Will You Score Big With Suburban Propane's Stock?

I recently looked at a simple way to separate the wheat from the chaff in the stock market. I focused on four areas -- earnings growth, valuation, dividends, and share growth -- and yielded an idea of what kind of returns you can expect from a given stock.

Today I'm going to put a stock I personally own -- Suburban Propane Partners (NYSE: SPH  ) -- through that wringer to see what kind of returns investors can expect from the stock.

But first ...
As I noted in my original article, it's important to remember that we're trying to predict the future here, which is -- to say the least -- a difficult task. For that reason, it's best to try to play sharpshooter and try to nail down one specific outcome. Instead, I like to look at a range of scenarios representing what could happen. That way we're not blind to downside risks nor are we ignoring potential upside surprises.

Earnings expectations
As I outlined in this article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect, and how fast the company has actually grown in the past.

Metric Annual Growth Rate
Analysts' estimates 4%
10-year historical 11.2%
5-year historical 30%
3-year historical (2.3%)
Last 12 months (14.4%)

Source: Capital IQ, a Standard & Poor's company.

Now comes the tough part: How fast do we actually believe Suburban can grow? The propane market is not a growth market; it's at a distinct cost disadvantage versus natural gas, and as such, the proportion of U.S. households relying on propane hasn't really changed in the past 20 years. Acquisitions have been a source of growth for Suburban as well as fellow propane suppliers AmeriGas (NYSE: APU  ) and Ferrellgas (NYSE: FGP  ) , but even so, all three companies have had middling revenue growth over the past decade.

The margins for Suburban have fluctuated over time and are currently at the higher end of their historical range. If we assume that they're going to settle somewhere toward the average historical level then that will provide a drag on profit growth. We can also loop in share count here and note that Suburban's share count has expanded over the years. If that continues, that will hurt growth on a per-share basis.

Assuming anemic top-line growth and a drop in profit margins, I set the midpoint of my growth estimate at a near-flat 0.2% per year. I used the 4% estimate from Wall Street as my upside scenario and used a 4% annual decline -- which could happen through slower growth, lower-than-expected margins, or continued share dilution -- as my downside case.

Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth above, using a range of values can give us a view of our potential returns without requiring a Miss Cleo-type prescience.

In creating our range, a good place to start is where the stock is trading right now and what its historical trading range has been. In Suburban's case, the stock currently changes hands at roughly 16 times its trailing earnings (after adjusting for certain non-operating expenses). Over the past decade it's had a wide trading range with an average annual P/E as high as 77 in 2006 and as low as 8.5 in 2009. However, the stock's earnings multiple has usually hung out between 11 and 15.

For broader context we can also look at how similar companies trade. We've already mentioned AmeriGas and Ferrellgas as very similar, but we can also look at companies in other parts of the industry.

Company

Industry

Trailing P/E

Estimated Growth

AmeriGas Propane distribution 17.6 4.4%
Ferrellgas Propane distribution 53.3 2.6%
Piedmont Natural Gas (NYSE: PNY  ) Natural gas distribution 14.9 4.3%
Questar (NYSE: STR  ) Natural gas production and services 16.3 5.3%
Energen (NYSE: EGN  ) Oil and natural gas production and services 14.9 6.2%

Source: Capital IQ, a Standard & Poor's company.

Suburban's current multiple falls right into the range of the companies above and -- when we consider analysts' estimates at least -- the expected growth for the company is also very similar to this group. So we don't have a case for its valuation rising to "catch up" to comparable companies, but we also don't have to worry about it falling to get in line with the rest of the industry.

Taking all of this into account, my mid-case scenario calls for Suburban's earnings multiple to fall slightly to 15 -- close to today's multiple but within the stock's historical valuation sweet spot. On the upside, I could see investors paying as much as 19 times, while a market chill could drag the multiple down to 12.

Dividends
Since we already considered share count above, that leaves us with dividends.

It should be noted that, as its name implies, Suburban is a partnership. That means that it has distributions, not dividends and those distributions have different tax consequences for investors than normal dividends.

Currently, the company pays distributions at a rate of $3.41 per year. Over the past decade its distribution rate has grown by roughly 5%. Looking ahead, though, the company's ability to pay larger distributions will depend a lot on its growth, and so that 5% growth rate is the upper-end of my range for how fast distributions will grow. I used 2% growth for my midpoint, and my bottom case is that distributions stay flat.

The verdict please!
The end result of all of this is the return we can expect under the various scenarios. Here's what my three scenarios would look like.

Scenario Annual Earnings-per-share growth Earnings Multiple Annual Dividend Growth Expected Annual Returns
Upside 4% 19 5% 13.1%
Mid-case 0.2% 15 2% 4.9%
Downside (4%) 12 0% (2.6%)

Source: Author's calculations.

This isn't a terribly good showing for Suburban's stock. So why is Suburban in my personal portfolio? That's where price comes in. Using the mid-case scenario above, the price I paid would show expected annual returns of 12.6%. The stock has done quite well since I've owned it, and as it's risen, expected future returns have fallen. I haven't been in a rush to sell because it's a good, stable company that pays a healthy dividend. But as the stock continues rising -- it's up 15% over the past six months -- it's gotten to the point where I'm considering better places for my money.

Of course, the future is an ever-changing picture. You need to keep on top of what's going on at Suburban to see whether the stock finds its way to a more attractive price. And you can do just that by adding Suburban to your Foolish watchlist.

Piedmont Natural Gas is a Motley Fool Income Investor choice. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Suburban Propane Partners, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


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