Tag Archives: linkedin

Heading Into Winter, Propane Sales Look To Repeat 2014 Results

Summary Propane distributors like Suburban Propane and AmeriGas Partners count on the next few months for substantially all their income. With propane supply near all-time highs, wholesale prices have fallen through the floor. Consumers look to benefit this year, but pricing spreads indicate a repeat of 2014 results. The early indicative data for propane distributors such as Suburban Propane (NYSE: SPH ) and AmeriGas Partners (NYSE: APU ) is a mixed bag heading into the incredibly important winter season. This period running from November-March of each year is an incredibly stressful time for these propane distributors, who derive substantially all of their operating income during the winter heating season. The first hurdle for these companies is the weather. The chance of a deep winter chill currently looks decent for some areas of the United States and mediocre for the rest . Most meteorologists forecast above average temperatures for the Northeast, with below average temperatures for much of the Southeast and East Coast. As the South and Midwest form the largest markets for propane, these forecasts end up being a mixed bag and are hard to call as solidly favorable in one direction or another. (click to enlarge) * Source: EIA.gov From a market perspective, available supply of propane continues to peak well above long-term historical averages, due to the significant bounce in production of the commodity from ever-increasing domestic production. Shortages that were widespread in many markets in 2014 seem unlikely to repeat themselves this time around. This excessive supply has brought wholesale and residential propane prices down, yielding what should be solidly lower prices going into this year’s heating season for consumers. This is a bright spot for those that count on propane to heat their homes, but what does it mean for propane distributors? Fixed Margin Pressures Usually, low propane prices provide a boost for propane distributors like Suburban Propane and AmeriGas Partners. All else equal, low propane costs increase the demand for their products and protects against customers switching to alternatives, such as heating oil or electricity. With propane and other alternative heating fuels more commonly used among rural homes with lower annual incomes, these consumers are much more cost sensitive to price changes than the heating markets served by traditional utilities. Propane distributors, while keeping that fact in mind, still try to maintain a fixed spread between the wholesale and residential cost of propane. This is where they can derive their profit, and we can see the results of that in a comparison from 2014 to 2015 below. (click to enlarge) Trying to protect this fixed margin per gallon is why we see the current market situation in propane today with resiliently high residential propane prices. While wholesale propane prices are down 46% from a year ago according to EIA data, skirting along at $0.50/gallon in 2015 from $0.93 gallon in 2014. Residential prices have remained stubbornly high in the meantime, and are only down 19% year/year. In my opinion, wholesale prices in the U.S. cannot fall much further, so this year will be as good as it can get for propane consumers. At these prices, it is barely worth it for producers to ship, store, and market it for sale. Look for propane exports to increase, as unlike natural gas, propane is more easily shipped abroad for sale, and these price declines make exporting increasingly attractive. (click to enlarge) Heating oil, a chief competitor of propane, looks more profitable going into the winter of 2015/2016. The profit spread is up, but heating oil is primarily used in the Northeast , where it heats nearly 30% of all households. If we remember our 2015 weather forecast data, this area is at this point expected to be a little warmer than usual. The demand may not simply be there for the product compared to 2014. Conclusion With margin spreads down and supply up, propane producers are counting on a chilly winter to drive some additional demand to make up the difference. Without old man winter swirling up some unexpected cold, investors should expect operating income flat to slightly down from 2014 levels. Suburban Propane has the most opportunity for surprise earnings upside over 2014 due to its heating oil exposure, but only if the Northeast comes in much colder than expected. Heating oil is set up to be better currently year/year, and with supply running at long-term averages, a cold shock in the Northeast could drive significant demand for the company.

OGE Energy – Should Investors Buy The Dip?

