A Closer Look At Suburban Propane Partners' Distributable Cash Flow As Of 1QFY 2013

| About: Suburban Propane (SPH)
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Suburban Propane Partners LP (NYSE: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.

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. Consequently, sales and operating profits are concentrated in the first and second fiscal quarters (ending ~December 31 and ~March 31, respectively). Cash flows from operations are greatest during the second fiscal quarter and the third (ending ~June 30) when customers pay for product purchased during the winter heating season. Lower operating profits and net losses (or lower net income) are generated in the third quarter and the fourth (ending ~September 30). To the extent necessary, SPH reserves cash from the second and third fiscal quarters for distribution in the fourth fiscal quarter and the first quarter of the following fiscal year.

On August 1, 2012, SPH consummated its transformative acquisition of the retail propane business of Inergy L.P. (NRGY), effectively doubling the size of its customer base and expanding its geographic reach into 11 more states, including a new presence in portions of the Midwest.

Acquisition consideration consisted of ~$1.9 billion, the principal components of which were (1) ~$1.075 billion in newly issued notes; (2) ~$185 million in cash to NRGY note holders; and (3) 14.2 million new SPH units (valued at ~$590 million) distributed to NRGY 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. Goodwill and other intangible assets were added to the balance sheet following the acquisition and now total ~$1.5 billion (vs. $1.1 billion, so tangible book value is now negative.

Comparison of results for the quarter and trailing twelve months ("TTM") ended 12/31/12 to the prior year periods is set forth in Table 1 below:

Table 1: Figures in $ Millions; fiscal year ends Sep 30.

The first quarter of fiscal 2013 (ending ~December 31, 2012) was the first full quarter of operations following the acquisition of the retail propane business from NRGY. The improvement in results for the quarter over the prior year period is primarily attributable to the inclusion, for the first time, of that business in SPH's financials. Results for the TTM ending ~12/31/12 were adversely impacted by the record warm temperatures experienced across SPH's service territories last winter. Nevertheless, the contribution of NRGY's retail propane business in the 3 months ended ~12/31/12 enabled SPH to report growth in revenues, net income and EBITDA in the TTM ending 12/31/12 compared to the TTM period ending 12/31/11.

On a pro-forma basis, assuming the acquisition of the retail propane business from NRGY had occurred at the beginning of fiscal 2012, propane volumes sold were 3.5% lower, combined operating and G&A expenses were ~10% lower, and EBITDA was ~37% higher in 1QFY13 compared to 1QFY12. On a pro-forma basis, gross margins (revenues less cost of product sold) improved slightly as a result of declining wholesale propane costs (average posted prices for propane in 1QFY13 were 38.5% lower than the prior year period).

Results for the quarter ended 12/31/12 provide a first real look at how management's original projections of achieving $50 million in synergies within three years of acquisition, of which $10-$15 million would be realized in year one, are shaping up. The 10% decline in combined operating and G&A expenses indicates a saving of ~$13 million in 1QFY13 alone. Management took care to point out that the savings were not all due to synergies, that you cannot annualize this number and that the original forecast still stands. Nevertheless, my level of confidence that the projected savings will materialize, and perhaps be exceeded, has increased.

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 reports earnings before taxes, depreciations & amortization ("EBITDA") but not DCF. The only non-GAAP measure it reports is Adjusted EBITDA which adds back to EBITDA items such as acquisition-related costs, losses on asset disposals, legal settlements, debt extinguishment and derivatives.

Comparing sustainable cash flow to partnership distributions is a good starting point to ascertaining whether distributions are sustainable and whether they were funded by additional debt, by issuing additional units or other sources of cash that I consider non-sustainable:

Table 2: Figures in $ Millions except Distribution Coverage; fiscal year ends Sep 30.

I generally do not include working capital generated in the definition of sustainable DCF because I do not regard it as a sustainable source. Over reasonably lengthy measurement periods, working capital generated tends to be offset by needs to invest in working capital. Therefore I ignore $88 million of the net cash generated by operating activities in calculating sustainable DCF for the TTM ended 12/31/12.

