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Yield Chasers Beware

By Ari Charney on June 18, 2017

I got a bit of a shock the other day while sorting the stocks in Utility Forecaster’s coverage universe by yield.

Though our newsletter has two formal portfolios, we also keep tabs on a much larger group of stocks that operate in many of the same sectors as our favorites.

And one of the stocks that we track—a master limited partnership (MLP) that distributes propane—now yields a staggering 14.7%. That’s a spit-take worthy yield reminiscent of what we saw at the bottom of the energy crash.

Given the warmer-than-average winters we’ve been having, I knew that propane distributors have been having a hard time lately.

Indeed, we hold one of the more conservative propane MLPs in our Income Portfolio and have watched its yield cross the 8% threshold as the market re-rated the stock in light of these challenges. But we remain confident that this particularly name has what it takes to endure until the weather accommodates its business again.

However, we’re less confident about the prospects of some of its lower-quality peers. And that’s certainly underscored by the aforementioned 14.7% yield.

While every company has its own unique circumstances, Ferrellgas Partners LP (NYSE: FGP), which we’ve rated a “Sell” for some time, seems like the canary in the coal mine. Last fall, the MLP’s unit price began to drop, as the market realized a steep distribution cut was likely imminent.

In late November, FGP announced it would be slashing its payout by more than 80%. Even after that action was taken, the unit price continued to decline.

The MLP’s EBITDA (earnings before interest, taxation, depreciation, and amortization) is on course to plunge 32% this fiscal year (ending July 31) and isn’t expected to recover to its former levels until 2019, at the earliest.

Compounding FGP’s woes is a debt burden that’s now four times its puny market cap. In 2020, the MLP will hit a wall of significant debt maturities that will continue for the next four years.

Yield of Dreams?

Now, let’s talk about the propane MLP whose units yield 14.7%. Suburban Propane Partners LP (NYSE: SPH) has held up far better than Ferrellgas, though its units are within shouting distance of last year’s bottom.

In fiscal 2016, SPH saw EBITDA drop sharply, primarily due to that year’s warmer-than-average winter. The situation improved somewhat this year, but not by much.

Although SPH carries substantial debt like many of its MLP peers, this burden still appears to be manageable. At the end of the most recent quarter, net debt to EBITDA stood at 5.3 times, which is pretty high, but an improvement from 5.76 times a year ago. Additionally, its next significant debt maturity isn’t until 2024.

But last year, distribution coverage plummeted to just 0.74 times, and full coverage isn’t forecast until sometime next year.

The question is how much longer the MLP can continue to under-earn its distribution without being forced to cut it.

During challenging times, a company’s line of credit offers crucial liquidity. Accordingly, SPH reached an agreement with its lenders to ease the covenants on its credit revolver through the end of next year. And that should give it some breathing room.

However, when pressed about the sustainability of the distribution during the most recent analyst call, management acknowledged that it was reevaluating its payout along with a number of other financial and operating metrics in light of two consecutive warm winters.

“What’s the right target distribution coverage to provide adequate cushion to space the potential for further softness in demand?” is one question that CEO Mike Stivala highlighted among a litany of questions that management is asking themselves.

While one analyst wondered whether having more flexibility with its line of credit would afford similar flexibility with budgeting for the coming fiscal year, management said they’re looking to be proactive rather than reactive.

After all, having suffered through two warm winters, the company can’t simply assume that means temperatures next winter will revert to the long-term average. They have to be prepared for any eventuality.

The $1.5 billion MLP currently pays unitholders $216 million annually in distributions. Aside from its line of credit, which has $327 million available, the other lever it could pull to maintain this obligation is monetizing non-core assets. However, management has yet to announce any divestitures.

Even though lenders are permitting SPH’s leverage to temporarily rise as high as 5.95 times EBITDA, the MLP isn’t all that far away from this threshold. Indeed, it would only take another $233.6 million in borrowing to hit this level.

Based on distribution coverage forecasts, SPH would need to borrow about $80 million to maintain its distribution this year.

It’s entirely possible that SPH could choose to slash its distribution before next winter. Although only two of the 11 analysts who track the MLP are currently forecasting a distribution cut for this year, the market certainly seems to be discounting the units as if it’s already a done deal.

But it looks like the MLP technically has the scope to see how one more winter unfolds before making this move. Even so, that would be a high-risk bet for yield chasers.


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