A Closer Look At Suburban Propane Partners' Q3 FY14 Distributable Cash Flow

Aug.25.14 | About: Suburban Propane (SPH)

Summary

Gross margins as a percent of revenues declined for the 3 recent consecutive quarters and latest 12 months.

Adjusted EBITDA per unit, net cash from operations and DCF also declined in the latest 12-month period.

Cash reserves have been used to fund distributions.

Despite its lower valuation multiple and significantly higher current distribution yield, SPH has underperformed its peers.

This article analyses some of the key facts and trends revealed by results recently reported by Suburban Propane Partners LP (NYSE:SPH). The quarters are noted with an FY designation because SPH's fiscal year ends in September. Thus its third quarter for fiscal 2014 ended on 6/30/14 and is noted as 3QFY14. The article evaluates the sustainability of the partnership's Distributable Cash Flow ("DCF") and shows how SPH is financing its distributions.

SPH is organized into 3 principal business segments. The propane segment, which generates the bulk of SPH's revenues and cash flows, is primarily engaged in the retail distribution of propane to residential, commercial, industrial and agricultural customers and, to a lesser extent, wholesale distribution to large industrial end users. The fuel oil and refined fuels segment is primarily engaged in the retail distribution of fuel oil, diesel, kerosene and gasoline to residential and commercial customers for use primarily as a source of heat in homes and buildings. The natural gas and electricity segment is engaged in the marketing of natural gas and electricity to residential and commercial customers in the deregulated energy markets of New York and Pennsylvania. SPH is also engaged in other activities, primarily the sale, installation and servicing of a wide variety of home comfort equipment, particularly in the areas of heating and ventilation.

SPH's business is highly seasonal. It typically sells ~ 2/3 of its retail propane volume and ~ 3/4 of its retail fuel oil volume during the peak heating season of October through March. Consequently, the bulk of sales and operating profits are concentrated in the quarters ending December and March (the first and second quarters of the fiscal year). In the quarters ended June and September SPH typically reports losses. Cash flows and DCF coverage ratios are typically highest during the quarters ending March and June; this is when customers pay for product purchased during the winter heating season.

SPH's profitability is largely dependent on its retail propane operations, which, in turn, is largely dependent on gross margin - the difference between retail sales price and product cost. Table 1 shows gross margin for recent quarters and the trailing twelve months ("TTM") ended 6/30/14 and 6/30/13:

Click to enlargeTable 1: Figures in $ Millions, except percentages. Source: company 10-Q, 10-K, 8-K filings and author estimates.

The percent change over the prior year for the TTM ending 6/30/13 reflects the impact of the August 1, 2012, acquisition of the retail propane business of Inergy L.P. (which has since been absorbed into Crestwood Equity Partners LP, symbol: CEQP).

In each of the latest 3 fiscal quarters gross margin, as a percent of revenues, is lower than the corresponding prior year period percentage. This is most pronounced in 2QFY14 and reflects harsh conditions of the recent winter when SPH was unable to fully pass on to its customers its higher propane costs. While average posted propane prices for these fiscal quarters were 33.9% higher than the comparable prior year period, the cost of products sold associated with the distribution of propane and related activities increased 43.3%.

Since SPH does not break out its gross margins by segment, the numbers in Table 2 above reflect not only the impact of higher propane prices. But propane is sufficiently dominant (accounting for ~83% of revenues and 95% of operating income) to reasonably assume the other segments' impact is not material.

DCF and adjusted earnings before interest, depreciation & amortization and income tax expenses ("Adjusted EBITDA") are the primary measures typically used master limited partnerships ("MLPs") to evaluate their operating results. But making comparisons between MLPs is difficult, sometimes because of lack of standard definitions for these terms and sometimes (as in the case of SPH) because other measures are used. SPH does not measure its results in terms of DCF at all. To enable comparison of that metric, investors must generate their own estimates of SPH's DCF. However, SPH does provide Adjusted EBITDA figures. These and other key operating parameters are presented in Table 2 below for recent quarters and the trailing twelve months ("TTM") ended 6/30/14 and 6/30/13:

Click to enlargeTable 2: Figures in $ Millions except per unit amounts, percent change and gallons sold. Source: company 10-Q, 10-K, 8-K filings and author estimates.

The acquisition of Inergy's retail propane business is the principal explanation for the sharp increase in volumes in the fiscal 2013 quarters and the TTM ended 6/30/13.

Following the recent harsh winter and its increased energy bills, management reported demand slowed as customers delayed deliveries in 3QFY14 while making payments on their winter usage. The 10% decline in retail propane gallons sold reflects this, as well as the impact of a late burst of cold weather that contributed to higher volumes in 3QFY13 compared to 3QFY14. Management also reported higher provisions for potential bad debts during the third quarter of fiscal 2014.

