Stock pick (actually MLP pick) Targa Resources announced $1.25 billion in new projects--enough to keep distributions climbing

08/19/2013 8:10 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

On August 1 Targa Resources Partners (NGLS) disappointed the market with a second quarter earnings report that missed analyst estimates by 17 cents a share. Revenue rose 9.3% year over year to $1.44 billion versus the $1.72 consensus.

And yet Targa Resources didn’t plunge. The price has retreated a relatively small 5.7% from the August 1 high at $51.75 to $48.80 at the close on August 19. Given the general retreat in the dividend income sector on fears of a September move by the Federal Reserve to reduce its monthly purchase of Treasuries and mortgage-backed assets, the stock-specific drop is almost non-existent.

Which is a good reminder that master limited partnerships (MLPs) such as Targa Resources aren’t judged by the market on earnings but by their ability to pass cash flows through to unit holders—and by their ability to increase those distributions over time.

On that basis, the company’s second quarter report was a solid success

The big problem hanging over units of Targa Resources isn’t the falling price of natural gas liquids due to a glut in the shale geologies of the mid-continent energy boom. Targa with an income stream from its pipelines that largely depends on fee-based contracts rather than contracts set to reflect the rising and falling price of natural gas liquids is relatively well insulated from that tough pricing environment.

Rather Targa’s problem is that the partnership has been distributing more than 100% of cash flow—that’s possible for a master limited partnership in the short-term but it’s not a formula for long-term rising distributions. So the key thing that investors wanted to hear from Targa was a solid plan for new projects that would raise the coverage ratio of cash flow to distributions to more than 1. And that’s what Targa delivered. For the fiscal 2013 year the partnership will achieve a coverage ratio of 1 with a significant improvement in cash flow in the second half of the year. Through fiscal 2014, management said, Targa has about $1.25 billion in fee-based projects scheduled to come on line. These additional fee-based projects will bring the company’s fee-based margin to 55% to 65% of total margin from 50% in the second quarter.

Although financial markets are afraid of rising interest rates and those associated costs, Targa continued to reduce its interest bill in the quarter by refinancing old high coupon debt at lower rates. For example, the company raised $625 million in May in 4.25% notes due in 2023 and then used some of those proceeds to redeem debt in June ($106.4 million in senior notes with a 6.375% coupon) and July ($80.9 million in senior secured notes with a 11.25% coupon.)

On July 16 Targa Resources Partners announced a 3% increase in distributions from the first quarter of 2013 (and an 11% increase from the second quarter of 2012.) The master limited partnership paid a 5.86% yield as of August 19. Targa is a member of my Jubak’s Picks portfolio http://jubakpicks.com/  As of August 19 I’m raising my target price to $51 a unit by December 2013 from my earlier target of $45.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Targa Resources Partners as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.

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