For several years, Suburban Propane Partners (NYSE:SPH) was hard to beat. Sure, dividend growth and share-price appreciation were never big, but it made up for them with a very high yield, one that now stands at 11.6%. Who needs share-price appreciation when you have dividend returns like that?
A dividend yield that high, though, typically means something is off and casts doubt on its ability to keep paying shareholders. So let's take a look at what has happened over the past year or so to see if there are any major issues with the payout and what the company can do in the future to put investors at ease.
Hanging on by a thread
Last winter was incredibly difficult for the propane business. Even for an El Nino year, this past winter was a very warm one, with Suburban reporting that the average temperatures were 17% warmer than the prior year. As a result of those warmer temperatures, volume sales were down across the board. At the end of its fiscal year in November, Suburban's volumes of propane and fuel oil sold were down 13.7% and 26.3%, respectively.
Looking at volume is much more reflective of performance than revenue with Suburban and other propane distributors because of the price and cost of commodities. Revenue can fluctuate heavily with the price of commodities, but those costs are mostly passed on to the customer as Suburban takes a cut for the distribution and delivery.
As you can imagine, this led to a big gap in the company's cash flow. Suburban reported $131 million in distributable cash flow for all of 2016. With its annual dividend at $3.55 per share, that represented a distribution coverage ratio of just 0.6 times. Luckily for Suburban, it had enough cash on hand to make up the difference.
Unfortunately, this is something that can only happen once. To make up for last year's shortfall, Suburban burned through $115 million and left it with only $37 million in cash on the balance sheet. If we have another warm winter this time, the company will likely have to reevaluate its payout policy.
What else can it do?
Most investors or armchair managers would say that the company needs to find a growth lever to pull. The problem for Suburban, though, is that there aren't many levers to pull. Propane and fuel oil sales and distribution is a very mature market already, and in fact it's steadily declining as more customers get hooked up to natural gas lines or simply use less because winter temperatures have been increasing.
Really, the only way for Suburban and its competitors to grow is via acquisition or through fierce pricing competition to take market share. Neither option is exactly low-hanging fruit. Management has been adept at the acquisition game over the years. Its modus operandi has been to acquire smaller mom-and-pop operations to grow and not take on large debts to fuel those acquisitions. Sometimes, however, these kinds of acquisitions can be few and far between.
There is always the possibility that the company will branch out of the propane retail and marketing business, but there are two reasons that that may not be a viable option right now. The first is that one of Suburban's largest competitors, Ferrellgas Partners (NYSE:FGP), tried to do this very thing and ended up falling flat on its face. Ferrellgas attempted to acquire some oil and gas midstream assets by buying Bridger Logistics in 2015. One year later, it was forced to write down almost the entire value of those assets because they had not panned out. Worse yet, the failed acquisition pushed the company beyond some of its debt covenants. As a result, it was forced to slash its payout to shareholders by 80% so that cash could be used to clean up its balance sheet.
The second reason is that the company's debt levels are already becoming a little too high for comfort. Suburban's debt to EBITDA stands at 5.6 times. That isn't end-of-the-world high -- and keep in mind that EBITDA over the past 12 months was very weak -- but it is certainly high enough that taking on any more debt should give investors pause.
What a Fool believes
This upcoming winter is a critical moment for Suburban Propane Partners. A harsh winter could restore the company's profitability lickety-split and fill the cash coffers to fight another day. If we see another warm winter similar to what we saw last year, though, then Suburban's business is going to be in trouble and it will bring the company's distribution into question.
With the future of the company's payout riding on something as unpredictable as the weather over the next four or five months, it's probably best to sit on the sidelines to see if Suburban gets winter-weather relief.
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