Back in early December, we wrote about the attractiveness of PetroLogistics, LP (PDH) for income investors as we expected their dividend, which does vary, to begin to increase both in Q4 but also into 2013. Since then, there have been a number of analyst upgrades, which was discussed in another Seeking Alpha article. While that article was interesting, it missed a few of the important points that investors need to consider. For example, the author stated that PDH has a stated yield of 6%, but that was based off of annualizing the depressed Q3 distribution of 21 cents per unit. Going forward, it looks like Q4 will produce a distribution closer to 30 cents and, based on futures markets, dividend growth for 2013 looks quite rosy.
The most compelling story for PDH is that the "glut" of natural gas liquids, both propane and ethane, benefits PDH in two ways. Directly, propane is an input, so any reduction in cost directly improves their margins. The decline in ethane price implies a reduction of propylene (PGP) production from other competitive producers, namely, ethylene crackers. Shown below is the most recent chart from the EIA, showing stocks of propane. As can be seen, Gulf Coast stocks are extraordinarily high, increasing by 1 mn barrels just over the last two weeks. In fact, the Gulf Coast is the only region to have increased stocks over the last year and they stand 56% higher compared to a year ago.
So, why is this important. Because Mont Belvieu, Tx propane (on the gulf coast) is the source of propane to PDH and, recently, spot prices have begun to decline again. The most recent data point, from the EIA, has it at 79.8 cents per gallon. At the same time, however, PGP prices have risen dramatically of late, with nominations for January being in the low 70s. The prices, going forward, using data from the CME futures exchange is shown below along with the "spread" which is adjusted to put both products into the same units (See our previous article for more details on the computation of the spread). Beyond Q4, where we think the average spread of about 31 will result in a distribution of 29 cents/unit (including the effect of the recent plant outage), the spread that is being priced by the futures market should produce robust distributions into 2013.
At an average spread of 50 spread, the resulting distribution according to our model is about 75 cents for Q1. Our model calibrates with PDH's own mapping of the spread to distributable cash flow, and thus distributions. At 75 cents, that would be a $3 running dividend but, suffice it to say, we consider it ill advised to annualize one quarter. More importantly, if the first quarter shapes up to the implied 75 cent distribution, then PDH's first year as a public company will have produced $1.70 in distributions and, on a forward basis, $2.50 looks achievable. This is above our recent forecast of $2 and is being driven by an improved macro-economic environment as well as pricing. We see no reason for the "story" of both too much propane and too little propylene to change in the near future. Recently, EPD has mulled the idea of doubling their future propylene production, which doesn't start until 2015/16 - certainly a sign of optimism. When we add it all up, we see no reason that PDH shouldn't make a run towards its initial IPO price of $17 and, if our 2013 distributions turn out true, a $20 price per share is in the cards.