PetroLogistics (PDH), a variable distribution MLP, had a rebound in the 3rd quarter with a distribution of 45c per common unit vs 30c in Q2 on higher production and sales numbers. On a trailing twelve month basis, PDH has paid out $1.70 per unit and we estimate a similar, to slightly better, result going forward. A reasonable 11-12% yield would imply a $14-$15 unit price versus its trading price of $13.25, which still includes the Q3 dividend (ex-div on 10/31). We look for further price appreciation as the volatility of PDH's distribution stabilizes and investors become more aware of the name.
PDH takes in propane and produces propylene, which is used downstream in many consumer products. The profitability of the company, quarter by quarter, is determined by the "spread" between these two commodities. The spread varies and last quarter its average was 39, an increase from Q2 and better than the TTM average. In fact, looking at the historical spread, it has been increasing as increased demand for propylene has been met with increasing supplies of propane from domestic shale gas plays. While, recently, exports of propane have gone up (e.g., EPD opened up an export terminal earlier this year), stocks of propane are still relatively high, particularly in the Midwest where midstream build-outs are still lagging new shale production. While increased exports were a source of concern, our analysis indicates that the export capacity coming on line will be met with increased supply as new infrastructure gets built out from, for example, plays like the Utica in Ohio.
The Q2 results for PDH, where production was low, was impacted by an unplanned turnaround at their dehydrogenation plant making sequential comparisons difficult. Further, a planned triennial catalyst change out was just completed skewing results somewhat. In particular, PDH stated that much of October's 89 mn-lbs of sales will be met out of inventory with reserves prepaid in prior quarters. That said, a necessary inventory rebuild in Q4 could have an impact on next quarter's distribution even running the newly started plant at near-full capacity. Based on current and expected market prices, next quarter's distribution would be 33c but a 6c impact for inventories puts the likely pay-out for next quarter at 27c and the TTM at $1.67. While variable, the distribution is showing signs of stability as well as seasonality into the winter/spring cycle.
While PDH may take a dip into Q4 announcement, we would view that as a buying opportunity. Assuming an initial propane-to-propylene spread of 38 (TTM=40) and a modest 2% growth and a 15-year plant life, we value the cashflows as worth between $13-$17 based on a 10-15% discount factor. Plant life is more than likely much longer than our 15-year assumption, which is based purely on current depreciation. All said, today's unit price looks priced to provide attractive returns to investors. There is one big caveat, however, PDH is simply one plant. If an issue was to occur - outage or, worst, an explosion - then suffice it to say unit holders would not have a good day. This lack of diversification implies that PDH will likely trade at the cheap end of MLP valuations (11-12% yields) and that investors need to temper their enthusiasm and not take an excessively large position. That said, the market appears to be offering a decent risk premium and, even with the recent run-up, we expect it to continue into 2014.