Table 2 indicates that for the TTM ending 12/31/12 sustainable DCF fell significantly short of covering distributions. However, bear in mind that the most recent TTM numbers include just 3 months of contributions from the retail propane business acquired from NRGY, so the numbers may not be as alarming as they initially seem. The 1st quarter of the fiscal year typically contributes ~1/3 of annual EBITDA (although in FY 2012 it reached 44%). Based on that, projecting EBITDA of ~$310 million for fiscal 2013 is not unreasonable. Assuming no adjustments for working capital (excluding maintenance), risk management activities and other items for the remaining 9 months of the fiscal year, I calculate sustainable DCF for fiscal 2013 should end up at ~$198 million (~$310 million of EBITDA, less ~$100 million in interest expense, less ~$12 million in maintenance cap ex). That should fully cover distributions even with the recent 2.6% increase (up $0.09 to $3.50 per common unit on an annualized basis).

A simplified cash flow statement is provided in Table 3 below.

Simplified Sources and Uses of Funds:

Table 3: Figures in $ Millions; fiscal year ends Sep 30.

Table 3 indicates that net cash from operations, less maintenance capital expenditures, more than covered distributions in the TTM ending 12/31/12 and 12/31/10 (there was an $18 million shortfall in the TTM ending 12/31/11). Although SPH issued additional partnership units in the latest TTM period (on August 7.245 million units were issued in a public offering at a price per unit of $37.61 realizing net proceeds of ~$260 million), proceeds were used for acquisitions and debt repayment, not for funding distributions.

While I think that, in calculating sustainable DCF for 1QFY13, it is appropriate to ignore the $88 million of cash generated as a result of a reduction in working (see Table 2) and therefore to conclude that distributions exceeded sustainable DCF for that period, management deserves credit for what seems like good working capital management. Despite the increased size of the organization, management was able to generate this cash, to fund all its working capital requirements with cash on hand, to avoid accessing the revolving line of credit and to end the quarter with $149 million of cash.

At 8.45%, SPH offers an enticing distribution yield at the high end of the universe of MLPs. Table 5 below compares SPH's current yield of some of the other MLPs I follow:

As of 02/09/13: Price Quarterly Distribution Yield
Magellan Midstream Partners (NYSE:MMP) $48.33 $0.5000 4.14%
Plains All American Pipeline (NYSE:PAA) $52.96 $0.5625 4.25%
Enterprise Products Partners (NYSE:EPD) $55.50 $0.6600 4.76%
Kinder Morgan Energy Partners (NYSE:KMP) $88.38 $1.2900 5.84%
Inergy $19.35 $0.2900 5.99%
El Paso Pipeline Partners (NYSE:EPB) $40.55 $0.6100 6.02%
Williams Partners (NYSE:WPZ) $52.96 $0.8275 6.25%
Targa Resources Partners (NYSE:NGLS) $41.46 $0.6800 6.56%
Energy Transfer Partners (NYSE:ETP) $46.15 $0.8938 7.75%
Boardwalk Pipeline Partners (NYSE:BWP) $27.47 $0.5325 7.75%
Buckeye Partners (NYSE:BPL) $53.13 $1.0375 7.81%
Regency Energy Partners (NYSE:RGP) $23.47 $0.4600 7.84%
Suburban Propane Partners $41.43 $0.8750 8.45%

Table 5

I established my SPH position in the hopes that management scrubbed the balance sheet and that charges taken in fiscal 2012 (acquisition-related costs, losses on asset disposals, legal settlements, debt extinguishment) were indeed one-time. While the very low leverage and high distribution coverage ratios achieved by SPH in prior years (pre-acquisition) were, to an extent, due to a much more favorable price and demand environment, they also reflected a careful, disciplined and conservative management style. I also hoped this approach would be applied to the acquisition of NRGY's retail propane business. Given its exposure to propane prices and the weather, SPH should yield more than pipeline MLPs. The question is how much more. Results from the first full quarter of operations following the acquisition of the retail propane business from NRGY are encouraging. I believe there is an opportunity to both capture an attractive yield and benefit from some capital appreciation through a modest narrowing of the spread relative to other MLPs.

Disclosure: I am long EPD, EPB, PAA, WPZ, SPH, ETP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.