The importance of cash flow
A company’s income statement shows a smoothed view of its performance and includes non-cash items such as depreciation. A balance sheet also has shortcomings, like the presence of intangible assets and the fact that it’s a snapshot of a company at a given date.
These things make drawing conclusions about a company’s health a little difficult.
A company’s cash flow, however, is far more straightforward. It reflects actual cash transactions for a period under review.
As the name suggests, a company’s operating cash flows (or CFO) is the cash it earns from its business operations—the sale of products and services. So, it’s one of the most powerful indicators of a company’s profitability.
This cash is very useful, because lets a company invest in future growth (projects) or reward shareholders.
In the case of MLPs—like Energy Transfer Partners (ETP)—whose business model requires them to distribute most of their earnings as distributions to unitholders or partners, raising cash from issue of debt or fresh equity to fund acquisitions and growth is quite normal.
But the strength of an MLP’s operating cash flow in tandem with well-managed distributions gives it a lot of flexibility in these activities and respect in capital markets—both important things for an MLP.
Energy Transfer Partners’ operating cash flows
Energy Transfer Partners is among the leaders of its industry. It generates large operating cash flows. Indeed, these have accelerated following its 2012 acquisitions—hinting at its success with the MLP “acquire-to-grow” model.
Energy Transfer Partners generated about a billion dollars in operating cash flow in the years before its 2012 acquisitions. The number consequently jumped to ~$2.4 billion at the end of 2013.
In the first three quarters of 2013 alone, Energy Transfer Partners’ operating cash flows reached ~$2 billion. In comparison, industry leader Enterprise Product Partners (EPD) generated ~$2.7 billion in CFO, while close peers Plains All American Pipeline (PAA) and Magellan Midstream Partners (MMP) generated operating cash flows of ~$1.3 billion and ~$700 million over the same period.
These four companies are the top four holdings of the Alerian MLP ETF (AMLP). While ETP alone accounts for just under 8% of the fund, the four companies together account for approximately one-third of the fund’s holdings.