Investors seeking income from energy stocks will find it difficult to match the impressive yields of Ferrellgas Partners LP (FGP) and AmeriGas Partners (APU), which sit at 11.9% and 9%, respectively. However, this is a textbook case of higher yields representing higher levels of risk.
The leading propane distributors have struggled to deliver growth after multiple years of unusually warm winter weather in their core markets, which lowered propane demand for residential heating. National propane inventories soared and selling prices tanked as a result, which made unwieldy debt levels and large distributions all the more burdensome.
While both businesses enjoyed a return to cold weather last winter, they're increasingly at the mercy of the climate. That could really throw a wrench in operations if milder winters become the new normal, especially considering the businesses -- and balance sheets -- are configured with historical average temperatures in mind. Which high-yield stock is better positioned to navigate these risks?
Image source: Getty Images.
The matchup
Ferrellgas Partners stock has fallen 85% in the last three years. Most of the drop came shortly after management slashed the dividend and rang the alarm bells over a toxic balance sheet, which was sullied after acquisitions aimed at building the midstream business didn't deliver against return-on-investment goals. With the propane market reeling, there was no other way to prioritize debt payments than to divert cash slated for distribution.
Unfortunately, not much has changed heading into the two-year mark of that fateful decision. Ferrellgas Partners brought back its namesake, James Ferrell, as interim CEO and president, and to lead the cleanup. He's deployed an aggressive strategy that doubles down on growth in core residential and retail markets, while offloading non-core assets and securing new capital to deleverage. The strategy has shown mixed results.
In the third quarter of fiscal 2018 (ended April 30), the propane segment grew revenue 22% compared to the year-ago period, but cost of sales swelled nearly 32% in that span. Exiting certain midstream operations allowed the business to grow operating income 18% from the third quarter of fiscal 2017, while generating $33 million in excess distributable cash flow.
Management and investors are hoping the aggressive growth strategy will allow the company to one day pull back on marketing and sales activities and pocket gobs of cash flow. While events could play out as scripted, it's a risky bet for sure. At the end of April, Ferrellgas Partners boasted nearly $2 billion in long-term debt and a net equity value of negative $812 million. In other words, if the upcoming winter is warmer than usual, then this would not be a stock investors would want to be holding in their portfolios.
Image source: Getty Images.
Meanwhile, AmeriGas Partners stock has navigated recent industry turmoil quite a bit better than its smaller peer. Translation: Shares lost about 11% in the last three years, although factoring in distribution payments results in total returns of 15% in that span.
The business announced fiscal second-quarter 2018 (ended March 30) results buoyed by colder winter weather, as temperatures were 14% colder than the year-ago period. That helped to drive higher volumes in both residential and retail, and deliver adjusted EBITDA that was 14% higher than last year.
However, above-average temperatures in February forced management to lower full-year fiscal 2018 guidance from a range of $650 million-$690 million, to a range of $625 million-$645 million. While that's still significantly higher than $551 million in adjusted EBITDA reported in fiscal 2017, it shows the risk posed by seasonally warmer weather in recent years -- even for a single month.
That's further evidenced by capital arrangements management has made in recent years. In November 2017, AmeriGas Partners entered into an agreement with natural gas utility UGI Corporation in which the propane leader can sell up to $225 million in common stock through July 2019 to smooth out volatile periods from above-average temperatures. Of course, that security comes at the cost of dilution to shareholders and, if executed (perhaps triggered by an unusually warm winter in 2018-2019), might begin to cause some worry over the balance sheet. The company ended March with $2.5 billion in long-term debt.
Image source: Getty Images.
By the numbers
These two propane distributors are still recovering from above-average winter temperatures in 2016 and 2017. Perhaps worse is the fact that both are still operating with the expectation that recent years were only an anomaly, and not the new normal.
Investors worried that Ferrellgas Partners and AmeriGas Partners will need to come to terms with milder winters in the coming years would need to know which is better positioned to navigate the changing market landscape. Luckily, a head-to-head matchup of key financial numbers provides a clear-cut answer.
|
Metric |
Ferrellgas Partners |
AmeriGas Partners |
|---|---|---|
|
Market cap |
$333 million |
$3.9 billion |
|
Distribution yield |
11.9% |
9% |
|
Forward P/E ratio |
30.8 |
15.4 |
|
Price-to-sales ratio |
0.15 |
1.42 |
|
EV to EBITDA |
10.5 |
11.3 |
Data source: Yahoo! Finance.
As investors can see, Ferrellgas Partners stock is priced to account for a healthy amount of risk. It trades at a sharp discount to sales compared to its larger peer, but a higher relative level of debt puts it on almost equal footing for the enterprise value to EBITDA ratio. That's unlikely to change until the company can make significant progress deleveraging -- and that could take years, if those efforts succeed at all.
The better buy is...
In this matchup, the bigger propane business of AmeriGas Partners is better positioned to adapt to new market realities that may arise from average winter temperatures trending upward. The company generates a healthy amount of adjusted EBITDA and cash flow, which provides the option to prioritize balance sheet clean-up if needed with only minimal cuts to the distribution. By contrast, Ferrellgas Partners is still fighting its way to a more financially secure future, and it has to navigate quite a few obstacles to succeed.
That said, if this upcoming winter is warmer than last year's, then it may be time for the propane industry to reevaluate the temperature benchmark considered to be normal. That would force difficult decisions for all companies, as deleveraging efforts would jump up the priority list. Therefore, while AmeriGas Partners is the better buy compared to Ferrellgas Partners, I wouldn't want to hold onto either high-yield stock for the long term. The risks don't seem worth it right now.
