AmeriGas Partners, L.P. (APU) summed up the problem facing the propane distribution industry when it announced fiscal second-quarter earnings: It was the warmest second quarter on record. In fact, it's been relatively mild the last few years, depressing demand and clouding the outlook for propane. Ferrellgas Partners, L.P. (FGP) is facing the same demon, but it's also dealing with two more of its making. Here's why AmeriGas is the better option for most investors.
That was a mistake
In mid-2014, Ferrellgas began building an oil and gas midstream business with the acquisition of Sable Environmental. Over the next couple of years, it added to that division through additional acquisitions. However, when it lost a key customer, the midstream investment quickly turned into a liability. The distribution was slashed a painful 80% at the end of 2016, the board dismissed the CEO who orchestrated the midstream investment, and the former CEO (company founder James Ferrell) was brought back to right the ship.
Image source: AmeriGas Partners, L.P.
There are two main problems faced by the company today. The first is an underperforming midstream business (around 15% of revenues in the fiscal second quarter). Although propane tends to be a relatively stable operation, Ferrellgas needs to fix the problems in midstream or jettison those assets. Neither is likely to be easy to do.
The second problem is related to the first: Ferrellgas has too much debt. That's why the partnership cut the distribution -- so it could push more cash toward the debt overhang. Crucial, as the company's midstream purchases increased debt by roughly 80% between 2014 and 2016.
So, Ferrellgas has a troubled business and too much debt. It knows about these problems and is working to fix them. I believe it will be able to do so, making it an interesting turnaround play. However, if you're only looking for propane exposure, it's a high-risk way to get it because of these self-imposed problems.
Rolling along
Warm weather led to a 6% decline in propane gallons sold at AmeriGas Partners in the fiscal second quarter. Warm weather and weak volumes have been a trend for a couple of years now. It's a headwind every propane company has faced, but it's important to point out that it's the only significant headwind AmeriGas is dealing with right now.
In fact, AmeriGas just increased its distribution for the 13th consecutive year. It was a modest 1% hike, but it was the thought that counted. Effectively, management was saying that distribution increases are significant even when the partnership is facing near-term adversity.
To be fair, long-term debt is a substantial 70% of the capital structure. But that's a lot better than Ferrellgas' capital structure: Long-term debt is over 100% of its capital structure because midstream asset writedowns pushed unitholder equity into negative territory. AmeriGas has also been pushing out its debt maturities, giving it added breathing room for an improvement in the weather. At this point, it doesn't have any significant maturities until 2022. Along the way, it also managed to lower its average interest rate (a double win).
AmeriGas has pushed out its debt and lowered its average interest rate. Image source: AmeriGas Partners, L.P.
Meanwhile, AmeriGas continues to acquire new propane businesses to expand its industry footprint. Note that it is already the largest propane distributor, with a 15% market share. So, it's rolling with the punches on the weather, so it will be in a better industry position when things get chilly again.
To be honest, the mild weather stress that propane companies are facing is theoretically a great opportunity for AmeriGas since it increases the likelihood of mom-and-pop competitors selling out. While Ferrellgas is continuing to expand, too, AmeriGas is doing so from a much stronger financial position.
It's also worthwhile to note that AmeriGas is a part of the UGI (UGI -0.37%) family. That diversified natural gas and propane company is AmeriGas' general partner and owns roughly 26% of the partnership's units. So, unlike Ferrellgas, AmeriGas has a strong parent backing its business and growth.
One problem or three?
Both AmeriGas and Ferrellgas are dealing with warm weather. However, Ferrellgas is also dealing with too much debt and a troubled midstream business. It's a turnaround play that might interest more aggressive investors. But if that's not your thing -- and it shouldn't be for most investors -- then AmeriGas is clearly the better option, here. Weather is an issue, but AmeriGas appears to be handling it with relative ease. And you'll get a nice 8.6% distribution yield while you wait for colder weather to arrive.
