PetroLogistics' CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.25.14 | About: PetroLogistics LP (PDH)

PetroLogistics LP (NYSE:PDH)

Q1 2014 Earnings Conference Call

April 24, 2014 11:00 AM ET

Executives

Mike Rogers - Corporate Controller

David Lumpkins - Executive Chairman

Nathan Ticatch - President and CEO

Sharon Spurlin - SVP and CFO

Analysts

PJ Juvekar - Citi

Selman Akyol - Stifel

Operator

Good day ladies and gentlemen. Welcome to the First Quarter 2014 PetroLogistics’ Financial Results Conference Call. At this time all participants are in a listen-only mode. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to today’s host Mike Rogers, PetroLogistics’ Corporate Controller. Please proceed.

Mike Rogers

Good morning and thank you for joining us to discuss our first quarter financial results and cash distribution, both of which we announced yesterday in our press release. On the call with me today are David Lumpkins, Executive Chairman; Nathan Ticatch, President and Chief Executive Officer; and Sharon Spurlin, Senior Vice President and Chief Financial Officer. Please note that during the course of this conference call, management may make forward-looking statements regarding future events, anticipated future trends and the future performance of the Company. We wish to caution you that such statements are based on what we believe are reasonable assumptions, but we can give no assurances that these assumptions will materialize.

Important factors that could cause actual results to differ materially from those in the forward-looking statements that may be made during our call are enumerated in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission. We will also make reference to non-GAAP financial measures on this call. A reconciliation and other associated disclosures are contained in our press release and associated filing on Form 8-K.

I will now hand the call over to the Executive Chairman, David Lumpkins.

David Lumpkins

Thank you for joining us this morning. Today we’ll discuss the following. I’ll provide an overview of recent results and the market dynamics affecting our business. Nathan will cover operation, Sharon will discuss our financial results and then we’ll close with your questions. As indicated in our earnings release yesterday the partnership posted first quarter results of $67.5 million in adjusted EBITDA and a distribution to unit holders of $0.37 per unit, up from $0.30 per unit in the fourth quarter of last year. That brings results for the trailing four quarters ending March 31, 2014 to $236 million in adjusted EBITDA and distributions to unit holders of a $1.42 per unit.

During the first quarter the partnership benefited from both a healthy propane to propylene margin and stable plant operations. Nathan will elaborate on the latter in his comments in a few minutes. So let me comment on the pricing dynamic affecting our business in the first quarter.

The most noteworthy element of the first quarter commodity price environment having an effect on our business was clearly the propane situation. Although it is somewhat old news at this point it is worth revisiting briefly because it is noteworthy in the extent to which its impact ultimately proved fairly minimal on our results. I’m referring of course to the sharp run up of propane prices we saw in January and February. As we have been discussing for some time, the propane outlook in the U.S. is increasingly driven by two countervailing forces, one rapidly growing propane supply from continued growth in unconventional oil and gas development and two, increased propane demand, driven by expansion in export capacity.

In the second half of last year more new propane export capacity hit the market than new propane production. In other words, new demand exceeded new supply. This situation was exacerbated by unusually high propane draws for crop drying because of rainy weather late in the harvest season in the Midwest. As a result, propane prices gradually increased each month in the second half of last year and propane inventories fell below the low end of the five year average as we headed into the winter heating season. These factors just happened to coincide with the coldest winter in the U.S. in many years.

In late January and early February propane prices briefly spiked to levels not seen in recent years as heating demand surged with record low temperatures. The average propane price in January was a $1.40 per gallon, and it hit a $1.45 in February, up from a fourth quarter average of about a $1.20. Fairly rapidly however the market responded to these strong price signals and the sources of demand having price elasticity backed off, principally ethylene cracking and exports as the international arbitrage for U.S. propane was significantly curtailed by the higher U.S. prices.

Accordingly propane prices sold off sharply in the month of March and have remained at more attractive levels so far into April. The March average price was a $1.06 per gallon and April to date has been about a $1.10. Propane inventories are also beginning to recover and most prognosticators expect prices to remain low throughout the summer. For the first quarter as a whole, the average propane price was about a $1.30 per gallon, well above the 2013 full year average of a $1.

