Suburban Propane's Growth Spurt

| About: Suburban Propane (SPH)

I cut firewood to heat my home. I do this for three reasons. I enjoy it, I need the exercise, and most importantly, I save a lot of money on my propane heating bills. I use these savings to buy shares of Amerigas (NYSE:APU), the nation's leading propane distributor. Now, because of the quarterly distributions I receive from Amerigas, I can sit by the fire and gloat on the fact that the gas company pays me. A similar opportunity awaits those who choose to invest in Suburban Propane (NYSE:SPH). All that's required to take advantage of this opportunity is money and patience. The first requirement is valuable; the second is priceless. If you're interested, read on.

In 2012, Suburban completed its acquisition of Inergy LP's retail propane assets (NRGY.N) for $1.2 billion. With this move, Suburban added 600,000 customers and around 325 million retail gallons sold to its operations. Retail sales for this fiscal year are expected to show a 70% increase because of the acquisition and position SPH as the country's number three propane distributor, trailing only Amerigas and Ferrellgas (NYSE:FGP) in retail gallons sold.

SPH made the transaction possible by putting up $200 million in cash, issuing $1 billion in notes and spawning $600 million in new common units.

Circumstances allied themselves with Suburban in this acquisition. First of all, the entire propane industry has the blues, which allowed Suburban to purchase the Inergy assets on the cheap. Secondly, Inergy, eyeing the shale oil boom, needed to spruce up its balance sheet before focusing on its pipeline business. Everybody is happy.

A glance at Suburban's first quarterly report since the Inergy procurement would suggest that the integration process is going smoothly. The numbers in the report are skewed, reflecting the impact of the acquisition. For this reason, it may be more enlightening to learn what the company's CEO, Mr. Michael Dunn Jr. had to say. If you'll allow me, I'll pluck a few phrases from the transcript of Mr. Dunn's comments. Mr. Dunn mentioned that things were "progressing very well," and that "significant milestones had been reached." Pertaining to the acquisition, he stated that " while much work still lies ahead, we're well on our way." These comments might be shrugged off as mere embellishments until you consider the fact that Suburban finished the quarter with a $150 million in the bank, and didn't have to touch a penny of its revolving credit line to meet any unforeseen acquisition expenses. Deals of this size can be unwieldy and more expensive than first thought. In Suburban's case, however, it's full speed ahead, at least for now.

As a seasoned investor, you'll understand why I qualified that last statement. In business deals, things can and do go wrong. The Suburban and Inergy arrangement is still wet behind the ears and certainly not immune to growing pains.

There might be a clash of corporate cultures as Suburban introduces more of its operating model into the business of its new acquisition. Such discord could lead to the loss of key personnel.

Customers could flee, opting for a smaller distributor.

Any major problems with the integration might distract management from the day to day running of the business. This could certainly hurt performance.

Occurrences having nothing to do with the acquisition could gum up the works. A few manifestations that come to mind are a slowing economy, supply disruptions of propane, a string of unusually mild winters, evolving government regulation, or rising commodity prices.

Something else to consider when deciding about Suburban is the lengthening grasp of natural gas pipelines. At present, a large amount of propane is delivered by trucks to rural residents. Though a small threat at present, some pipe has been put down in rural areas around the country. Even so, the cost of such infrastructure is prohibitive and even when a new extension of pipeline has been completed, another subdivision pops up just out of reach. When looked at in that light, a bigger threat to Suburban would be another slowdown in the housing market.

Shoptalk in the propane industry estimates that it will take Suburban three years to fully digest the Inergy assets. (Reminds me of a burrito I once had.) Anyway, if problems arise along the way it could have a negative effect on earnings, and we all know what will happen to Suburban's unit price if that happens. If this situation arises, patience becomes the watchword. A plummeting share price and a host of press releases announcing yet another charge to earnings could make it a long 3 years for a Suburban investor.

I'm sure you're familiar with the adage, "Misery loves company." I'm sure the long suffering shareholder I just mentioned would appreciate a little companionship. How about a 7.8% yield with which to hold hands? That comes to $3.50 a unit on a annualized basis. Throw in the fact that Suburban has raised its cash distribution 29 times since 1999 and the wait suddenly becomes more palatable.

SPH distributes not only propane, but also fuel oil and refined fuels. In addition, it markets natural gas and electricity in unregulated sectors. On top of that, the company sells, installs and services home heating and air conditioning systems. I mention this just to illustrate that an investor in Suburban would get a modicum of diversification within the energy sector.

That being said, the fact remains that most of SPH's revenues come from the distribution of propane. That certainty begets uncertainty, and that uncertainty is called the weather. If you'll recall, I stated that Suburban has raised its cash distributions 29 times in the last 13 years. During that time, we've experienced winters warm, cold and just right. If you make the capriciousness of the weather the main determinant in whether or not to invest in SPH, you're reading the wrong article. Let the cash distributions and their sustainability be your barometer.

If you're still awake, here's a short recap. Suburban units yield nearly 8%. The company is not only able to sustain these payouts, but also raise them. The acquisition of Inergy Propane is expected to boost revenues 70% this year. On the face of it, the integration of the Inergy assets looks to going reasonably well. Suburban appears to have ample cash flow to service its debt. Given time, the increasing revenues brought about by the acquisition will translate into increasing distributions. As with any investment, there are risks. It's up to you as an investor to weigh those risks against the possible rewards.

So, the ball is in your court. (Sorry for the cliche. Too much March Madness.) Do your research and give me your opinion.


Disclosure: I am long APU. 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.