In my coverage of the various master limited partnership - MLP - companies, the preference goes towards the bigger organizations with multi-year histories of steady and - preferably - rising distribution payments. However, it is sometimes interesting to take a look at new entrants into the L.P. space to see if there are any new wrinkles. Recent IPO PetroLogistics L.P. (PDH) does bring something new to the MLP universe.
The assets of PetroLogistics consist of a single processing plant producing propylene, a petrochemical commodity product. Propylene is the second most used by volume chemical commodity and its majority use is to produce polypropylene. Propylene is also required for the production of another half-dozen chemical products. The majority of propylene produced is a by-product of crude oil refining or natural gas liquids steam cracking. The PetroLogistics plant is the first - and currently only - dedicated propylene production facility. The plant uses a catalyst initiated propane dehydrogenation - PDH - to produce propylene using propane as a feedstock. The profit level for the company is determined by the difference between the prices at which propylene is sold and the cost of propane. The prices for both commodities can vary significantly.
Recent price history shows that propylene production from propane should be a very profitable business. However, there are a host of factors involved in the final profit margin for PetroLogistics. Here are some of the more important considerations.
- About 60% of the U.S. propylene production comes from oil refiners. These companies can choose to sell the commodity at current market prices or blend it back into gasoline. As a result, of propylene prices decline, production will automatically cut back, bringing price support to the propylene market.
- Steam crackers - the number 2 source of propylene - are converting to the cracking of natural gas liquids rather than heavy by-products from petroleum refining. Cracking NGLs results in a much smaller portion of propylene produced.
- The current global consumption of propylene is about 80 million tons with growth expected to match overall economic growth. Propylene is not shipped around the globe. Local production is sold to local chemical companies.
- The shale gas/NGL production explosion has set the stage for many years of low-cost raw materials for chemical production in the U.S.
Currently, PetroLogistics is the only dedicated propylene producer in the U.S. but other companies are planning/considering building additional plants. Dow Chemical - one of PetroLogistics' biggest customers - has received board authorization to build a similar plant which could come online as early as 2015. The fears are that too much production capacity could squeeze the current healthy profit margins of propylene production. The current U.S. demand for propylene is about 25 million tons and the PetroLogistics plant has an annual production capacity of about 700,000 tons. It is very possible that the market for propylene will grow faster than production growth as U.S. chemical companies ramp up production to take advantage of low raw material costs.
The main metric for the PetroLogistics level of profitability is the propylene/propane spread per pound. For the 2012 second quarter, the gross spread was about 38 cents per pound, producing a gross profit of $72.5 million on $193 million of sales. Of the gross profit, the $62.7 million was cash available for distribution. The resulting 45 cent per unit dividend was pro-rated for the remaining time in the quarter after the May 9 IPO and investors were paid 26 cents per unit. In the quarterly earnings conference call, management indicated the spread per pound for early in the third quarter was lower than in the second quarter.
As an income producing investment, PetroLogistics is going to look a lot like Terra Nitrogen (TNH) - just in a different commodity sector. There will be quarters with very profitable spreads and large dividend payments and other quarters when the spread tightens and the distribution amount shrinks accordingly. This will be an investment in which to pick up shares during the bad stretches and rake in the cash when the profit levels are good. The share price is down significantly from the $16.50 value at the IPO, but well above the recent low of $10. PetroLogistics is not unattractive at the current $12.35 level. Distributions over the next year could range from a 6% yield to well over 10%.
A couple of final points I put down on the positive side of the ledger. As a result of the IPO, every single employee of PetroLogistics is a unit holder. With a single plant, it helps that the employees are vested in a record of steady production with the least possible amount of down time. On the quarterly conference call, the members of management who spoke and answered questions were very open and forthcoming about the pros and cons of their business. They obviously believe in what they are producing, but were willing to discuss the challenges which could reduce profitability.