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Sum­mary

PetroL­o­gistics (NYSE: PDH - $10.85) reported quar­terly results and a cash dis­tri­b­u­tion of $0.26 per unit (the pro-rated amount of the full quar­terly div­i­dend of $0.45/unit). The near-term com­mod­ity pric­ing envi­ron­ment has been unfa­vor­able to PDH but even in these adverse con­di­tions the yield to hold­ers of record August 6th is not bad. It's not pos­si­ble to pre­dict the next quar­ter or two but it appears that mar­gins will begin to improve at the end of the cur­rent quar­ter (Q3) and into Q4 and 2013.

Our best guess, and it is a guess, is that for the full Q3 the dis­tri­b­u­tion will be in the range of $0.30-$0.35/unit for a yield of 12%. What's much more inter­est­ing though is if spreads increase going into Q4 we could see div­i­dends recover to $0.45 and higher. If these con­di­tions mate­ri­al­ize annu­al­ized yields of 16-20% are achievable.

Shares may lan­guish again in Q3 until evi­dence of spreads improves and/or the com­pany demon­strates that they can deliver another high yield quar­terly dis­tri­b­u­tion under these adverse conditions. Similar publicly traded companies like CVR Partners (UAN), Rentech Nitrogen (RNF) and Terra Nitrogen (TNH) are currently priced to yield between 7.5% and 8.7%. If the price of PDH were to move to make the reported distribution inline with the mid-point (8.1%) of this range PDH stock would trade at $12.80.

Addi­tional Details

Com­mod­ity prices have been under pres­sure. Propane prices declined but so did the propy­lene. The spread went from $0.43 to $.30 and the aver­age spread was $0.38. Brent crude oil is the major dri­ver of the pric­ing envi­ron­ment. Most recently propane prices have moved up while propy­lene pric­ing has remained flat. We appear to be in an "unusual period" in terms of propy­lene pric­ing below Brent crude oil. This has tended to last one to three months and should improve. Of course his­tor­i­cal rela­tion­ships of com­mod­ity pric­ing can remain in flux for long peri­ods and visit new areas of divergence.

Over­all sales vol­umes of 310M pounds was as expected. Pric­ing seems poised to improve but buy­ers remain cau­tious due to ques­tions about global demand.

Shale gas devel­op­ment is a big poten­tial boost for PDH over time. Should be a long-term ben­e­fit for the petro­chem­i­cal indus­try in gen­eral and propy­lene in par­tic­u­lar. Basi­cally users are switch­ing to lighter inputs which results in a reduc­tion of propy­lene out­put from "steam crack­ers." How­ever many oth­ers will build sim­i­lar facil­i­ties to PDH to exploit this trend. But this will take until 2015/2016 to have a major impact on the mar­ket. Management's posi­tion on this is that this short-term neg­a­tive con­di­tion will reverse over time and improve their prof­itabil­ity. [A useful signal on this stock may be meaningful insider buying in Q3.]

The largest cus­tomer, Dow Chem­i­cal (DOW), has announced their own plant which could be online at the end of 2015/early 2016. At the same time they extended their con­tract with PDH through 2018. Dow's appetite for propy­lene is very large rel­a­tive to the cur­rent market.

Since PDH has a sin­gle plant they have more risk than larger com­pa­nies. For exam­ple they are hav­ing a mul­ti­ple day planned out­age right now to make repairs but see no dis­rup­tion in Q3 results thanks to care­ful plan­ning and on-time repair operations.

The cash dis­tri­b­u­tion is a pro-rated amount of $0.26 to unit hold­ers of record on August 6 based on a full quar­ter amount of $0.45. (Com­pany was pub­lic for 53 days of the quar­ter.) Losses from swaps and deriv­a­tives are not absorbed by unit hold­ers. Stock award costs are also being absorbed by prior own­ers, not cur­rent unit holders.

Unfor­tu­nately the optics of the deriv­a­tives and swap con­tracts are unfa­vor­able even though they don't impact pub­lic unit hold­ers and the cash yield of the secu­rity. It will take the mar­ket a bit of time to get used to this which may cre­ate an oppor­tu­nity to build posi­tions at attrac­tive prices if these con­di­tions hold over time.

$53.6M less debt ser­vice, cap­i­tal expenses, state income taxes and some non-cash expenses which total $10.6M. A reserve of $5.9M is deducted for the cat­a­lyst change­out sched­uled for 2013. Then the $25.6M losses from deriv­a­tives are added back to the amount to reach a total dis­trib­utable amount of $62.7M before being pro-rated.

In gen­eral propy­lene inven­to­ries are at the upper end of their his­tor­i­cal range but over the past few months pric­ing has not been directly linked to inven­tory.

So far in Q3 the aver­age spread of $0.27 is much lower than that of Q2 and will prob­a­bly per­sist in August. The improve­ment may start in Sept/Oct. Spot prices reflect a thin mar­ket so shouldn't be overly relied upon. It is the case that we are in a "touch com­mod­ity pric­ing envi­ron­ment" right now and not com­ing out of it yet. For exam­ple propy­lene prices are below crude. [Management does ignore the fact that this could also be fixed by crude oil prices com­ing down!]

There is a lot of propane out there and more com­ing. Pric­ing there will remain favor­able from some time. This is the key to the longer term invest­ment case for PDH. Over­all sales were in-line but there was a mix: some came in at the low end of their con­tract range and some were at the top and asked for addi­tional volume.

Con­clu­sion

The pro-rata div­i­dend pay­ment of $0.26 rep­re­sents a 9.58% annu­al­ized yield at the cur­rent price of $10.85. But it gets com­pli­cated to "unpack" what this pay­ment would have or could have been under dif­fer­ent cir­cum­stances; on a full quar­terly basis it would have been $0.45 but if the spe­cial arrange­ments with exist­ing unit hold­ers had not been in place the amount avail­able for dis­tri­b­u­tion would have been a lot less.

Q3 probably won't be much to write home about but if they generate 2/3 of the distribution they did in Q2 it will still drive yield to 10% or more since there is no pro-rata calculation.

There is substantial yield upside if conditions moderate into Q4. In this case the company would be in a position to deliver results that result in 0.45 to 0.55 quartelry distributions.

Source: PetroLogistics Delivers 9.58% Yield In A Tough Enviornment