Ferrellgas Partners, L.P. (FGP) has long operated in the propane delivery space. That's a boring corner of the energy world, driven by bolt on acquisitions that build reach and scale and offset the slow attrition that plagues the industry. A move to expand beyond this niche, however, has taken a big toll on Ferrellgas. While the pain started in 2016, the full impact of this move really hit home in 2017. Here's why 2017 was a year to forget for Ferrellgas Partners and its unitholders, and what it tells us about the future.
A bold mistake
On the surface, Ferrellgas' idea of expanding beyond propane made complete sense. It would increase the partnership's diversification with assets that appeared to be complementary to its core energy business. The expansion into midstream oil and natural gas really started to take shape under CEO Steve Wambold with the 2014 acquisition of Sable Environmental, a purchase that led to the creation of Ferrellgas' midstream oil and gas division.
Fast forward a couple of years and a few more acquisitions, and midstream had grown to the point where it represented around 30% of revenues in fiscal 2016. But when Ferrellgas lost a key customer the bottom literally fell out from under this business. The big hit came in late 2016, when Ferrellgas announced it would be taking a more than $650 million impairment charge to write down the value of its newly built midstream operations.
The problem was that the business was built using debt, which increased from roughly $1.1 billion at the end of fiscal 2013 to $1.9 billion by the end of fiscal 2016. Looking at that a different way, long-term debt increased by a massive 75% in just three years. And the assets that were supposed to support that were now expected to fall short of revenue targets. Not surprisingly, the CEO who orchestrated the midstream move left the company in late 2016, with the company's founder and namesake stepping back in as the replacement.
It didn't get better in 2017
The big hit for income investors, however, didn't take shape until fiscal 2017 (technically late December of 2016). That's when the company lowered its distribution by a massive 80%. Not a great way to start a new year... and it hasn't gotten much better from there.
For example, the partnership's already heavy long-term debt load has actually continued to rise each quarter through the fiscal year. The overall increase of around 1.5% is, admittedly, modest, but the trend is going in the wrong direction. Ferrellgas needs to reduce debt, especially when you note that the write off pushed unitholder equity into negative territory -- which means long-term debt makes up more than 100% of the partnership's capital structure. Debt to EBITDA, meanwhile, is now at around 10.5 times, the highest level in the partnership's history.
The midstream business saw revenues decline 25% through fiscal 2017. The division's gross margin, however, declined a disastrous 75%. Clearly Ferrellgas isn't getting any help from this business in its efforts to turn things around, which explains the need to amend its credit facility in April of 2017, the second time it was forced into this position in less than a year. Although it's positive that lenders are working with Ferrellgas through this difficult period, it's not a good sign that one change wasn't enough.
But what about the rest of the partnership's business? The core propane side is continuing its slow and steady approach, adding bolt-on assets to build for the future and offset the loss of customers to competing fuel options (like electric heat). However, propane volumes have been under pressure for a number of years due to relatively warm winters -- it was 18% warmer than normal in fiscal 2017. So that business isn't great right now. To put a number on that, gross margin in the propane segment was, effectively, flat year over year.
But stable results in propane clearly aren't going to be enough to offset the pain on the midstream side. In total, Ferrellgas' gross margin fell around 16% year over year in fiscal 2017. This was clearly a year to forget for Ferrellgas and its unitholders on more than one front.
It'll be a while
The big takeaway here, however, isn't that 2017 was a lousy year for Ferrellgas. That was baked in before the year even began. The takeaway is that there's no quick fix that will solve all of its troubles.
Although a lot of the damage has already been done, Ferrellgas is a turnaround play that's only appropriate for aggressive investors looking for a special situation play. Simply put, it could take a long time to straighten things out here. Most investors would be better off looking elsewhere until there's more evidence of improvement on the midstream front. That remains true despite the partnership's lofty 8.7% yield.