After reducing their distributions by three-quarters during 2020, Green Plains Partners (NASDAQ:GPP) marked 2021 far more positively by sending them surging back towards almost their previous level, thereby seeing that their very high 11.76% yield returns. Apart from offering a very desirable source of income, this seemingly ignored Master Limited Partnership now sees potential upside of over 50% for their unit price, thereby creating a very desirable opportunity for investors to generate alpha.
Whilst I have not always been bullish on their units, this was primarily due to the risks posed by their credit facility terms that as my previous article discussed one year ago, were choking their cash flow performance and caused their large distribution reduction. Thankfully this was refinanced and thus rectified earlier in 2021, which not only removed these risks but when combined with their ample free cash flow it also paved the way for higher distributions, as my other previous article discussed.
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It been very positive to see management already seize upon this opportunity and thus increase their quarterly distributions by over 200% to $0.435 per unit, which will cost them $40.4m per annum given their latest outstanding unit count of 23,227,653. They generated free cash flow of $44.1m during 2020 and $32.7m from the first nine months, which annualizes to $43.6m and thus they should have no problem at least adequately covering their new distribution payments. Although at the same time, they will consume the most of their free cash flow and thus given their almost non-existent capital expenditure, they will largely be treading water and drifting sideways into the future with little to no future growth.
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When looking at their financial metrics, it can be seen that their leverage plunged throughout 2020 and the first nine months of 2021 as they aggressively repaid their credit facility to help smooth over the refinancing process. This has left their net debt-to-operating cash flow and net debt-to-EBITDA sitting at 0.97 and 0.86 respectively, which are both under the maximum threshold for the very low territory of 1.00.
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Aside from deleveraging at a brisk pace, the other benefit of their significantly reduced distributions was the boost that their liquidity has seen, which mostly came during the third quarter of 2021. This has seen their current ratio increase from its crisis low levels of 0.11 and 0.15 at the end of 2019 and 2020 respectively to now sit at a solid 1.48, which is further strengthened by their strong cash ratio of 0.73. When their strong liquidity is combined with their very low leverage and adequate distribution coverage, their new distributions appear safe and sustainable.
Since they are a Master Limited Partnership with a very high distribution yield that consumes most of their free cash flow, it stands to reason that their intrinsic value centers upon the income that they can provide their unitholders. This means their intrinsic value can be estimated by utilizing a discounted cash flow valuation that exchanges free cash flow for their distribution payments. If interested, all of the details regarding the inputs utilized for these valuations can be found in the relevant subsequent section.
Since selecting variables for discounted cash flow valuations can be rather difficult and open to small errors as well as manipulation, Monte Carlo Simulations have been provided to illustrate how the odds are stacked in each scenario. There is never a silver bullet for ascertaining whether the intrinsic value of an investment but generally speaking, the more positive the results are skewed, the better the probability of generating alpha. When conducting the analysis an estimated target price was found through finding the point in which whereby the results were equally split between positive and negative.
A baseline scenario was provided for the valuation because following the previous discussion, their distributions now appear safe and sustainable but at the same time, they appear unlikely to increase significantly within the foreseeable future. This foresees their quarterly distributions of $0.435 per unit remaining unchanged perpetually into the future with their excess free cash flow providing a margin of safety.
It can be seen that even with zero future distribution growth, this scenario still sees a massive 100% of their results producing an intrinsic value above their current unit price of $14.80, plus a target unit price of $22.90 that itself sits a very desirable 54.73% higher. Even though the future is inherently uncertain, this nevertheless indicates that investors should generate very significant alpha even with the partnership merely treading water and drifting sideways, which should be easy for management to achieve given their very healthy financial position. To sweeten the deal, these very favorably skewed results imply that there is only a very minimal downside risk of overpaying for their units.
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The Monte Carlo Simulations utilized 121 different discounted cash flow valuations, which were based upon a wide range of cost of equity assumptions with expected market returns from 5% to 10% and risk-free rates from 0% to 5%, both of which using 0.5% increments. Each of the discounted cash flow valuations utilized a cost of equity as determined by the Capital Asset Pricing Model that utilized a 60M Beta of 1.02 (SA).
It has always been my personal viewpoint that the most desirable income investments are the ones that remain appealing even without bullish assumptions and also do not require any future growth to generate alpha. Since these very impressive results meet these criteria, I believe that upgrading my rating to very bullish is now appropriate following their recent inclusion in my personal portfolio.
Notes: Unless specified otherwise, all figures in this article were taken from Greens Plains Partners' SEC Filings, all calculated figures were performed by the author.
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Disclosure: I/we have a beneficial long position in the shares of GPP either through stock ownership, options, or other derivatives. 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.