Suburban Propane Partners (SPH) markets and distributes fuel oil, kerosene, diesel fuel and gasoline to approximately 48,000 residential and commercial customers in the northeast region of the United States. It is one of the largest retail marketers 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. In an article dated 4/21/12, I noted results for the second half the heating season in fiscal 2012 (i.e., quarter ended 3/31/12) will, based on the warmer than usual weather, compare unfavorably with the prior year period and that would indicate fiscal 2012 will also not look good compared to fiscal 2011. A review of the first 6 months of the fiscal year illustrates the difficult business environment faced by SPH:
|6 months ended:||3/31/12||3/31/11||3/31/10|
|Fuel oil and refined fuels||75||102||101|
|Natural gas and electricity||40||52||46|
|Cost of products sold||392||446||399|
|General and administrative||26||25||34|
|Restructuring charges and severance costs||2||–|
|Depreciation and amortization||15||17||14|
|Total Costs and expenses||571||635||600|
Table 1: Figures in $ Millions; fiscal year ends Sep 30.
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In the past 12 months the unit price has dropped ~27% (from $52.77 to $38.51 on 5/25/12). SPH has maintained its distribution per unit at $3.41 ($0.8525 per quarter) for the last 8 consecutive quarters despite deteriorating business fundamentals. At 8.85%, SPH offers an enticing distribution yield. However, investors should review SPH’s results of operations as of its second fiscal quarter ended 3/31/12 (2Q FY2012) in an attempt to ascertain whether the distribution is sustainable. This review should be undertaken independently of looking into the implications of SPH’s $1.8 billion acquisition of NRGY’s propane business announced on 4/26/12,
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 does not define DCF at all and the only non-GAAP measure it reports is adjusted EBITDA. A review of its cash flows and the sustainability of its distributions can still be performed, albeit without a comparison to reported DCF.
Given quarterly fluctuations in revenues, working capital needs and other items, it makes sense to review trailing 12 months (“TTM”) numbers rather than quarterly numbers for the purpose of ascertaining whether distributions are sustainable DCF and whether they were funded by additional debt, by issuing additional units or other sources of cash that I consider non-sustainable. A good starting would be to compare sustainable cash flow to partnership distributions:
|12 months ended:||3/31/12||3/31/11|
|Net cash provided by operating activities||100||148|
|Less: Maintenance capital expenditures||(10)||(11)|
|Less: Working capital (generated)||(13)||–|
Table 2: Figures in $ Millions except Distribution Coverage; fiscal year ends Sep 30.
Table 2 indicates that for the TTM ending 3/31/12 sustainable DCF fell significantly short of covering distributions. The gap has not been filled by issuing debt or equity, but rather by reducing cash reserves. This can be seen from a simplified cash flow statement in Table 3 below:
Simplified Sources and Uses of Funds:
|12 months ended:||3/31/12||3/31/11|
|Net cash from operations, less maintenance capex, less distributions||(31)||18|
|Capital expenditures ex maintenance, net of proceeds from sale of PP&E||(7)||(4)|
|Acquisitions, investments (net of sale proceeds)||(18)|
|Debt incurred (repaid)||(2)||–|
|Net change in cash||(41)||(4)|
Table 3: Figures in $ Millions; fiscal year ends Sep 30.
As of 3/31/12 SPH’s balance sheet was strong with equity capital at $931 million and long term debt only at $348 million, representing a conservative 3.3x EBITDA multiple for the TTM ending 3/31/12. There were no intangible assets to speak of.
On 4/26/12 SPH announced an agreement to purchase the propane operations of Inergy L.P. (NRGY) in exchange for approximately $1.8 billion, comprised of $600 million in the form of ~13.7 million common units (now worth less than $600 million), $200 million in cash and $1 billion in the form of an exchange of NRGY’s outstanding senior notes for new SPH senior notes.
Assuming the distribution rate remains unchanged 13.7 million units will require ~$47 million of cash per annum. I estimate $1.15 billion of debt will be raised; $1 billion for the above-mentioned exchange and $150 million ($200 million net of $50 million of the cash already on the balance sheet) for the cash portion of the acquisition. Assuming an interest rate of 7%, the new debt will require ~$81 million of annual interest payments, bringing the total requirement to just shy of $130 million per annum.
The most difficult variable to estimate is what can NRGY’s propane operations generate for SPH. For the 6 months ending 3/31/12, NRGY generated gross profit on propane operations equivalent to ~24% of propane revenues. In the same period, SPH’s propane operations generated operating profit (i.e., after deducting from gross profit operating expenses, general & administrative expenses, and depreciation) equivalent to ~22% of propane revenues. This indicates to me that SPH can run the propane business much more efficiently than NRGY and, given that NRGY’s propane business generated over $1.4 billion in revenues in the TTM ending 3/31/12, the additional cash it can generate via an acquisition of this scale could significantly exceed the ~$130 million required to breakeven.
Nevertheless, I don’t consider this to be a sufficiently solid basis for initiating a position in SPH and remain concerned about the challenges (declining volumes, declining margins) in the retail propane business. I don’t see SPH providing much of an upside vs. some of the other MLPs I have covered, including for example: El Paso Pipeline Partners (EPB), Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), Targa Resources Partners (NGLS), Plains All American Pipeline (PAA), and Williams Partners (WMB).