PetroLogistics Hits Another Pothole

| About: PetroLogistics LP (PDH)

PetroLogistics (NYSE:PDH) just announced a unexpected shut down of production Monday, December 17th to fix a damaged compressor. Repairs are expected to take about 3 weeks and cost around $2M. This all based on the press release that came out after the close on Tuesday the 18th.

We expect the shares to take a hit from the current $13.20 as investors sort out what the real impact should be.

There are two major facets of this investment story to consider. The first is the easiest which is the short-term impact of this event. Secondly though as a newly-public company investors are still sorting out the ability of the management team and the validity of the strategy. It's still unclear what type of long-term investment returns the company can deliver.

Short Term

Just looking at the recent outage the impact should be relatively small. Last quarter the company had $28.7M of cash for distribution which resulted in the $0.21 quarterly dividend. If the company can service three weeks of demand from inventory the hit to the dividend from the extra expenses would only be 2-3c.

Looking at inventory the company had roughly 10 days of inventory on the balance sheet at the close of the September quarter. If they managed to build a little inventory during the current quarter it's possible that they will satisfy demands from that. However we can't be sure at this point and probably won't know until the company gets the plant back in operation and issues a new press release. Even then management may elect to wait until the December Q conference call to tell the full story.

On a purely fundamental basis the near-term hit to the stock should not be catastrophic. The shut down can reduce the quarterly dividend by 10-12% and the annual payout by 2-3%. It would argue for a 5% or so decline in share price to $12.50.

There may be more to the story and the stock reaction if we take a look at the bigger picture in the context a company that has yet to fully resonate with long-term investors. For example just a few days ago, on December 5th, the company filed an 8-K noting that INEOS, an 18% customer, terminated the automatic renewal of their supply agreement. These developments create uncertainty over the long-term potential of the shares.

Longer Term

For a "yield story" PDH has been volatile since their IPO in May. They filed high (at $19 to $21) and priced below the range at the still-rich $17. The shares opened slightly lower and traded all the way down to $10 in July. The sharp decline in July was also due in part to the expiration of the IPO lock-up agreement which generated the additional selling volume shown in the chart. Click to enlarge

Lately there has been a bit of a rehabilitation of the stock as investors began to appreciate the yield potential amidst their volatility. For example a few weeks ago one contributor posted a good overview - PetroLogistics: The Time is Ripe for Dividend Fruit.

But we remain bothered by a bad pattern at PetroLogistics since we've been following them. For example back in July with the stock at $10.85 we put out a note pointing out their attractive (9.58%) yield at the time and it helped to get the stock moving again to over $13 in July.

The company however badgered us with the argument that our yield assumption was too low (at $0.26/share) versus their stated intention of delivering $0.45/share. It might be hard to remember those days after the company paid just $0.21/share last quarter.

For investors the challenge is a combination of figuring out the real yield of these shares, the potential for capital appreciation and the volatility of the shares. A rough consensus seems to be that in "normal" times PDH can generate a $0.30/share quarterly dividend. That would put the yield at a solid 9%. This is the figure that keeps getting money back into the shares if they dip.

Share price and volatility are a bigger factor for PetroLogistics than for other yield stocks because 1) they are determined by a commodity price spread and 2) PDH has only one facility.

We've just learned that in the case of the spread they contracts are not quite as solid as they seem and that "unusual" pricing can characterize a market longer than many expect.

Recent events have reminded investors that both contracts and operations are not completely reliable.

We only have recent history to go on but below $11 there is pretty substantive support as the yield, even in an unfavorable environment, creeps into double digits. Selling some options in this context can add to yield and provide some downside risk. For now that's the only way to play this name.

Disclosure: I 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.