Summary OGE Energy has suffered lately due to its ownership interest in Enable Midstream Partners. This weakness is likely to remain in place in the short term, but the regulated utility business will bolster earnings. Compared to partner CenterPoint Energy, OGE Energy looks to be the more attractive deal currently. OGE Energy (NYSE: OGE ) is another pseudo-utility option for investors, with both a regulated electric business and an equity ownership interest in master limited partnership Enable Midstream Partners (NYSE: ENBL ). The regulated business does substantially most of its business in Oklahoma, serving nearly one million customers throughout the state (including Oklahoma City). Power is provided through the company’s ownership of 6.8GW of mixed electric generation. By peak capacity, OGE Energy has more production available at its natural gas facilities, however in general the company has relied on its coal-fired units for baseload generation due to cost advantages. The equity ownership in Enable and how it came to be is an interesting one. Enable was founded by OGE Energy, ArcLight Capital Partners, and CenterPoint Energy (NYSE: CNP ) ( prior research by myself on CenterPoint is available here on SeekingAlpha ) in 2013. CenterPoint has a majority interest through the limited partner units, but both parties have equal management ownership rights. CenterPoint and OGE Energy elected to spin-off Enable from Centerpoint in April of 2014 to raise capital, while also swapping their common stock ownership to subordinated to appease prospective investors. As I cautioned investors in October when I wrote on CenterPoint, while exposure to midstream operations has been a trend in many utilities lately and can boost the earnings growth, such operations can also bring volatility to the stock price. In the time since that research was published under two months ago, Enable has fallen over 30%, now down 45% over the past six months. This has dragged both CenterPoint and OGE Energy down along with it, compared to a relatively boring performance for the utility sector as a whole over the same timeframe. Is it time to go bottom fishing for a deal in either of these two names? Historical Results For The Utility Business (click to enlarge) I’ve stripped out the results for OGE Energy’s utility assets above, so this is purely the results from the regulated utility segment. Revenue growth has been solid for the company, primarily due to Oklahoma’s relatively favorable economic profile compared to the rest of the country. Oklahoma City and other large cities have seen sizeable inflows of interstate migration, and charge-offs have been low due to below average unemployment and better than average median household incomes. Operating margins, however, have contracted. This is primarily due to increased depreciation and amortization expenses, stemming from additional assets being placed into service throughout the period. Capital expenditures have been quite high, even excluding the midstream pipeline infrastructure, from 2011-2013. This has moderated somewhat in 2014/2015, but further ramp-up is likely in the coming years. The reason for that is the company’s coal power plant exposure. From 2015-2019, the company estimates it has over $1B in capex costs directly related to bringing these coal power plants into emissions and regulatory compliance, while also converting two to natural gas where it deemed upgrades unfeasible. (click to enlarge) * OGE Energy Investor Presentation, EEI 2015 Like many Midwestern utilities that have traditionally used coal as a primary source of power generation, OGE Energy has been engaged in a lengthy dance with federal and state regulators. It recently won a one year extension for compliance for Mercury Air Toxic Rules (through April 2016) and lost many filings and appeals over the EPA’ Federal Implementation Plan, which it tried to push all the way to the U.S. Supreme Court. While these costs will be eventually passed along to utility customers and likely recovered, this recovery will take time and the burden of the costs over the next several years will likely dent short-term cash flow. The likely cash flow shortfalls in the coming years will be a continuation of recent trends. OGE Energy has raised $1B in net debt since 2011, but managed to minimize the impact of this by using proceeds from the spin-off of Enable as an offset. Given the current market appetite for Enable common units being weak at best, it is unlikely management will elect to sell any of its currently held units to the public to raise cash. To pay for 2016-2019 capex, investors should expect the company to turn back to the credit markets again, making good use of its solid credit ratings. While OGE Energy is already paying $150M in annual interest expense, its leverage ratios remain low (roughly 2.7x net debt/EBITDA on 2015 full year expectations). Conclusion Enable’s results are the wildcard here. In my opinion, if you’re willing to shop for or own OGE Energy, you should also be willing to buy CenterPoint Energy, and vice versa. While CenterPoint trades cheaper at 7.9x ttm EV/EBITDA compared to OGE Energy’s 9.7x, I think the risk/reward favors OGE Energy still. You’re getting a lower levered player with a higher quality regulated business. However, in the end, you might end up with both company’s assets anyway as I think OGE Energy and CenterPoint are ripe for a merger. Both management teams already work closely together due to their interests in the Enable entity, and tying the companies’ fates together makes economic sense. The joined company would enjoy further diversification and the companies operate right next door to one another geographically. Utility consolidation has been an ongoing trend, and a merger here is one of the more obvious remaining moves among smaller utility names in my opinion.