However the propane to propylene spread in the first quarter was a healthy $0.36 per pound, up from $0.34 in the fourth quarter of last year. This improvement resulted from the fact that the price of propylene in the first quarter increased by an amount sufficient to more than offset the effect of higher propane. This upward trend in propylene prices commenced late in the fourth quarter last year with an increase in the benchmark polymer grade price of $0.04 per pound in December, to $0.705 followed by an additional $0.04 in January to $0.745.

Prices had dropped small amount each month since January with the April benchmark price at $0.71 per pound. The first quarter average price was $0.733 per pound, about $0.05 higher than the fourth quarter average of $0.682. One development we have observed in recent months regarding propylene prices is reduced volatility. We attribute this to an improvement in the consistency of demand for propylene derivatives as general economic conditions continue to gain traction. And with propylene inventories well within the normal range of approximately 3.1 million barrels, we expect this trend to continue. Finally, considering the $0.71 polymer grade benchmark priced for April and the average propane price month-to-date of a $1.10, the propane to propylene spread for the month thus far is approximately $0.40 per pound.

Let me turn it over to Nathan now to discuss operations.

Nathan Ticatch

Thank you, David. During the first quarter, we produced 316 million pounds of propylene and our total sales volume for the quarter was 311 million pounds. This is a very good quarterly production level given the short month of February and our previously mentioned heat exchanger replacement outage that began of March 23rd and was completed on April 2nd. We achieved 98% capacity utilization for the period January 1st through March 22nd and an 89% capacity utilization for the quarter including the exchanger outage. Rounding out the usual statistics, our on-stream rate was 100% for the quarter through March 22nd and 90% for the quarter as a whole.

The 109 project continues to progress well. We have completed engineering and have begun field construction on the project. As you may recall 109 project involves placing an existing fractionation tower into service to augment the capability of the splitter tower. This project will increase polymer grade propylene production, enhance plant efficiency and reliability, and provide a marginal increase in plant capacity. The project is expected to be mechanically complete in December of this year and placed into service in January. This roughly $28 million project is currently on schedule and under budget.

We continue to remain very focused on insuring the plant’s reliability with most of our efforts now of a prevented nature rather than reactive. During the March outage, in addition to replacing the heat exchangers, we were able to do perform preventative maintenance, as well as proactively inspect a number of systems. For example, we did a full inspection of our auxiliary boiler and found only minor exceptions. We also inspected the significant upgrades that were made to the waste heat boiler during the October turnaround and were pleased to see that the system is performing as designed.

Further we have a project underway to improve the operating efficiency of our jet engines and to proactively eliminate potential reliability risk we have identified. These upgrades will be completed in June and will not require a planned outage. We have also analyzed and added a number of items to our spare parts inventory in order to minimize the impacts on plant operations should a part need to be replaced. I can go on but the message is that our plant relativity has improved significantly and we are taking the steps necessary to continue to enhance their performance.

I will now turn the call over to Sharon to discuss the financial results of the quarter.

Sharon Spurlin

Thank you, Nathan. We declared a cash distribution for the first quarter of $0.37 per unit for unit holders of record as of May 5th with the payment date of May 14th. Our $0.37 cash distribution is based on our ongoing intention to payout all of our available cash to unit holders on a quarterly basis. As David mentioned, the total cash distribution for the 12 months ended March 31, 2014 was $1.42 per unit. We recognized total sales of $220 million during the quarter, which included propylene sales of $214.4 million.

Our cost of sales totaled a $161.6 million, of which $123.8 million represented propane feedstock cost which is the primary driver of our cost of sales. Our propane to propylene spread averaged $0.36 per pound for the quarter. This spread is the key driver of our gross profit, which was $58.4 million for the period.

Gross profit is determined by multiplying the propane to propylene spread by our sales volume and subtracting applicable customer discounts, propane transaction cost, and other operating cost including depreciation and amortization expense. Additionally, we incurred $4 million for general and administrative expenses.

Net income for the quarter was $46.7 million. To reconcile to adjusted EBITDA, we start with net income and add back $6.4 million of interest expense primarily related to our $365 million of senior notes which bear interest at 6.25% and are due in March of 2020, $12.5 million of depreciation, amortization and accretion expenses and $1.9 million of income tax expense and equity-based compensation expense on our LTIP units.

