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.
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.
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.