Will JP Energy Partners Ever Make Money?

| About: JP Energy (JPEP)

Summary

Management predicts that cash flow from operations will cover distributions but the market has serious doubts about that goal.

The company has never made any money. But publicly traded units currently have a superior claim to distributions over subordinated units that management owns.

The sale of the Bakken business and the decision to concentrate on the Eagle Ford and the Permian has the company in two low cost areas that should outperform.

The units have a 24% yield that will hold if management cuts costs sufficiently or grows the business enough (with possible help from a commodity price rally).

The long term debt to cash flow ratio is conservative and long term debt is less than a third of shareholders equity.

Going public in 2014 may not look like the greatest strategy in the world, especially after the commodity price drop that occurred since then. Building a company during an industry down turn is so much easier in theory than it practice. To make things more interesting, the owners (click on the 10-K for 2015) of JP Energy Partners (NYSE:JPEP) received much of the proceeds from that public offering, and debt payment another big chunk, so very little of the money from the public offering was available to the new company for future uses.

Nonetheless, JP Energy Partners has some interesting assets that focus on the Permian and the Eagle Ford while dumping some assets that served the Bakken. These two core areas are known low cost areas that could well outperform other areas of the country and enable the partnership to reap the rewards for servicing these areas. However, the partnership has never made a profit, and managed to record a sizable loss for the fiscal year that just ended, so the market questions the viability of this company.

The low commodity pricing and the outlook for commodity prices do not inspire confidence in the future either. The units went public at $20 per share and now trade at $5.33 per share (as of the close of the market on April 1, 2016). Even though the company has stated its intention to try and pay the unit distribution of $.325 per unit each quarter for the foreseeable future, the market clearly has its doubts about this plan. After all, if the company cannot show a profit, than where is the money to distribute to the shareholders??

Click to enlarge

Source: JP Energy Partners LP January, 2016 guidance for the 2016 fiscal year.

The publicly traded common units have an advantage over the subordinated units for the time being. Nearly half the units owned by the general partner interests are subordinated, meaning that they receive no distributions until the publicly traded common units receive the promised $.3250 distribution each month. As shown above, there is some seasonality to earnings due to the retail propane business (among others) that can be covered by the other quarters. The arrangement could put some pressure on management to borrow to pay the distribution which may not be in the best interests of the partnership (long term), but so far the long-term debt-to-cash flow ratio is a little better than 3:1, which is comfortable enough.

Pipeline companies generally have very low capital requirements and lots of depreciation to protect cash flow. So even though this pipeline is far from full, it generates enough cash to pay the distribution with a little help (about $5 million or so) from the general partnership last year. Management is projecting that the cash flow will grow to cover the full distribution this year with no help from the general partner. However, the market is clearly skeptical based upon the five year history of the partnership. Even if the partnership attains its cash flow goals, the lack of profits would indicate that any distributions are a return of capital. As such they may not be taxable to shareholders, but such a classification still indicates a lack of profits, as well as a current orientation at the possible expense of future prospects.

Click to enlarge

Source: JP Energy Partners LP January, 2016 guidance for the 2016 fiscal year.

Management has done what it can to limit the downside risk of a further earnings decline, and it does have a great record of growing cash flow. There is a fair amount of detail on the cost cutting that has occurred as well as some volume expansion to increase cash flow. As a result, management reported that cash flow increased to $46 million from $31 million in the annual filings of the company. Some of the increase was a relatively permanent increase in business and some was slowing down (or reversing) company growth staffing and purchases for growth due to extremely hostile marketing conditions. One of the bugs in the growth strategy that this company is trying to execute is the persistence of supply despite the falling commodity prices. If the world economies grow enough to use that extra supply, and prices stabilize, this company will have enough breathing room to grow further and increase its different business segments.

However, persistent production oversupply could hurt this company badly at this stage in its development. The company does have tremendous operating leverage because the pipeline is at 25% of capacity. So additional throughput probably will accrue with minimal extra costs if the company can find the customers. Like financial leverage, operating leverage rewards on the upside and punishes on the downside. So the company needs to avoid the downside punishment if at all possible.

Click to enlarge

Click to enlarge

Source: JP Energy Partners LP Barclay MLP Corporate Access Day Presentation, March, 2016.

The company actually operates fairly close to its breakeven at this time. Several one time factors prevented the bottom line from improving. First there was a goodwill impairment charge of nearly $30 million. Second there was a net loss from discontinued operations of about $15 million. If those two items are excluded from the reported loss, the remaining loss falls to about $13 million, which is less than half the loss reported the year before and actually represents quite an improvement.

However, the market could care less about those kinds of improvements and usually focuses on the continuing history of losses. The cash flow improvement shows tremendous operating leverage, and the company tried to demonstrate how to take advantage of this operating leverage by showing the costs it managed to cut during the fiscal year as well as the notes in the above slides on additional volume impacts.

