Ferrellgas Partners, L.P. (OTC:FGP) sells propane. That sounds like a pretty easy business for investors to understand, and it is. But there's a subtle nuance to the industry model that makes a huge difference on the bottom line. Here's what you need to know to understand how Ferrellgas Partners makes most of its money.

Who uses propane?

The first big thing to understand is that propane's primary use is for heating. It has plenty of other uses, including cooking (think your summertime backyard cookouts), drying crops, and powering forklifts. But the most important driver of demand for propane is the weather.  

Ferrellgas employee waving.

Image source: Ferrellgas Partners, L.P.

That's been a thorn in Ferrellgas Partners' side that last couple of years because the winters have been on the warm side. Which helps explain why the partnership sold 7% less propane in fiscal 2015 than it did in 2014... and 11% less in fiscal 2016 than in 2015. That's a roughly 18% drop over the two year span. No wonder the partnership's top- and bottom-lines have been weak.  

Forget about propane prices

But here's the interesting thing, since Ferrellgas has to buy the propane it distributes the price of propane has a huge impact on the top line. But it basically passes the cost of propane on to its customers, instead getting paid for delivering it to their homes.

For example, the price of propane was 43% lower year over year in fiscal 2015, but the partnership's bottom line only fell about 15%. That drop was driven by the 7% decline in propane gallons delivered, not propane prices. In other words, if you are looking at Ferrellgas, don't focus on propane prices... they aren't the real driver of the business.  

The fly in the ointment

That said, propane delivery made up nearly 85% of Ferrellgas' revenues in the recently ended fiscal second quarter. Filling out the top line was the company's oil and gas midstream business. And any discussion of Ferrellgas today has to include the unfortunate impact of the partnership's decision to diversify into this business just a few short years ago.  

A timeline of Ferrellgas' unfortunate move into midstream assets.

This business shift didn't work out as planned and left Ferrellgas loaded with debt.  Image source: Ferrellgas Partners, L.P.

Outside the vagaries of the weather, the propane business tends to be fairly stable. It grows through bolt-on acquisitions intended to offset the slow drip of attrition as customers switch to other fuel options. Between 2014 and 2016 Ferrellgas, under different leadership, acquired midstream assets that led to an 80% increase in the partnership's debt. The hope was to grow the top- and bottom-lines at a faster clip using the propane business as a foundation. When those investments didn't pan out as expected, the CEO was fired and the distribution was cut by 80%.  

The company has since refocused on getting its balance sheet back in order. So while the propane delivery business is where Ferrellgas makes most of its money, the oil and gas midstream business has been a driving force for the units over the past year or so. And that's going to continue being the case until debt is paid down and new management (the "new" CEO is actually the old CEO and founder) figures out what to do with the midstream assets it owns.

Who, or what's, driving?

So, when it comes to Ferrellgas, there's a complicated mix of issues to understand. The first thing to know is that the partnership gets paid for distributing propane. So weather, and the volume delivered, is more important to the bottom line than the price of propane. And while the price of propane will impact the top line, propane prices generally get passed through to customers, limiting the impact on the bottom line.

But, right now, overriding all of that is the trouble that Ferrellgas is having with the relatively small oil and gas midstream business it was trying to build. This division may have a relatively small revenue impact, but the debt hangover from building this business is going to be a key issue to watch over the near term.

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