Adjusted EBITDA is the most representative metric for the cash earnings of our business. It is therefore used as the basis for the calculation of cash available for distribution. Cash available for distribution is calculated, beginning with adjusted EBITDA of $67.5 million for the period. We then subtract debt service, maintenance capital expenditures, state income taxes, insurance reimbursement and cash payment on our unvested LTIP units, all of which total $10.2 million. We also deduct a $5.9 million reserve for the next planned triennial turnaround. This results in total cash available for distribution of $51.4 million, which when divided by our 139.2 million units outstanding is $0.37 per unit.

And now with respect to the balance sheet, as of March 31, 2014 we had cash on the balance sheet of $23.4 million, total working capital was $64.2 million and $170 million of available capacity under our revolving credit facility which expires in March 2018. Together our cash, plus available revolver capacity yields current liquidity of a $193.4 million. Our total long term debt was $365 million which consists of our fixed rate senior notes. We have maintained and plan to continue to maintain a conservative capital structure. Our debt to adjusted EBITDA was 1.5 times and our adjusted EBITDA to interest expense was 9.2 times for the 12 month period ended March 31, 2014.

That concludes our prepared discussion. We would be pleased to entertain your questions. Operator, would you please explain the question and answer procedure.

Question-And-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from PJ Juvekar of Citi. Please go ahead.

PJ Juvekar - Citi

IHS recently, at the conference sounded quite negative on propylene due to the PDH units starting up in the U.S. from Dow and Enterprise and more propylene supply coming from China. I was just wondering if you can give us your long-term outlook for propylene.

Nathan Ticatch

This is Nathan Ticatch. If you -- certainly there is a couple of plants that will be starting up, Dow and Enterprise. The counter balance is that they’re still, cracker lightning. That is continuing by a number of ethylene crackers, not one of which is Dow, and so there will be capacity added. There will also be other supply that disappears. Refinery supply seems to be on a downward trajectory, but it is a true statement that U.S. production will increase. The U.S. market has been supply constrained. So there is derivative capability in order to ramp up should supply increase. I think if you look at the IHS chemicals forecast, they take these items into account, they show increased supply, and increased demand -- with some material moving off shore. When they forecast the propane to propylene spread, I think they do show it coming down marginally, later in the decade but again, not a huge overhang.

And with regard to China, there’s an awful lot of projects that are being discussed for China. China’s also a huge net importer of propylene derivatives today. It’s a rapidly growing market. So there certainly needs to be additional propylene capacity built in China and propylene worldwide grows above the rate of GDP. So capacity needs to be added on a worldwide basis. So what you say is definitely part of the equation. There’s additional capacity being added but at least as I say if you looked at IHS, they’re not showing a huge overhang or collapse in the market.

PJ Juvekar - Citi

Okay. And Nathan, I think you just mentioned about refinery supply of propylene. If propylene were to go up, how quickly can refineries add capacity or bring on this propylene supply?

Nathan Ticatch

So what’s happening on the refinery side right now is -- and the trend over the last couple of years is the value of propylene in gasoline, as alkylate has been consistently and significantly above the value of propylene in the chemical market. So right now the benchmark price for polymer grade is $0.71. The alkylation value of propylene is $0.84.

So its worth more to the refinery and gasoline than it is to sell it to chemical folks. The drivers for that and the reason that it has changed is that isobutene, so when you feed an alka unit, you feed an olefin plus isobutene. Isobutene prices have gotten very cheap and that is a trend along with other LPGs and that’s a trend that I think everyone agrees will continue. And then secondly octane has become far more valuable than the gasoline pool and that’s also a long term trend it’s just a function of the spread between natural gas and crude oil and reformer economics. So there has been a fundamental change in the market and refiners right now are looking to alkylate, more olefins including the C3s. So I think there’s a strong economic driver for them to do so and right now there are some capacity limitations on the alka units but we have seen the amount of propylene coming from refineries decline over the last year, nothing compared to the decline that’s occurred from ethylene crackers but certainly it’s a downward trend.

PJ Juvekar - Citi

All right. So just to understand what you said, as isobutene prices came down, propylene and went up to make up the alkylate value that is defined by octanes. Is that?

Nathan Ticatch

That’s right. So there is a value for the product the alkylate product. If one feedstock becomes cheaper the other -- then you can afford to pay more for the other feedstock.

PJ Juvekar - Citi

Right. Is there any rules that butane goes up because we export more?