Click to enlarge

Click to enlarge

Source: JP Energy Partners LP Barclay MLP Corporate Access Day Presentation, March, 2016.

The company management demonstrates with these slides that it has a pretty good handle on the challenges it faces in the current industry environment. Therefore, they are not predicting much growth even though both the Permian and the Eagle Ford are seeing some continuing activity even in the current environment. An uptick in commodity prices or the continuing decrease in operating costs posted by many operators could change that outlook. However, last year, the company managed to pick up some customers because the companies that are drilling are also rationalizing their costs. So the company extended its pipeline to accommodate a customer, and it has the ability to make that kind of deal this year.

It not only has an unused credit capacity of $97 million, but lenders also will accept a long term agreement (properly executed to the lenders standards of course) against further borrowing, so the company has a way to expand its credit if it needs to. The company shows more than a $500 million in assets with long term borrowing of less than a third of those assets, so there is definitely room to grow the borrowing any time the company can demonstrate increased cash flow. Plus, pipeline extensions are relatively cheap and usually very profitable.

In any event, managements that clearly face the challenges ahead usually handle those challenges far better than managements that sugar coat those challenges. From that standpoint, this company looks like a winner. The company not only trumpeted last year's cost cutting and savings (the presentation details several million in savings one project at a time), but also predicted more of the same this year, so it is clearly focused on the correct goals, and in a position to make that operating leverage an advantage for the shareholders in a very hostile environment.

Click to enlarge

Click to enlarge

Source: JP Energy Partners LP Barclay MLP Corporate Access Day Presentation, March, 2016.

The company completed a major project that has the potential to immediately add to volumes the pipeline services. New customers may cost a little more than usual, but still that incremental cost should be relatively cheap. Now whether some more (un-budgeted) customers can be signed up in neighboring areas to increase pipeline usage remains to be seen but that is a distinct possibility. Expanding during an industry downturn usually takes a lot of guts and fortitude, especially when the company has not been profitable, still this company is positioning itself very well for the next upswing in the industry cycle. The risk of course is that the next upswing may be further in the future than is good for the company (or the industry). Management, however appears to be doing all it can to wait out the current market conditions while maintaining the balance sheet, credit options, and operating flexibility. So far management is succeeding on all counts.

Clearly, the market disagrees that the company will be successful, as the units have a current yield of 24%. Since the unit distributions have not been covered by cash flow in the past, the market has a very valid point. However, the more than adequate bank credit line, and the ability to enter into alternative types of financing if needed (such as asset based), plus the backing of the general partner all point to the maintenance of that distribution for the rest of the year. Plus management has a history of meeting or exceeding its stated goals.

After this year (ideally) the company needs some help from industry conditions, although there are some additional credit routes that would cost some more money. It is quite possible that if oil and gas prices stabilize, combined with the reduction in operating costs across the industry, that activity could increase later in the year without a commodity price increase. That kind of cost based activity levels have led to a very persistent oversupply of oil and gas. However, the worlds economies may finally grow enough that such a cost based recovery could take hold.

In addition, there are all the forecasts of commodity price increases in the beginning of 2017 or even the second half of 2016 (which now seems less likely). Any event that leads to more customers for the pipeline and more customers for the other business would cause the market to re-evaluate the future value of the company. This company is a bet that one way or another management will increase the pipeline volumes and grow the other businesses to become profitable. As such, this stock is a speculative stock. However, it is a very well positioned speculative stock that an investor who accepts above average risk may well want to consider.

When the company went public at $20 per unit, management clearly thought that it was getting a good price for its units and history has borne out that assessment. Now, however, the company is reasonably healthy during one of the worst industry downturns in decades. While the company has reported losses throughout its history, cash flow has significantly increased every year. Currently management has a goal of a smaller cash flow increase, but that is still an increase for the current fiscal year. The debt is very manageable, and there are several very reasonable ways for this company to beat its guidance (by showing more growth than forecast).

If the company covers the distributions with cash flow (and the capital expenditures) within the next two years, this stock could explode. If management shows no cash flow progress or industry conditions deteriorate, the company could be in serious trouble, distribution can be cut as the market has anticipated (or in a very extreme case eliminated), or the stock price could decline more. The stock price is unlikely to decline more as a fair amount of failure is already priced into the stock.

Disclaimer: I am not a registered investment advisor and this article reflects my own opinions. I do not and will not advise anyone to invest or not invest in this stock. You have to do your own due diligence and your own homework, by reading the company's filings and press releases, as well as any other relevant information to make up your own mind at your own risk. Your investments must match your own risk profile as well as your desire to take on risk and the patience to see out speculative situations such as this.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.