Consider AmeriGas, A Compelling Holding In The Propane Industry

| About: AmeriGas Partners (APU)

Summary

Propane is a fragmented industry.

There are high switching costs.

There is also high yield.

AmeriGas (NYSE:APU) is structured as an MLP and is currently the largest propane distributor in the U.S. It delivers around 1.2 billion gallons of propane annually to approximately 2 million residential, commercial, motor fuel, agricultural and wholesale customers. It breaks out to about 36% each for commercial and residential, 15% for motor fuel, and 10% for agricultural.

Propane Industry in the U.S.

The propane industry in the U.S. is very fragmented. AmeriGas is the largest distributor. There are thousands of smaller players in the industry, and the number of residential consumers is around 8 million.

Most residential users are in rural areas where there is no natural gas access. These customers don't often switch suppliers as switching costs are high (e.g., removing and installing tanks, hook ups, etc.) and the economics of the switch aren't always clear. Most customers end up being price takers, with few easy ways of determining if switching will make sense. While this isn't always good for the consumer, it gives APU the ability to push through margin increases with few ill effects.

APU Consolidating the Industry

Although the market is fragmented, APU needs to worry about internal volume declines of up to 2.5% per year. APU is continually looking for acquisition targets. In 2015, it closed on nine small local acquisitions. The management team at APU has done a good job adding and integrating new acquisitions over the years. The largest recent one was its takeover of the propane distribution business from ETE partners in 2012.

Performance

Last year, its performance wasn't as good as it could have been because of the volatility in propane prices. The company got stuck with some high-priced inventory at the beginning of the heating season, and it took some time to work that off. The company has been able to add much better priced inventory for the 2016 season.

Risks to the Business

As most of the company's product is used for home heating, the business is seasonal. Mild winters hurt the volumes they are able to deliver. APU is in a commodity business with little ability to differentiate itself from the competition. High switching costs tend to mitigate this risk. The volatility of the propane market and the requirement to inventory some product can adversely affect results. With natural gas supply being very high, consumers might pressure municipalities to connect them to natural gas.

Current Valuation

APU is currently paying an 8.66% yield (it's technically not a yield, as the distributions aren't dividends) with a current quarterly distribution of $0.92. Its coverage ratio is about 1.1. The shares are currently trading at $42.8 and are about in the middle of their 52-week range (low of about $32 and high of around $50).

The Trade

In a low interest rate environment, this company makes for a compelling holding. Be aware that MLPs have specific tax implications and some investors might not want to own them.

Disclosure: I am/we are 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.