Ferrellgas Partners, L.P. (FGP) has an 8.7% distribution yield. Compare that to the 2% or so yield that you can get from an investment in an S&P 500 index fund, and income-focused investors might be tempted to jump in and buy units in this propane distribution specialist. However, unless you are in the market for a turnaround, you'd be better off avoiding Ferrellgas Partners, L.P. for now. Here's what you need to know.
The core of the partnership
For most of its existence, Ferrellgas Partners has focused on distributing propane. It's a pretty stable and boring business. Ferrellgas largely passes the costs of the fuel on to customers while charging for delivery. That said, propane, which is primarily used in heating applications, is slowly being replaced by other options (like electric heating), so the industry uses acquisitions to offset slow and steady customer attrition. That's pretty much the main story of propane.
Ferrellgas is one of the big players in the space. It's deftly used bolt-on acquisitions since being founded in 1994 to expand its reach across all 50 states. And along the way it has grown into the second-largest domestic propane distributor. That provides it with notable scale, material recurring income, and increased opportunity for further bolt-on acquisitions. So far, there's nothing to be concerned about.
Good intentions, bad result
The problem here is that in 2014 Ferrellgas started up a midstream oil and natural gas business. Over the next couple of years it grew that business to the point that, by the end of fiscal 2016, midstream business accounted for roughly 30% of revenue. The acquisitions that built the new division, meanwhile, were funded with debt.
That's the big problem. At the start of fiscal 2014, Ferrellgas had long-term debt of roughly $1.1 billion. By the end of fiscal 2016, long-term debt had ballooned to $1.96 billion, an increase of more than 70% in just two years. The idea, of course, was that the revenue and earnings from the new midstream assets would help cover the added debt burden. And, as it reached into a new business, Ferrellgas would become a more diversified and stable partnership.
Unfortunately, the loss of a key customer led to a roughly 25% drop in midstream revenue between fiscal 2016 and fiscal 2017. The division's gross profit margin, meanwhile, fell from around 25% to just 8%. Overall, Ferrellgas' adjusted EBITDA declined by 33%, largely because of the poor results out of the midstream division. It's no wonder, then, that Ferrellgas cut its distribution by 80% as it entered fiscal 2017. It knew it would need the extra cash to cover its interest expenses.
Although a string of warm winters has been another headwind for Ferrellgas, for the most part its propane business is doing OK relative to peers'. For example, the partnership managed to increase retail gallons sold by 2% in fiscal 2017 compared to the 1.4% increase at competitor Suburban Propane Partners and a slight decline at Amerigas Partners, L.P. (APU). Note that a heavy debt load also led to a distribution cut at Suburban Propane. Amerigas, however, increased its quarterly disbursement by a token penny a share in 2017.
The biggest problem for Ferrellgas is really the overhang left behind from its diversification effort that didn't pan out as expected. In fact, the partnership's debt levels actually increased slightly in fiscal 2017, which is not the type of thing investors will be pleased to see at an already heavily leveraged partnership.
Not for the faint of heart
Ferrellgas is attempting to fix the situation, a process that includes the ouster of the CEO who orchestrated the ill-fated diversification effort. Although its debt levels rose slightly in fiscal 2017, the big goal is debt reduction. Ferrellgas is working with its creditors toward that goal, but progress is obviously slow. That said, the still-solid propane business should allow it to right the ship over time. With the units down 80% from their 2014 highs, there's material turnaround potential.
But it is not going to be a smooth ride, and most investors are better off avoiding Ferrellgas until it starts to show concrete progress on the debt front and in turning around, or selling off, the midstream business. There are better options in the propane space, such as Amerigas Partners and its still-rising distribution, and more broadly in the midstream partnership space, though you'll trade lower risk for a lower yield.