SPH markets and distributes fuel oil, kerosene, diesel fuel and gasoline to residential and commercial customers, and is now the third largest retail marketer of propane in the United States, measured by retail gallons sold.
On August 1, 2012, Suburban Propane Partners (SPH) consummated its acquisition of the retail propane business of Inergy L.P. (NRGY) in exchange for consideration of ~$1.8 billion consisting of (1) $1 billion in newly issued notes; (2) $184.8 million in cash to NRGY note holders; and (3) $590 million of new SPH units distributed to NRGY, all but $5.9 million of which will subsequently be distributed by NRGY to its unit holders. The notes and cash were issued and paid to holders of ~$1.2 billion NRGY notes. In addition, SPH paid ~$65 million to these note holders as a consent payment.
SPH typically sells ~ 2/3 of its retail propane volume and ~ 3/4 of its retail fuel oil volume during the peak heating season of October through March. In an article dated 4/21/12, I noted that fiscal 2012 will not look good compared to fiscal 2011. Indeed, a review of the first 9 months of the fiscal year illustrates the difficult business environment faced by SPH:
9 months ended:
Fuel oil and refined fuels
Natural gas and electricity
Cost of products sold
General and administrative
Restructuring, severance & pension settlement charges
Depreciation and amortization
Total Costs and expenses
Table 1: Figures in $ Millions; fiscal year ends Sep 30.
Retail propane gallons sold in third fiscal quarter ended 6/30/12 (3Q FY2012) decreased ~ 5.6 million gallons, or 10.3%, to 49.0 million gallons compared to 54.6 million gallons in the prior year third quarter. Sales of fuel oil and other refined fuels decreased approximately 1.3 million gallons, or 23.2%, to 4.3 million gallons during the third quarter of fiscal 2012, compared to 5.6 million gallons in the prior year third quarter. The most significant factor cited by management as impacting volumes in both segments during the third quarter of fiscal 2012 was a near-record warm April 2012, which added to the effects of a record warm second quarter of fiscal 2012, across the SPH's service territories.
SPH has maintained its distribution per unit at $3.41 ($0.8525 per quarter) for the last 9 consecutive quarters despite deteriorating business fundamentals. At 8.5%, SPH offers an enticing distribution yield. However, investors should review SPH's results of operations as of its third fiscal quarter ended 6/30/12 (3Q FY2012) and the implications of SPH's $1.8 billion acquisition of NRGY's propane business consummated on 8/1/12, in an attempt to ascertain whether the distribution is sustainable.
Distributable cash flow ("DCF") is a quantitative standard viewed by investors, analysts and the general partners of many master limited partnerships ("MLPs") as an indicator of the MLP's ability to generate cash flow at a level that can sustain or support an increase in quarterly distribution rates. Since DCF is not a Generally Accepted Accounting Principles ("GAAP") measure, its definition is not standardized. In fact, as shown in a prior article, each MLP may define DCF differently. SPH does not define DCF at all and the only non-GAAP measure it reports is adjusted EBITDA. A review of its cash flows and the sustainability of its distributions can still be performed, albeit without a comparison to reported DCF.
Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review trailing 12 months ("TTM") numbers rather than quarterly numbers for the purpose of ascertaining whether distributions are sustainable DCF and whether they were funded by additional debt, by issuing additional units or other sources of cash that I consider non-sustainable. A good starting would be to compare sustainable cash flow to partnership distributions:
12 months ended:
Net cash provided by operating activities
Less: Maintenance capital expenditures
Less: Working capital (generated)
Table 2: Figures in $ Millions except Distribution Coverage; fiscal year ends Sep 30.
Table 2 indicates that for the TTM ending 6/30/12 sustainable DCF fell significantly short of covering distributions. The gap has not been filled by issuing debt or equity, but rather by reducing cash reserves. This can be seen from a simplified cash flow statement in Table 3 below:
Simplified Sources and Uses of Funds:
12 months ended:
Net cash from operations, less maintenance capex, less distributions
Capital expenditures ex maintenance, net of proceeds from sale of PP&E
Acquisitions, investments (net of sale proceeds)
Debt incurred (repaid)
Net change in cash
Table 3: Figures in $ Millions; fiscal year ends Sep 30.
As of 6/30/12 SPH's balance sheet was strong with equity capital at $896 million (down from $976 million in the prior year) and long term debt only at $348 million (unchanged from a year ago). The EBITDA multiple for the TTM ending 6/30/12 was conservative 3.4x. There were no intangible assets to speak of.
The acquisition of NRGY's retail propane business was consummated after the end of the fiscal quarter and its results of operation are not reflected in Tables 1-3. They are provided in a pro-forma statement issued 8/6/12 and indicate deteriorating margins, operating income and net income:
Inergy Propane, LLC and subsidiaries: 9 months ended:
Cost of product sold:
Operating and administrative
Depreciation and amortization
Loss on disposal of assets
Other income (expense):
Interest expense, net
Income before income taxes
Benefit (provision) for income taxes
Table 4: Figures in $ Millions
The reason the interest expense in Table 4 is so low is that the ~$1 billion of debt assumed by SHP is not on the balance sheet of Inergy Propane, so the interest expense does not appear on the income statement. Adding depreciation and amortization to operating income for the 9 months period ending 6/30/12 gives us ~$150 million of operating cash flow. From this we should deduct maintenance capital expenditures (say $8 million), interest expense on $1 billion of debt for 9 months (say $57 million), leaving ~$85 million. The $590 million worth of SPH units will require distributions of ~$38 million (on a 9-month basis), so there should be an excess of ~$47 million ($63 million annualized) which makes the deal accretive for SPH unit holders. If, in addition, SPH can extract operating efficiencies from the combined businesses, sustainable DCF may cover distributions. With the units trading at around $40, this may be an opportune time to establish or increase a position in SPH. Unlike some of the other MLPs I have covered, including for example: El Paso Pipeline Partners (EPB), Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), Targa Resources Partners (NGLS), Plains All American Pipeline (PAA), and Williams Partners (WPZ), I don't see much potential for growth in distributions. However, the yield is already at 8.5% and if the coverage ratio improves there is possibility for some capital appreciation.