligations, primarily reflecting lower actual and forecast volumes and margins. This noncash gain materially affected reported results. The remaining earn-out liability was $290.8 million; potential payments under the acquisition agreements total up to $935.0 million.
- The March Permian Acquisition had an initial cash cost of $574.1 million and added fee-oriented assets in the Delaware and Midland Basins. Acquired businesses contributed $75.2 million of revenue and a $13.4 million net loss from March 1 through September 30. Targa also acquired the Flag City assets and sold its Venice Gathering System, recording a $16.1 million loss on that divestiture.
- Hurricane Harvey reduced Q3 operating margin by approximately $10 million through temporary facility constraints and customer disruptions. Targa expected to recover approximately $7 million in Q4 as stored NGL volumes were fractionated and sold; it expected minimal insurance claims.
- Cash interest expense fell year over year, while financing activities included repayment of a $160 million term loan and redemption of $278.7 million of 6⅞% notes. After quarter-end, the Partnership issued $750 million of 5% notes due 2028 and redeemed its 5% notes due 2018.
- Commodity derivatives were a net liability of $63.4 million at September 30. The filing estimates a 10% increase in forward commodity prices would produce a net derivative liability of $149.9 million, while a 10% decrease would produce a net asset of $22.2 million, before counterparty credit adjustments.
Outlook, projects, and risks
- Management estimated approximately $1.32 billion of 2017 net growth capital expenditures for announced projects, excluding acquisitions, and approximately $110 million of net maintenance capital expenditures. These are estimates, not earnings guidance.
- Major growth plans included the Grand Prix NGL pipeline, expected in service in Q2 2019, with Permian capacity of about 300,000 barrels per day and potential expansion to 550,000. Targa expected its share of Grand Prix growth spending to be about $975 million, including about $275 million in 2017. New Permian processing plants were also planned for 2018.
- Key risks include commodity prices and production levels, drilling activity and customer volumes, access to capital, counterparty credit and collateral requirements, project execution, regulation, and weather. Targa noted that commodity-price changes can affect both sales revenue and product purchases; reported revenue growth alone does not indicate improved profitability.
- The filing describes adoption of the new revenue standard planned for January 1, 2018, using the modified retrospective method, subject to further evaluation. Certain embedded fees may be presented as reductions of product purchases rather than service revenue; the company had not completed assessment of all arrangements.
- Management reported that disclosure controls were effective at September 30 and that the previously identified material weakness in interim income-tax controls had been remediated.
Important facts for investors to verify
- How much of operating performance and cash generation is recurring after excluding the North Texas impairment and the fair-value gain on acquisition earn-outs?
- Whether Permian production, realized margins, and potential earn-out payments match the assumptions used in the acquisition valuation.
- Progress, cost, financing, customer commitments, and expected returns for Grand Prix and the announced processing expansions.
- Whether Logistics and Marketing margins recover from the year-to-date decline and whether the expected Harvey-related recovery occurred.
- Debt maturities, covenant headroom, access to Partnership-level liquidity, and the sustainability of common and preferred dividends alongside the capital program.
- Potential revenue presentation and disclosure effects from the 2018 accounting-standard adoption, and continued effectiveness of remediated tax controls.