Nathan Ticatch

Yes, certainly there is that dynamic. Typically I think when folks think about the export market they’re thinking about normal butane. It’s the iso that you use for alkylate. But right now there’s not a lot of butane that moves offshore and certainly there’s a lot of supply of NGLs of alky.

PJ Juvekar - Citi

Okay, lastly what are your thoughts currently on the second PDH plants?

Nathan Ticatch

You mean on our second PDH plant?

PJ Juvekar - Citi

On your -- sorry, I meant, yes; your second PDH client that you shelved any thoughts.

Nathan Ticatch

Yes, as I think we have talked about, we never really made any formal announcement of plans for second plant. We did do engineering to design a second plant. We actually got it permitted. We had contemplated having commercial arrangements on a propane plus basis, similar to what some others have done who have announced new plants. What we found at the completion of our analysis was construction cost capital cost had gone up very, very dramatically since the time that we built our plant. And just to put some specifics on that, it’s public information in our 10-K, we spent about $640 million to build our plant and one of the reasons that we were able to get that capital cost so attractively is because of the unique attributes of the e ExxonMobil site where we built our plant and the extent to which we were able to minimize our capital cost as a result.

But the cost of building a new plant, that very same plant as we had designed was well in excess of $1 billion. And what we concluded was that the propane plus economics that the market was willing to provide you weren’t sufficient for our taste to provide us a satisfactory rate of return to make $1 billion plus capital investment. So we decided to pass just from the risk-reward standpoint. So we do have a project sitting on the shelf and it is well engineered and it takes full advantage of the all that we’ve learned with our new plant and so at some point in the future if conditions change, we can take that off the shelf to move forward but we have no plans to do so in the near term.

Operator

And our next question comes from Vincent Andrews of Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi. Good morning. This is actually Matt on the line for Vincent. Just on project 109. I think maybe I missed this somewhere but can you just help understand how that will modify or how that will change maybe your product mix. So I understand you’re going to get a little more polymer grade productivity but it’s not going to increase the capacity. So is that just a mix shift?

Nathan Ticatch

So there is kind of four categories of good things that the project does. It allows us to make more polymer grade, just giving us more capacity to do so, as there is a market trend where customers are looking to use more polymer grade and less chem grade. That’s basic economics. When they buy chemical grade propylene they are getting about 6% propane and if all the buyer can do is burn that material, that’s an economic loss. So he has incentive to find ways to run polymer grade in his system. Not everybody can do that. They have to make process changes. So it’s a trend but it’s not happening all at once. So we want to be proactive and able to make more polymer grade. Economically, generally we make about the same amount of margin, whether we’re making chem. grade or polymer grade. But making polymer grade -- more polymer grade is a good market point.

Secondly, one part of the project is today we send out chemical grade, which is higher purity than it needs to be, because we hit another point on the spec and so as part of the project, we’re going to make some changes and put in a treater that allows us to actually hit the spec rather than -- the example is we’re kind of sending out a premium gasoline and all we’re getting a regular gasoline price. So that’s another benefit of the project that we’re doing.

It’s also going to allow us to have a more pure feed reactors, which will make the process more efficient. And then the final thing is we do -- we have the potential of a marginal increase in capacity. And the reason that I put it so obliquely is this. Today we do have a bottleneck around our propylene splitter. We’re going to eliminate that bottleneck with this project. But the nature of eliminating bottlenecks is when you eliminate one you’ll hit the next one. And we don’t quite know where we hit the next bottleneck. So we are hopeful and expect some marginal increase in capacity but we don’t believe it will be dramatic.

Unidentified Analyst

Got it, that’s helpful. And then just looking at some of the contracts I know, Dow was a large customer and that contract doesn’t roll off until 2018. How should we think about that? Is there a way for them to potentially get out of that early? And is your focus to maybe shift more into the spot market going forward?

David Lumpkins

So we’re -- what I would term fully contracted. When our customers request nominate contract max -- the maximum volumes they can nominate under our arrangements. It essentially matches the capacity of the plant. So we are -- we have done all the contracts that we can, given our plant capacity. With regard to -- and we’ve renewed a number of these contracts. All of our contracts are through ‘16, all those significant ones. And as you mentioned Dow goes through ‘18.The answer is no -- there is no way this is a firm contract between us and Dow. We have a commitment to sell and they have a commitment to buy. So we do have a fair amount of runway on that.

