America's natural gas boom has truly been incredible. Since 2009, US gas production has increase by 21%, and the Energy Information Administration is projecting that by 2040 gas production will increase by another 56%.
This growth has been possible in large part by the Marcellus shale, which has increased its production 15.5-fold since 2007 and is expected to surpass the annual gas production of Qatar, the world's third largest gas producer, by September.
A major by-product of natural gas production is natural gas liquids, such as ethane and propane. While most Americans' experience with propane is limited to backyard barbecues, it's actually a vitally important gas, used in everything from generators and home heating systems to small vehicles and agriculture. This article's goal is to show how the boom in propane, an unintended consequence of natural gas production, might offer long-term income investors a chance to get rich from a formerly slow growing and boring industry.
Propane: the key to immense riches?
|MLP||Yield||10 Year Projected Annual Distribution Growth Rate||10 Year Projected Annual Earnings Growth Rate||10 Year Projected Annual Total Return|
|Suburban Propane Partners||7.40%||2.17%||2.40%||9.57%|
As seen in this table, analysts are expecting Ferrelgas Partners (NYSE: FGP ) , Suburban Propane Partners (NYSE: SPH ) , and AmeriGas Partners (NYSE: APU ) to beat the market over the next decade. The key to this expectation is continued strength in propane exports, which will drive margins higher.
Propane is a highly fragmented industry with AmeriGas Partners, Ferrelgas Partners, and Suburban Propane Partners being the largest three providers, yet only commanding 31% market share. The vast majority of the market, 68%, is owned by 5,000+ small independent retailers. This provides a major growth catalyst: industry consolidation.
For example, Ferrelgas Partners has recently acquired 24 regional gas companies.
AmeriGas prefers larger consolidation targets, snapping up Heritage Propane in 2012 for $2.9 billion and adding over 1 million customers and 500 million gallons/year of capacity to its empire.
Suburban Propane Partners really likes to swing for the fences, acquiring Inergy Propane in 2012. That $1.8 billion deal doubled Suburban Propane's customer base, increased its annual propane capacity by 108%, and extended Suburban Propane's presence to 41 states.
Each MLP has a unique strategy for growth moving forward. For example, AmeriGas, the nation's largest propane distributor with over 2 million customers and 1.2 billion gallons of annual propane capacity, is focusing on two key areas: residential canister exchange and commercial accounts.
AmeriGas has 47,000+ canister exchange locations, and right now this segment of its business accounts for just 10% of adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) yet is experiencing 8% volume growth. Commercial contracts are AmeriGas's other major growth driver, accounting for just 5% of adjusted EBITDA yet experiencing 30% volume growth. AmeriGas is expecting both segments to deliver 4%-6% annual EBITDA growth, helping the MLP to achieve its stated goal of partnershipwide EBITDA growth of 3%-4% and 5% annual distribution growth.
AmeriGas has a full-year distribution coverage of 1.2 for 2013 and a history of growing profit margins by 6.8% annually over the last eight years. It's well situated to continue growing its already generous distribution and continuing its track record of market-beating total returns.
Ferrelgas, owner of 46,000+ Blue Rhino tank exchange locations, has a unique alternative way of attempting to grow. In May of 2014 it acquired Sable Environmental for $125 million, 6.25 times 2013 EBITDA.
Sable Environmental operates a saltwater reclamation service in the hyper-prolific Eagle Ford shale in Texas. It currently has five sites in which 8,000-10,000 barrels/day of polluted salty frack water is deposited. The company separates the water from chemicals and oil, resulting in higher efficiency for oil producers and less environmental damage.
Ferrelgas hasn't raised its distribution since 1995, but analysts believe that by 2017 growth in its Sable operations will result in sufficient earnings growth to warrant 8.3% distribution growth through 2023.
In the meantime, with a trailing 12-month coverage ratio of 1.2, yield-seeking income investors can rest assured that Ferrelgas' generous distribution is safe.
Suburban Propane Partners by far represents the worst of the large propane partnerships. Since 2012 it hasn't been able to cover its distribution, with coverage ratios of .72 and .71 in 2012 and 2013. The first quarter of 2014 offered no relief, with a coverage ratio of just .3.
All told in the last 12 months Suburban propane has a coverage ratio of just .49 with no end in sight for the DCF shortfalls.
The combination of booming propane production, growing propane exports, and industry consolidation is turning propane into an income investor's dream sector. AmeriGas Partners, Ferrelgas Partners, and Suburban Propane Partners are three potential ways to profit from these trends, however I feel AmeriGas is the best option of the three. Its distribution growth history is the most consistent, and its industry-leading scale allows it to continually increase profitability.
Ferrelgas' approach of acquiring small, local propane distributors and its foray into the midstream space may help it break its 19-year distribution growth drought, but I would wait for Ferrelgas to prove it can successfully operate in a non-propane industry before investing. Suburban Propane Partners is facing an imminent distribution cut, as much as 50+%, which threatens to devastate investor principle and should be avoided like the plague.
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