UGI Corporation's Transformative Moves

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About: UGI Corporation (UGI), Includes: APU, TRP
by: Daniel Jones
Summary

The management at UGI continues to focus on ways to transform the entity.

This lately has been through M&A activity, which management believes will be accretive to the company in the long run.

The structure of the assets being acquired will set UGI up to benefit from reliable cash flows down the road.

The investments being made by UGI Corporation (UGI) never seem to cease. On July 2nd, news broke that the company, through its subsidiary UGI Energy Services, had agreed to acquire a significant set of operations from a subsidiary of TC Energy Corporation (TRP) in a deal valued at nearly $1.3 billion. For a firm whose market cap is measured at only $9.1 billion, and that is already making another acquisition valued at $2.34 billion, this is a significant move that will fundamentally re-shape the business and its future prospects. Fundamentally, this will help to reduce leverage over time, open the door for significant investments over the next few years, and guarantee investors that the firm is dedicated to focusing more on natural gas relative to the LPG it has relied so much on in recent years.

A look at the deal

UGI is, at its core, a holding company dedicated toward catering to the energy industry by offering storage, transportation, and other valuable midstream-oriented services. To better position itself for the future, the company decided to acquire all of the stock (structured for tax purposes as an asset purchase) in Columbia Midstream Group LLC (referred to by management as CMG) in exchange for $1.275 billion in cash.

*Taken from UGI

As you can see in the image above, UGI consists of 5 different gathering systems, with a total of about 240 miles of pipeline. The image below illustrates that the assets in question are located within the Appalachian Basin, granting management a firm hold on that region. What’s more, management said that it intends to invest somewhere between $300 million and $500 million into these assets for the purpose of expanding them (both the pipelines and the compression assets) over the next five years.

*Taken from UGI

Because the transaction is being done in all cash, the move, according to management, will be EPS-neutral next year and EPS accretive starting in 2021 (adjusted for transaction and integration costs). The reason why it won’t be accretive sooner, likely, has to do with the debt taken on to make the deal a reality. The firm intends to rely on a mix of debt-related financing, including a $700 million bridge facility, to help close not only this purchase but its purchase of AmeriGas Partners LP (APU), the largest retail propane marketer in the US, as well.

There are benefits to this transaction

On the whole, this acquisition of CMG will prove to be beneficial for UGI and its shareholders. You see, according to management, not only does it get the assets in question, naturally the company will get the customers using the said assets. Many of these are under long-term contracts. In fact, as you can see in the image below, the weighted-average contract life from today on CMG is about 9 years. This is driven by the fact that 49% of the contracts (by value) are for a period in excess of 10 years. Acquiring something with long-term deals in place helps to guarantee cash flow and reduce risk for the acquirer.

*Taken from UGI

While contract life expectancy is important, what should also be touched upon is the nature of the work being locked in. Following completion of both UGI’s AmeriGas acquisition and the acquisition of CMG, UGI will see 66% of its revenue come from take-or-pay contracts. As the name might suggest, take-or-pay contracts require UGI’s customers to take delivery of some specified amount of product (in this case propane, natural gas, etc.) or to pay a fine. This serves to guarantee UGI a stable source of cash during the life expectancy of the projects in question, instead of leaving it forced to sell more products than it would like to on the spot market. As the image below shows, more and more of the firm’s overall margin is fee-based in nature. Back in 2013, only 39% of its margin came from fee-based arrangements, but by 2023 it's expected for this to climb to 81%.

*Taken from UGI

On a more company-specific basis, this maneuvering by management in recent months to buy up the 69.2 million shares (or 74%) of AmeriGas it didn’t already own, and to buy up CMG, will position UGI to be healthier on a leverage basis. At close for both of these transactions, UGI expects to have a net leverage ratio of between 4.3 and 4.4. However, by the end of 2021, continued cash flows generated by these acquired assets, plus the results of any investments made into the region, will allow this figure to fall to around 3.5 by the end of 2021. With that lower leverage should come lower interest rates on its debt and the ability for the company to eventually resume M&A-oriented growth at a time that’s convenient for it.

Takeaway

At this point in time, UGI is making a lot of large, bold moves aimed at reinventing itself. Some details that I would like to see are missing, but on the whole, it looks to me as though management’s general approach to growth here is sensible. In an industry as developed as this, it can be more sensible to buy out your peers than to try and defeat them through organically growing in their markets and competing on price. So long as management can make this deal and lower leverage after it, plus after the AmeriGas move is completed, that suggests that the company should do well moving forward. This is especially true when you consider the reliable stream of cash flows that can be captured in this space and the overall reduced level of risk compared to other industries or even different aspects of the energy industry.

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.