SPH was required to increase its investment in working capital in the TTM ended 6/30/14. Higher propane prices required an increased investment in both inventories and accounts receivable. This resulted in a sharp decline in net cash from operations, as shown in Table 3 below:

Table 3: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings.

As previously noted, SPH does not report DCF numbers. Table 4 below provides my estimate of sustainable DCF generated by SPH in the periods under review, as well as my estimate of what SPH's reported DCF would have been had it adopted a methodology similar to that used by some other MLPs (see article titled "Distributable Cash Flow"). Most of the MLPs I follow exclude working capital changes, whether positive or negative, when deriving their reported DCF numbers. Hence the differences between the estimates of DCF and its sustainable counterpart in Table 4 below:

Table 4: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

The two corresponding coverage ratios are as follows:

Table 5: Figures in $ Millions except coverage ratio. Source: company 10-Q, 10-K, 8-K filings and author estimates.

For the TTM ended 6/30/14 coverage ratio was positive (above 1x) if you consider cash invested in working capital to be part of what is distributable, or if you believe the investment that was made in that period was temporary in nature and will shortly be liquidated, thus generating additional distributable cash.

Table 6 presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded. It provides further insights on changes in coverage ratios.

Simplified Sources and Uses of Funds:

Click to enlarge

Table 6: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Table 6 indicates that net cash from operations, less maintenance capital expenditures, exceeded distributions by $52 million in the TTM ended 6/30/13, but fell short of covering distributions by $67 million in the TTM ended 6/30/14. The shortfall was funded by reducing cash reserves.

Table 7 below provides selected metrics comparing SPH to some of the other MLPs I follow based on the latest available TTM results:

As of 08/22/14:

Price

Current Yield

TTM

EBITDA

EV / TTM EBITDA

2014 EBITDA

Guidance

Buckeye Partners (NYSE:BPL)

$77.38

5.75%

642

19.2

-

Boardwalk Pipeline Partners (NYSE:BWP)

$20.36

1.96%

689

12.0

650

El Paso Pipeline Partners (NYSE:EPB)

$42.00

6.19%

1,139

12.5

1,200

Enterprise Products Partners (NYSE:EPD)

$39.38

7.31%

4,922

18.7

-

Energy Transfer Partners (NYSE:ETP)

$56.47

6.76%

3,142

11.0

-

Kinder Morgan Energy (NYSE:KMP)

$97.27

5.72%

5,565

11.7

5,900

Magellan Midstream Partners (NYSE:MMP)

$82.90

3.09%

985

22.1

1,011

Targa Resources Partners (NYSE:NGLS)

$71.52

4.36%

879

12.7

950

Plains All American Pipeline (NYSE:PAA)

$58.25

4.43%

2,036

14.4

2,175

Regency Energy Partners (NYSE:RGP)

$31.09

6.30%

690

24.2

-

Suburban Propane Partners

$44.42

7.88%

310

12.4

-

Williams Partners (NYSE:WPZ)

$51.73

7.09%

2,293

14.4

2,760

Click to enlarge

Table 7: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; TTM numbers are as of 6/30/14. Source: company 10-Q, 10-K, 8-K filings and author estimates.

It would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table. Note that BPL, EPD, and MMP are not burdened by IDRs; hence their multiples can be expected to be much higher. But SPH, despite also not being burdened by IDRs, has the second lowest multiple.

A lower valuation multiple combined with a significantly higher current distribution yield are positive factors to be taken into consideration when assessing an investment in SPH. Add to that its low leverage (3.5x long terms debt, net of cash, over TTM EBITDA), a careful, disciplined and conservative management team, and encouraging results so far from the Inergy retail propane business acquisition.

The negative factors to take into consideration are the susceptibility of SPH to volatile commodity costs and significant weather changes (both warmer and colder than usual winters), declining gross margins, no growth in distributions and lack of a clear path to achieving such growth, personnel changes in top management (retirement of the CEO and his replacement by the CFO), and the concern regarding sustainable DCF coverage given past needs for increases in working capital. These factors appear to weigh heavily on the unit price. In the last 12 months SPH's unit price declined 3.6% vs. an increase of 18.7% in the Alerian MLP Index.

On balance, I believe SPH's value proposition is not as compelling as some of the other MLPs I cover and remain on the sidelines. Were I long, I would use the recent trading range of $43-$45 per unit to reduce positions.

Disclosure: The author is long EPB, EPD, ETP, MMP, PAA.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.