Interestingly Dow ask us and we negotiated an extension to that contract, even after Dow put in place their plans to build a PDH. So Dow’s PDH will come online they say the later part of ’15. Our contract runs through the end of ‘18. We also have considerable interest from other potential customers that are not currently in the portfolio. So we have every expectation that Dow will continue to be an important customer to us. It is way early to commence detailed discussions to that now. As Nathan said they will continue to be very short propylene even with the construction of their own plant but we also have a nice list of other potential new customers in the future who would like to get into the portfolio. So we really spend no time worrying about whether or not we will remain contracted up in the future.

Unidentified Analyst

Got it. So it’s likely that you’ll remain contract pricing, not likely that there’ll be any major switch on the out years to spot economics, since it might be a little more advantageous.

David Lumpkins

No. Absolutely. Our strategy is always going to be to be fully contracted.

Unidentified Analyst

Got it, great. And then just as we think about the reserve for the turnaround, we didn’t have much since your IPO and then this is the recent triennial turnaround. Should we just think about that kind of as the run rate that we saw this quarter?

David Lumpkins

So our reserve has been $5.9 million a quarter. We’ve now gotten through the first turnaround. That reserve proved to be adequate and in the right range of what’s the turnaround cost those from an -- if you recall our reserve covers both loss margin as well as the actual cost of the turnaround. The reserve proved adequate and so at this point in time, we’ll continue to have that same reserve for the next cycle.

Operator

And our next question comes from Selman Akyol of Stifel. Please go ahead.

Selman Akyol - Stifel

Maybe you said it, but just during the quarter can you -- and I missed it, but what was done under spot versus contract?

David Lumpkins

Everything was sold under contract.

Selman Akyol - Stifel

Okay. And then…

Nathan Ticatch

And I will make this point that the -- even when we do spot sales, we typically do it relative to benchmark anyway for our existing customer, right.

Selman Akyol - Stifel

Okay. And then can you just talk about how nominations were for April, and are discussions underway for May?

David Lumpkins

We don’t disclose our nominations, that’s been our policy. I would just reiterate comments earlier. We’re pleased about the constructive demand environment we’re seeing there. It’s really a bit more consistent than we’ve seen for the last couple of years and that’s led to the increased stability in the price. We’re pretty pleased with the way that we see derivative demand shaping up for propylene related products.

Selman Akyol - Stifel

Okay.

Nathan Ticatch

Selman, going back, one point on your question about sales. You know we had -- we actually typically have this every quarter. On sales recognition, if a customer pays -- if we make product and a customer pays for it, but due to operations they haven’t taken delivery, so it’s still in our system, then due to their operations we can’t recognize the revenue. So there are pounds that we’ve got and paid for but haven’t been recognized in revenue. One thing we did have this quarter was an unusually large amount. There were 20 million pounds that we sold, but did not recognize the revenue.

David Lumpkins

We sold and got paid for, but the accounting requirements will not allow us to recognize revenue until we actually deliver the pounds.

Selman Akyol - Stifel

Okay. From a balance sheet standpoint as well as the income statement, but that is all good. So previously you guys had talked about building a safety stock of about 40 million pounds. How is that going?

Nathan Ticatch

Well, in fact, as I mentioned, we did take this exchanger outage that we’ve talked about previously in late March and continue to make customer deliveries through that average. So we ended up expanding what we had built up and the much of what we had built up right now, but that’s what the safety stock is for.

David Lumpkins

That’s right. For exactly that purpose.

Nathan Ticatch

So right now we have about 10 million pounds in the inventory. And 40 million is our target. So we got more to build but we did use a bit of it.

Selman Akyol - Stifel

And my last question, previously you guys had discussed or thought about having a second supplier of propane. I was just kind of wondering where that stands.

Nathan Ticatch

So the, our current arrangement for propane is a dedication for our full demand. So we do have a contract that require us to provide that full demand to the current supplier. The flip side of that is it’s not a take or pay. So we don’t have to take a certain volume each month but whatever we take, we buy from them and that’s a five year contract. There’s still 18 months or so left on that contract. We are in discussion as to what our future arrangements will be. So we will ultimately extend or replace or renew this contract but it’s little early at this point.

Operator

And we have no further questions at this time. Mr. Lumpkins, do you have any closing remarks?

David Lumpkins

Okay. Thank you all for your participation this morning. We appreciate your interest in the company and look forward to speaking with you again soon.

Operator

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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