Northwestern Corporation: Great Business Fundamentals

Summary Montana has a healthy, stable population that pays its utility bills. Hydroelectric generation acquisition changed the company for the better. The acquisition did increase leverage. Debt is manageable, but free cash flow should go to paying down debt. NorthWestern Corporation (NYSE: NWE ) is an electricity and natural gas provider that serves the energy needs of hundreds of thousands of customers in Montana, South Dakota, and Nebraska. Unlike many utilities that have diversified into non-regulated activities, NorthWestern remains a pure-play regulated utility. Management has been wise, making strong moves to diversify away from coal-fired generation in a bid to lower regulatory risk. In turn, investors have rewarded this move, with shares returning roughly double the return of the broader utility index since the September 2013 announcement of the purchase. Will this long-term outperformance continue? Renewable Energy Diversification Those that have followed my work know that I have been especially critical of utilities that have not begun to meaningfully diversify away from coal, shifting power generation into cleaner plays such as natural gas and hydroelectric generation. Coal will continue to play an important, but shrinking, role for most utilities in providing stable energy generation for some time. We all know that sometimes the wind doesn’t blow or the water doesn’t run. But its days of dominance are numbered and utilities must position themselves for a future where coal is not the primary source of power generation, primarily due to continued pressure from environmental regulation. From what I’ve found, utilities in the Midwest have been especially guilty of ignoring renewables. NorthWestern Corporation, operating right next door to many of these slow-to-adapt utilities, has not been ignoring industry trends. The $900M acquisition of eleven hydroelectric facilities from PPL Montana was a game-changer for the company, shifting more than 50% of available base-load generation to renewable water and wind. Hydroelectric is a great source of power for utilities to meet light-load requirements on most operational days. There is no fuel cost to worry about, which reduces operational headaches, and the assets are obviously quite clean when it comes to greenhouse gas production and waste. Best of all, NorthWestern got these facilities for a steal of a price. Montana In Focus The vast majority of NorthWestern’s earnings comes from its Montana operations. When you think of Montana, you probably think of something like this: ‘ * Wildnatureimages.com This honestly isn’t too far from the case. Montana is a vast state, with low population density and a high concentration of people over the age of 65. However, this doesn’t make it a poor market for a utility. The unemployment rate has remained under the U.S. national average for many years (currently at an incredibly low 4.0%), and population growth remains stable. * NorthWestern Energy Investor Presentation Along with this, bad debt write-offs for NorthWestern are incredibly low, even during the recession where you would expect a jump in defaults. With more than 80% of Montana revenue coming from residential customers, low unemployment and bad debt write-offs creates a situation of high stability and predictability when it comes to company earnings. For utility owners, this should be far more important than chasing growth potential. Steady as she goes is the name of the game. Operating Results (click to enlarge) Electric operations revenue growth has accelerated, especially for full-year 2015, due to approval of increased rates related to the hydroelectric acquisitions that have come into effect. Gas operations revenue has fallen, but like with all natural gas utilities, this is a function of the underlying commodity price rather than a lack of demand. As natural gas prices have fallen, the cost of gas passed along to consumers as part of rider agreements falls as well, resulting in lower revenue. Investors should remember, however, that NorthWestern’s fixed margin per unit of gas sold remains the same. Lower gas prices mean higher gross and operating margins for the natural gas division, which we can see coming down in 2015’s estimated full-year results. (click to enlarge) As I usually do with utilities, I look to see that operational cash flow can cover capital expenditure requirements and dividend payments. If not, the utility is likely stuck in a cycle of taking on debt to cover its obligations. For NorthWestern, total cash flow from operations will grow greatly in 2015, eliminating some of the slightly larger deficits we saw in 2013 and 2014, likely a result of larger capex requirements for its new hydroelectric facilities. Overall, leverage for NorthWestern has gone up as a result of its hydroelectric and wind acquisitions, which cost a touch over $1B. Total long-term debt now stands at $1.8B, putting its net debt/EBITDA ratio at around 4.5x, which is on the high side but manageable for the time being. Management here has been traditionally cautious – all of NorthWestern’s debt is non-callable, long-term fixed rate debt. The company does have $455M of debt coming due by 2019 ($150M 2016, $55M 2018, $250M 2019), which it will have to refinance. I’d expect this to price around 4.5% on mid-term extensions (coming due in 2030) which will actually reduce the company’s interest expense somewhat given the 6%+ coupons these issuances have carried. Conclusion Overall, NorthWestern is a well-run utility. Management seems to be taking all the right steps and the 3.75% annual dividend yield is solid. 12.5x ttm EV/EBITDA is on the high side, but the company likely carries a premium given the strong growth performance and future earnings profile. I wouldn’t be a buyer at current prices, but I’m keeping the shares on my watchlist.