This article analyzes some of the key facts and trends revealed by results reported by Suburban Propane Partners LP (NYSE:SPH) for the first quarter of fiscal 2017 ended on 12/31/16 (designated as 1QFY17). The quarters are noted with an FY designation because SPH's fiscal year ends in September
SPH is organized into 4 business segments:
- Propane: Generates t he bulk of SPH's revenues and cash flows through the retail distribution of propane to residential, commercial, industrial and agricultural customers and, to a lesser extent, wholesale distribution to large industrial end users. The propane segment accounts for the bulk of SPH's revenues and operating income.
- Fuel oil and refined fuels: Distributes fuel oil, diesel, kerosene and gasoline to residential and commercial customers, primarily to heat homes and buildings.
- Natural gas and electricity: Markets natural gas and electricity to residential and commercial customers in the deregulated energy markets of New York and Pennsylvania.
- Other: primarily the sale, installation and servicing of a wide variety of home comfort equipment, particularly in the areas of heating and ventilation.
SPH's business is highly weather dependent and seasonal. It 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, the bulk of sales and operating profits are concentrated in the quarters ending December and March (the first and second quarters of the fiscal year). In the quarters ended June and September SPH typically reports losses. C ash flows and distribution coverage ratios are typically highest during the quarters ending March and June; this is when customers pay for product purchased during the winter heating season.
SPH's profitability is largely dependent on volumes generated by its retail propane operations and on the gross margin it achieves on propane sales - the difference between retail sales price and product cost. Table 1 shows volumes and gross margins for the 9 most recent quarters:
Table 1: Figures in $ Millions, except gallons and percentages. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Volumes were down in 6 of the last 9 quarters (measuring each quarter vs. the prior year quarter) and in 9 of the last 13 quarters. Gross margins, measured in absolute dollar terms, were down in 7 of the last 9 quarters and in 9 of the last 13 quarters. Management attributed this to "sustained warmer than normal temperatures" that resulted in reduced propane, fuel oil and natural gas consumption (SPH Form 10-K, 11/26/16) and is hopeful that the all-important December and March quarters (1QFY and 2QFY) will reverse the downtrend in this fiscal year. The December quarter provided reason for optimism. While there were record warm temperatures in October and November (the first two months of the 2017 fiscal year), management noted that "customer demand was unleashed by a blast of cold weather throughout most of our service territories in the month of December" (Earnings Call Transcript, 2/3/17), hence the improvement in 1QFY17 over 1QFY16 in terms of both retail propane gallons sold and gross margins.
The lower volumes in the past two winters (1QFY15, 2QFY15, 1QFY16 and 2QFY16) were driven principally by record-breaking warm temperatures and, to some extent, also by customer migration to alternative energy sources such as natural gas and electricity. Despite that, as shown in Table 1, gross margins, measured as a percent of revenues, increased. The main reason is that SPH did not pass on to its customers all the benefits of lower propane costs.
The declines in EBITDA and net income in the crucial winter quarters of the prior two fiscal years (1QFY15, 2QFY15, 1QFY16, 2QFY16) did not continue into fiscal 2017:
Table 2: Figures in $ Millions except per unit amounts, percent change and gallons sold. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Table 2 shows the substantial improvement in EBITDA and net income in 1Q17. This reflects the impact of the volume and gross margin changes shown in Table 1.
But a comparison of the most recent trailing 12 months ("TTM") period to the TTM ended 12/31/15 shows a sharp decrease in net cash from operations:
Table 3: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Table 3 also indicates that in the latest TTM period, cash from operations was not sufficient to cover maintenance capital expenditures and distributions.
Distributable cash flow ("DCF") and adjusted earnings before interest, depreciation & amortization and income tax expenses ("adjusted EBITDA") are the primary measures typically used master limited partnerships ("MLPs") to evaluate their operating results. Making comparisons between MLPs is difficult because of lack of standard definitions for these terms (a prior article discussed some examples). It is even more so in the case of an MLP such as SPH that does not measure its results in terms of DCF and does not provide DCF data.
To enable comparison of DCF, investors must generate their own estimates because, as previously noted, SPH does not utilize this metric. Table 4 provides my estimate of sustainable DCF generated by SPH in the periods under review:
Table 4: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Coverage of distributions deteriorated substantially and was below 1x in the latest TTM period, indicating distributions were funded from non-sustainable sources (such as liquidation of working capital).
The simplified cash flow statement in Table 5 provides additional insights on how distributions have been funded:
Table 5: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
As seen in Table 3, in the TTM ended 12/31/16, net cash from operations, less maintenance capital expenditures, fell short of distributions by $61 million. Table 5 indicates SPH funded this shortfall by drawing down cash reserves and selling assets. Both are non-sustainable sources of cash.
My concerns about SPH center on its susceptibility to global warming, volatile commodity costs, customer migration to natural gas or electricity, difficulties encountered in passing on higher propane costs to its customers when prices are rising, and lack of a clear path to achieving distribution growth. SPH has used acquisitions of other retail propane operators to generate growth and mitigate the adverse effect of being a player in a declining industry as customers migrate away from propane. SPH expects overall demand for propane and fuel oil to be "relatively flat to moderately declining over the next several years" (SPH Form 10-K, 11/26/16) and may find it difficult to increase the aggregate number of retail propane customers except through acquisitions. While it can continue consolidating, that path is becoming harder. Long-term debt is at 5.09x Adjusted EBITDA, far higher than historical levels (e.g., 3.94x as of 12/31/15 and 3.67x as of 12/31/14).
In February 2016, I expressed concerns about declining coverage ratios. The trends pointed out in the August 2016 report showed further weakening, and I recommended reducing positions. Since then, SPH has significantly underperformed the Alerian MLP Index (-10.7% vs. +7.2%). Given the MLP rally has bypassed SPH, it could outperform the Alerian should the index pull back, especially if cold weather prevails in SPH's service areas for the rest of the winter.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.