- Global Partners managed to push their distributions back to new heights quickly after reducing them following the onset of the Covid-19 pandemic.
- Whilst this sounds desirable, they do not sport the desirable attributes of a solid income investment.
- Not only is their cash flow performance very volatile, but their financial position also carries very high leverage and thus makes a distribution reduction quite likely.
- Even if their distributions were sustained perpetually into the future in a bullish scenario, there is very limited potential upside remaining.
- This increases the risks of overpaying for their units, and thus, I believe that maintaining my bearish rating is appropriate.
After initially reducing their distributions following the onset of the Covid-19 pandemic, Global Partners (NYSE:GLP) quickly grew them back to new heights with their yield currently sitting at a very high 10.11%. Whilst their very high double-digit distribution yield is appealing on the surface, investors should not get blinded because, under the surface, there appears to be very limited potential upside remaining at their current unit price.
There are several desirable attributes that make for a solid income investment with the first being steady cash flow performance, which is partly why investors continue owning tobacco companies for their distributions despite the secular decline that tobacco demand faces. Sadly, their cash flow performance is particularly volatile with their operating cash flow, and thus, free cash flow varying significantly.
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After seeing their operating cash flow plunge from $168.9m in 2018 to only $94.4m in 2019, it then surged to a massive $312.5m in 2020 before only amounting to $99.1m for the first nine months of 2021. In fact, if not for a particularly strong third quarter of 2021, their results would have been far worse with their operating cash flow for the first half of 2021 actually being negative $53.6m. This by extension obviously makes their free cash flow fluctuate wildly in tandem, which hinders their ability to cover their distribution payments, and as a result, it impedes their desirability as an income investment. The second desirable attribute that makes for a solid income investment is a healthy financial position, but sadly once again, their financial position is anything but healthy.
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Whilst their moderate net debt-to-EBITDA of 4.29 does not seem problematic, it was a very high 6.63 only one quarter ago following the first half of 2021, as per my previous article. This further highlights the implications of their volatile financial performance, but even if ignored, their net debt-to-operating cash flow of 6.28, interest coverage of only 1.69 and gearing ratio of 65.63% all nevertheless indicate very high leverage. When this is combined with their volatile cash flow, it creates immediate issues for sustaining their risky distributions and thus makes a reduction quite likely within the medium-term, or at best, they have no scope for any material future growth. If interested in further details regarding their financial position, please refer to my previous article that covered this topic in greater detail with nothing material changing since publishment.
Discounted Cash Flow Valuations
When combining their very high double-digit distribution yield with their status as a Master Limited Partnership, it naturally follows that their units are almost exclusively sought for their income-producing prospects. This means that, by extension, their intrinsic value should be closely tied to the present value of their future distribution payments and thus a discounted cash flow valuation that replaces their free cash flow with the former was utilized. 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.
Whilst my valuations normally focus on both conservative baseline scenarios and bearish scenarios to highlight appealing opportunities with limited downside risks of overpaying, this time, a bullish scenario has been utilized to assess any remaining potential upside. This scenario foresees their current quarterly distributions of $0.575 per unit remaining unchanged perpetually into the future.
Even though simply sustaining their distributions at their current level may not necessarily sound bullish, this would see them not only defy their volatile cash flow performance and very high leverage but also navigate the ongoing clean energy transition that will begin sapping fossil fuel demand in the coming decades. Whilst fossil fuels are not going to disappear quickly, their demand will still decrease as alternative cleaner energy sources take hold. This makes sizeable investments required to maintain their earnings, which impede their free cash flow and thus ability to fund their distributions, thereby creating a questionable long-term future outlook even if looking past their immediate issues.
Despite being a bullish scenario, there were still only 60% of the results producing an intrinsic value above their current unit price of $22.76 with a target unit price of $24.15, which is only a small and immaterial 6.11% higher. Whilst there may be some investors who see this as justification for their current unit price and thus support buying their units to collect their very high double-digit distribution yield, it should be remembered that this represents a bullish scenario that, in my view, is unlikely to eventuate and thus has virtually no margin of safety. This actually means that their units have very limited potential upside remaining, and by extension, there is a material downside risk of overpaying for their units, thereby making their units unlikely to generate alpha.
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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 0.77 (SA).
Whilst I love very high double-digit yielding investments, it nevertheless is always important to remember that not every impressive yield is a buy, and in this instance, it is a reflection of their riskiness and questionable long-term future outlook. Given their very limited potential upside even under a bullish scenario whereby they somehow sustain their distributions, I believe that maintaining my bearish rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Global Partners’ SEC Filings, all calculated figures were performed by the author.
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