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Propane MLPs Are Burning Bright

By Jim Fink on January 5, 2011

Master limited partnerships (MLPs) boast three main attractions: high yields, growing distributions and tax-deferral advantages.

Elliott Gue, MLP Profits

The holiday season is a slow period for news, including any news on energy master limited partnerships (MLPs).  But an acquisition yesterday (Jan. 4th) by propane MLP Ferrellgas Partners (NYSE: FGP) caught my eye. Ferrellgas is the second-largest retail marketer of propane gas in the United States, serving one million customers in all 50 states. It was also the first propane company to organize as an MLP back in 1994.

Propane MLPs: Simple Is as Simple Does

I’ve always liked propane MLPs because they are simple businesses with very stable cash flows. Believe it or not, there are still people living in the U.S. who are not connected to the electric grid. These homes in isolated rural areas rely on generators for their electricity and the propane is the fuel used to run these generators. Propane MLPs distribute this essential gas (usually by truck) to residential and industrial customers, as well as farmers who use it to power irrigation equipment and both dry and ripen their crops. No costly pipelines to build nor finicky regulators to appease.

Roger Conrad, co-editor of MLP Profits, wrote a detailed article on propane MLPs called Propane Partners in Profits. In it, he describes propane MLPs as “utility like” yet unregulated, making them an ideal investment if one is looking for sustainable dividends:

Customers tend to be locked into single supplier, usually by contracts of some sort but more often than not by force of habit. That hasn’t changed despite the growing population of many rural areas. And there’s little sign it will any time soon.

This adds up to steady cash flows for propane distributors. The best have been able to grow by acquiring smaller operators and building economies of scale. And that, in turn, spells an ideal model for running high dividend-paying master limited partnerships (MLP).

Propane vs. Natural Gas

Why not natural gas? Because natural gas is much harder to compress and transport, requiring a temperature of negative 256 degrees Fahrenheit to liquefy compared to only negative 46 degrees for propane. Consequently, propane is a crucial and un-substitutable energy source for off-grid consumers if they want to stay warm in winter, cool down in summer, see in the dark, watch TV, or cook food. Even people on the electric grid often own propane generators in case there is a power blackout, something that is becoming all too frequent with our aging and overburdened grid infrastructure. Lastly, propane is increasingly being used as an alternative transportation fuel (thanks to tax credits), with more than 250,000 vehicles on the road and more than 500,000 propane-powered forklifts.

MLP Profits co-editor Elliott Gue wrote last year in Why Some Natural Gas is Worth $7.28 that propane is one of the main natural gas liquids (NGLs) extracted from “wet” natural gas (30% by volume), as well as from crude oil (60%).

Propane and Liquor Have a Lot in Common

Propane MLPs’ low-risk business model reminds me of Canadian liquor distributorships, which I wrote about in Warren Buffett Loves Liquor. Both are retail distributors with very sticky customer bases. Neither has much, if any, risk associated with the volatile manufacturing and wholesale segments of the business chain. Consequently, the way they compete and win is through acquisitions, which allows them to grow dividends and achieve economies of scale and scope, which smaller operators can’t match.

Both the propane and liquor businesses are dominated by small, “mom and pop” operations that are just screaming to be consolidated.  In fact, the market share of the “big five” propane companies – Ferrellgas, AmeriGas (NYSE: APU), Inergy (NYSE: NRGY), Suburban Propane (NYSE: SPH), and Energy Transfer Partners’ (NYSE: ETP) Heritage division – collectively control only 31% of the propane market. More than 62% of the market is still serviced by over 5,000 small independent retailers.

Ferrellgas Continues to Make Acquisitions

Ferrellgas’ January 4th acquisition of the Georgia-based Bennett Gas Company was its third in fiscal 2011 and just the latest of a long line of 225 acquisitions Ferrellgas has made over its more than 70-year history. One of its most famous acquisitions was its 2004 purchase of BBQ-gas-grill designer Blue Rhino, which I wrote about in 5 Stock Themes for Memorial Day. I really like the Blue Rhino acquisition because it is a great diversifier. Whereas most propane sales occur during the cold winter months, Blue Rhino’s BBQ gas grill and gas canister sales occur during the summer months, thus smoothing out Ferrellgas’ quarterly earnings. 

Ferrellgas’ Earnings Report Signifies Better Times are Coming

Speaking of earnings, Ferrellgas released its first-quarter report on December 10th and it was encouraging. Although the first quarter (August, September, and October) typically loses money, the loss this year was less than last year despite temperatures averaging 27% warmer than last year. The reason for the better performance was significant reductions in operating and administrative expenses, a sign of efficiency and good management. The company’s sweet spots are its second and third quarters during the cold winter months and these are straight ahead. If the current cold snap in the Midwest is any indication, Ferrellgas’ propane sales this year should do very well, indeed.

In the conference call, CEO Stephen Wambold painted a pretty picture:

We are entering the rest of fiscal 2011 in our best financial condition ever, giving us a flexibility we’ve really never had before. There is no public debt due until 2017. We have the finances to handily fund our profitable growth initiatives, both organically and through acquisitions.

The number of deals that we are taking a look at has gone up rather dramatically and it helps that our cost of money is at record lows. I can’t emphasize enough, however, that while we are aggressively pursuing acquisitions, we refuse to detour from our strict criteria – acquisitions must be accretive and they must represent geographic fits.

MLP Profits rates Ferrellgas a “buy” up to $25 per share. Since the stock is currently trading at $26.05, above the recommended limit price, I wouldn’t jump in until there is a small correction down to $25. But Roger has told subscribers that Ferrellgas’ “coverage ratio remains strong for 12 months,” so the juicy 7.7% yield appears sustainable. Since becoming an MLP in 1994, the dividend has never been cut.

Stick with MLPs in 2011 With the Help of MLP Profits

MLPs have performed spectacularly over the past two years and are likely to continue outperforming in 2011. They continue to grow and raise their cash distributions. Consequently, MLPs are not overvalued. Only one propane MLP is recommended in Roger and Elliott’s “Growth Portfolio” and it’s not Ferrellgas. To find out the name of the one propane MLP Roger and Elliott like most right now, give MLP Profits a try today!

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