Targa Resources Corp. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing, not a standalone fourth-quarter report; the quarterly figures below are included in its unaudited selected quarterly data. Amounts are U.S. dollars unless stated otherwise.
Business context
Targa is a midstream energy company operating Gathering and Processing and Logistics and Marketing businesses. It gathers and processes natural gas, produces and handles NGLs, and provides crude oil, storage, terminaling, fractionation, transportation and export services. On February 17, 2016, Targa acquired the remaining publicly held common units of Targa Resources Partners LP (TRP) in a stock-for-unit transaction; the transaction was accounted for as an equity transaction, with no gain or loss recognized.
Financial and operating performance
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Revenue | $6,690.9 million | $6,658.6 million | Up 0.5% |
| Gross margin (non-GAAP) | $1,768.0 million | $1,821.0 million | Down 3% |
| Operating margin (non-GAAP) | $1,214.3 million | $1,281.0 million | Down 5% |
| Income from operations | $55.8 million | $159.3 million | Down 65% |
| Net income (loss) | $(159.1) million | $(151.4) million | Larger loss |
| Net income (loss) attributable to common shareholders | $(278.1) million | $58.3 million | Turned to loss |
| Adjusted EBITDA (non-GAAP) | $1,064.9 million | $1,191.7 million | Down 11% |
| Distributable cash flow (non-GAAP) | $762.4 million | $830.3 million | Down 8% |
| Net cash from operating activities | $837.4 million | $1,034.7 million | Down $197.3 million |
The filing does not provide a single consolidated gross-profit margin percentage; gross and operating margin above are the company’s non-GAAP dollar measures. The net loss included $207.0 million of goodwill impairment, compared with $290.0 million in 2015. Net interest expense was $254.2 million, up from $231.9 million. Income taxes were a $100.6 million benefit.
- Fourth quarter: Revenue was $2,012.6 million versus $1,647.4 million in Q4 2015; gross margin was $468.6 million versus $459.8 million. Operating loss was $97.6 million versus $206.9 million, and net loss was $140.6 million versus $231.9 million. Fourth-quarter 2016 included $183.0 million of goodwill impairment.
- Segments: Gathering and Processing operating margin rose to $577.1 million from $515.1 million (up 12%); Logistics and Marketing fell to $574.4 million from $681.7 million (down 16%). Management attributed the latter decline primarily to lower LPG export and fractionation margins and lower terminaling and storage throughput.
- Volumes: Average natural gas plant inlet volumes increased 5% to about 3,412 MMcf/d; NGL production increased 15% to about 305.5 MBbl/d; crude oil gathered decreased 1% to 105.2 MBbl/d. Fractionation volumes fell 10% to 309.3 MBbl/d, while export volumes were nearly flat at 181.4 MBbl/d.
- Cash and investment: Cash and cash equivalents were $73.5 million at year-end. Cash used in investing activities was $558.6 million and cash used in financing activities was $345.5 million. Capital expenditures totaled $592.1 million, including $506.4 million of expansion and $85.7 million of maintenance spending.
- Debt and liquidity: Debt obligations totaled approximately $4.92 billion, including $4.06 billion of senior unsecured notes, revolving borrowings, term debt and the receivables securitization facility. Long-term debt on the balance sheet was $4,606.0 million; the $275.0 million securitization balance was current. As of February 10, 2017, reported total liquidity was $2,469.9 million, including cash and available facilities. The Partnership’s senior unsecured debt was rated BB- by S&P and Ba3 by Moody’s; both companies reported covenant compliance at year-end. A 100-basis-point increase on variable-rate debt was estimated to raise annual consolidated interest expense by about $8.6 million.
- Dividends: Targa declared $0.91 per common share each quarter in 2016, or $3.64 per share for the year. The Series A preferred stock carries a cumulative 9.5% annual dividend.
Material changes and unusual items
- The merger increased Targa’s common shares and eliminated TRP’s publicly traded common units. It also changed the company’s segment reporting; prior periods were recast for the two-segment presentation.
- Commodity prices remained depressed through the first half of 2016 and partially recovered thereafter. Average realized natural gas and condensate prices in Gathering and Processing fell 10% and 14%, respectively, versus 2015; average realized NGL price increased 3%. Management cited weaker Logistics and Marketing margins alongside stronger Gathering and Processing margins.
- Targa raised $994.1 million gross through a private placement of Series A preferred stock and warrants, and received $572.7 million net from common stock issued under equity distribution agreements. TRP issued $1.0 billion of senior notes in October and used proceeds and revolver borrowings to refinance or redeem other notes. Debt tenders and redemptions generated $68.9 million of extinguishment losses; open-market note repurchases generated a $21.4 million net gain.
- Management reported a material weakness in internal control over financial reporting involving preparation and review of interim income tax provisions. Disclosure controls were therefore judged ineffective at December 31, 2016. A separate weakness concerning valuation of Atlas merger assets was reported as remediated. Management planned additional tax-control procedures and testing during 2017.
- The TRP merger litigation was dismissed with prejudice in December 2016. A New Mexico environmental notice concerning alleged emissions violations at the Monument plant remained under discussion; the agency offered to settle for $29,223.
Outlook, risks and contingencies
Management expected growth to depend on producer activity in its operating basins, demand for downstream services, commodity prices, access to capital and execution of growth projects. It planned at least $700 million of 2017 growth capital expenditures for announced projects, assuming the Permian Acquisition closed in the first quarter. This is a stated estimate, not a guarantee. Projects included the Raptor processing plant, expected to be fully operational in April 2017, and the Joyce plant, expected in early 2018. The Channelview Splitter was expected to be completed by early 2018 at an estimated cost of approximately $140 million.
In January 2017, Targa agreed to acquire Outrigger’s Delaware and Midland Basin assets for $565 million of initial consideration, with up to $935 million in potential performance-linked earn-outs. The transaction was subject to approvals and closing conditions. Targa completed a $524.1 million net common-stock offering in January 2017 and intended to use proceeds toward the purchase price.
Key risks include commodity-price and producer-activity volatility; debt service and refinancing needs; customer and derivative-counterparty credit; capital-market access; acquisition and project execution; hedge effectiveness; regulatory and environmental obligations; pipeline safety; weather and operational hazards; and possible further goodwill impairment. The company noted that hedging reduces, but does not eliminate, commodity exposure, and that future hedge coverage declines over time. The filing also cautions that dividends depend on cash flow, board decisions, debt restrictions and preferred-stock obligations.
Important facts for investors to verify
- Reconcile debt balances across the balance sheet, debt note and liquidity disclosures, including current securitization borrowings, revolver availability and maturities.
- Review the tax-provision material weakness, planned remediation and subsequent testing results; the audited financial statements received an unqualified opinion, but internal controls were deemed ineffective.
- Assess the sustainability of common dividends against $762.4 million of distributable cash flow, preferred dividends, capital spending and debt service; distributable cash flow is a non-GAAP measure.
- Confirm the closing, funding and integration of the Outrigger acquisition, including any earn-out obligations and expected operational synergies.
- Track goodwill assumptions and impairment sensitivity, as year-end goodwill was $210.0 million after impairment charges in both 2015 and 2016.