Expiring Hedges Hurt DCP Midstream Partners, LP's Q2 Results

By Markets Fool.com

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Commodity price hedges have helped DCP Midstream Partners (NYSE: DPM) mute some of the impacts of volatile commodity prices. Unfortunately, itshedges do not last forever. In fact, a big swath of them rolled off at the end of the first quarter. While this had a noticeable impact on the company's second quarter results, 90% of the company's cash flow is still backed by fees or hedged, which certainly lessens the blow. Because of that, the company remains on pace to maintain its distribution this year, despite the continued troubles in the energy market.

DCP Midstream Partners results: the raw numbers

Metric

Q2 2016 Actuals

Q2 2015 Actuals

Growth (YOY)

Adjusted EBITDA

$138 million

$151 million

(8.6%)

Distributable cash flow

$128 million

$141 million

(9.2%)

Distribution coverage ratio

1.06 times

1.17 times

N/A

Data source: DCP Midstream Partners, LP.

What happened with DCP Midstream Partners this quarter?

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DCP Midstream Partners was hurt when its hedges rolled off:

  • Adjusted EBITDA in DCP Midstream Partners' natural gas services segment slumped 18.4% to $102 million because of the expiration of some commodity price hedges, as well as lower volumes on its Eagle Ford and East Texas systems. Partially offsetting this was the ramp up of projects in its DJ Basin system.
  • NGL logistics adjusted segment EBITDA grew 23.3% to $53 million, driven by higher volumes on its pipelines and increased NGL production at its plants.
  • The wholesale propane logistics adjusted segment EBITDA jumped 25% to $5 million. This was primarily due to lower operating expenses.
  • The company sold its non-strategic Northern Louisiana system during the quarter for $160 million and used that cash to pay down some of the outstanding borrowings under its credit facility.
  • DCP Midstream Partners also idled 320 million cubic feet per day of underutilized processing capacity in its Eagle Ford and East Texas systems to boost utilization and lower costs.

What management had to say

CEO Wouter van Kempen commented on the quarter as follows:

Our focused execution in a continued difficult environment delivered lower operating costs, growth in fee-based assets, and improved asset utilization offsetting our anticipated hedge roll-off. Once again these results underscore how the execution of our DCP 2020 strategy continues to contribute to our performance and is resetting the business to be sustainable in any environment.

DCP Midstream has been able to mute much of the impact of the downturn in the energy markets because about 75% of its margin comes from fee-based assets, while another 15% is hedged. That said, despite the limited direct exposure to commodity prices, the company is seeing a noticeable impact on its unhedged volumes, which is growing more pronounced as additional hedges roll off. In fact, by next year 18% of its margin will be exposed to commodity prices because of looming expirations.

The company is doing two things to combat this issue. First, it is continuing to make investments in fee-based assets, which are expected to push fees up to 80% of its margin next year. In addition to that, the company is selling assets, cutting costs, and improving utilization in order to bolster cash flow. These strategic initiatives will help mute the growing impact of commodity prices on the company as more of its hedges expire.

Looking forward

Because fees and hedges support 90% of DCP Midstream's cash flowthis year, it expects to be able to maintain its distribution while supporting solid coverage and leverage metrics. That said, next year that number is projected to drop to 82%, which could prove problematic if commodity prices remain weak. Furthermore, the company has a $500 million bond maturity to deal with at the end of next year. So while the distribution looks to be in good shape this year, 2017 could be more challenging if the current conditions persist.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends DCP Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.