When we last covered NGL Energy Partners LP (NGL), we had a clear message about the distribution. We believed that NGL would soon be partying with our favorite singer.

NGL gets the following dividend safety rating on our proprietary Kenny Loggins Scale.

A “Call Kenny Loggins” rating implies a 90% plus probability of a distribution cut within 12 months.

Source: Quantum Of Solace In The NGL Bonds

Well, NGL decided that waiting was pointless, and in about a month after our article, cut the distribution by 50%.

“Our Board has made the strategic decision to adjust our annualized common unit distribution to $0.40 per unit,” stated Mike Krimbill, NGL’s CEO. “Numerous considerations factored into this decision. Our business segments performed in-line with our expectations during the fiscal second quarter and we expect over 5.0x common unit coverage for the period. We are working with our bank group to extend our credit facility maturity. This distribution adjustment should benefit those discussions. We were also yielding over 20% on our common units and we believe the best use of our cash at this time is to reduce indebtedness, improve leverage and reduce bank commitments in the short-term.”

Source: NGL press release

We dissect out where we stand today after the distribution cut.

Was It Enough?

From our perspective, the bonds were the driver, and they were clearly suggesting that NGL needed to cut the distribution. We would have preferred an elimination of the common distribution here rather than the 50% cut. NGL has $1.5 billion of debt coming up for renewal in under 11 months. Unless the company can get an extension on that, every other consideration is a moot point. Interestingly, management is hinting at a 5.0X coverage of the common distribution after this cut. This is completely irrelevant in the context of the company’s survival. The more relevant “5” number they need to stress is that the company’s debt-to-adjusted EBITDA is well over 5.0X.

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On the bright side, NGL has started the deleveraging process, although it has been rather modest to date.

With respect to debt reduction, we continue to identify opportunities to monetize assets at favorable multiples and, since March 2020, we have repurchased and retired approximately $125 million of unsecured notes at a discount, resulting in a net $50 million debt reduction.”

Source: NGL press release

NGL preferred shares are celebrating this, as it does create additional cash flow over and above the preferred distributions.

Source: Seeking Alpha

While the preferred shareholders appear dazzled, the only opinion that actually matters – that of the bondholders – was far less sanguine.

Source: FINRA

Outlook

NGL needs to either monetize its asset base rapidly via sales or prove us wrong by stabilizing the EBITDA rapidly. In the absence of those outcomes, this cut will be a bit of “too little, too late.” The common has 100% upside, if everything goes well, but it will be a wipeout if NGL cannot get the credit facility extended. How probable is a wipeout? We give it low chances currently, but we would have felt better about the situation had the company eliminated the distribution payment entirely.

The preferred shares are definitely a better buy here, but not by much. In both cases, you are getting a double-digit yield in return for 100% possible upside. While present shareholders may think it is improbable that the preferred shares would get wiped out, they have to look at it in a different way. They have to ask what precisely are the odds that the preferred shareholders would have any say in bankruptcy. Our thinking here is that the bonds have been asked that question, and their answer is “None whatsoever.”

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Bonds remain the only sensible way to play this. NGL’s current assets and current liabilities just about offset each other. That leaves the $3.2 billion in debt.

Source: NGL 10-Q

As long as the underlying asset base can produce even $500 million of EBITDA (NGL has FY 2021 at $580 million), we are hard-pressed to get negative on the bonds. Assuming even modest deleveraging of $200 million in the next 12 months, the whole company should be worth at least 6X-7X this adjusted EBITDA. With $3.1 billion of total debt and bonds trading at 56 cents on the dollar, the prospects for at least recovering those 56 cents appear incredibly high. One must note here that the credit facility and term credit agreements are ahead of the bonds.

For the bonds to recover 56 cents on the dollar, those two need to be paid up in full. That still remains the play for those – and we stress this next part – that are bullish on the company.

Conclusion

NGL has had a long history of disappointing shareholders. Guidance has been missed on more occasions than we can count. The current situation, though, has been largely driven by COVID-19. Under the circumstances, the last two quarters have actually come in reasonably well. The bankruptcy of Extraction Oil & Gas (XOG) should not be a very big hit to EBITDA, but NGL has gone into this so leveraged that even that small delta might be the straw that breaks the camel’s back.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.



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