Tag Archives: opinion

AmeriGas Partners: Proceed Cautiously

Summary 8.5% yield is enticing for income investors, but has risks. Heritage Propane acquisition just isn’t working well; leverage up, earnings per share are down. Propane faces stiff competition from continued natural gas expansion and increasing market supply. AmeriGas Partners (NYSE: APU ) is a nation-wide propane distributor operating as a MLP. The company’s primary business model is to supply propane to rural areas where natural gas is not run due to the costs involved. To operate as a business that serves these small communities, AmeriGas has had to develop significant transportation and distribution infrastructure, helping give the company the current market advantage it holds. Propane is a multi-faceted commodity. The fuel source is plentiful, easily separated from crude oil during refining and also extracted as a byproduct from oil/natural gas wells. The resurgence of fracking in the United States has unlocked a major supply source for the fuel that is unlikely to go away anytime soon – the Marcellus and Bakken shale plays are expected to produce billions of gallons of propane annually by 2020. However, propane is less energy efficient than other sources of power generation like gasoline and natural gas. This relative energy inefficiency will continue to have propane play second fiddle to more efficient fuels. Over the past decade as energy markets have evolved, propane prices have collapsed in comparison to alternatives like gasoline and home heating oil. Toughening the market for AmeriGas, residential consumer propane use has shrunk as well, outside of years with exceptionally cold weather. The future of the fuel primarily relies on commercial uses such as use in internal combustion engines. However, commercial users have more options than residential buyers who have little to no access to alternative sources of heat production. Any sustained growth in propane prices compared to alternatives will be met by falling demand by end-users. Overall, given my views on natural gas pricing remaining low despite strong demand from utilities and chemical companies, my views on propane fall in the same category. I’m in the camp that propane prices will remain lower for longer. To offset losses, the company has to rely on continued expansion in propane cooking and water heating. This will likely at best offset the downtrend in residential heating markets. This doesn’t mean that AmeriGas is doomed, but the company does face headwinds given the environment it is currently competing in. Whatever your opinion on propane’s future, there isn’t any denying that the North American energy market, propane included, is in the middle of significant and profound change. Mixed Bag Of Operating Results *numbers in millions CAGR 2015 (est) 2014 2013 2012 2011 Total Revenue 3.76% 2942 3713 3167 2922 2538 Cost of Revenue -3.44% 1395 2121 1660 1720 1605 Operations & Maintenance 11.21% 950 964 944 889 621 Depreciation & Amortization 19.39% 193 197 203 169 95 Total Operating Expenses 2.67% 2592 3250 2774 2764 2333 OpEx as % of Total Revenue -1.06% 88.10% 87.53% 87.59% 94.59% 91.92% Investors should note that the above are fiscal year results – AmeriGas’ fiscal year ends 9/30 which means only one quarter needed my estimation. As investors can see, 2015 total revenue is set to fall over 20% primarily due to a more mild winter season compared to prior years. On the plus side, gross and operating margins have improved and operating income expanded. It might surprise investors to find out that 2011 was the more profitable year. Why? The acquisition of Heritage Propane in 2012 was incredibly expensive, paid for by nearly $1.5B in cash that had to be raised in the debt markets, along with a $1.1B dilutive stock issuance that diluted shareholders nearly 40%. Total debt now stands at $2.2B, compared to $929M in 2011 and AmeriGas now pays $100M more in interest expense annually than it used to, even in a falling interest rate environment that has improved. Debt used to finance the purchase wasn’t cheap – the majority ($1B due 2022) carries a burdensome 7% rate that cannot be refinanced due to covenants until 2017. I have yet to see much value in this purchase. While operating income has nearly doubled, shareholders haven’t seen any reward as earnings per share has moved nowhere. The estimated $2.38/share AmeriGas will earn in 2015 is less than the $2.93/share the company earned in 2011. *numbers in millions CAGR 2015 (est) 2014 2013 2012 2011 Cash From Operations 30.07% 521 480 356 344 189 Capital Expenditures 7.54% 111 114 111 103 77 Dividends Paid 20.45% 362 347 327 272 172 Resulting Free Cash – 48 19 -82 -31 -60 Additionally, when evaluating utilities I like to see how the cash is used. When looking at a utility, there are two main uses for cash from operations: capital expenditures and dividend payments. If investors in their research see continued years of negative free cash after these two items are paid, eyebrows should be raised. Utilities with healthy leftovers have cash balances they can use for acquisitions, debt retirement, share repurchases, or just setting aside cash for a rainy day. This is an area that has seen improvement for AmeriGas, although I would like to see more improvement than what I’ve seen. As another critique, historically, approximately 60% of capital expenditures have been “maintenance” capital expenditures, or capital expenditures that are done simply to maintain the current asset base. So from a growth perspective, only 40% of 2015’s capital expenditures, or $45M, is used to build new plants, storage devices, or purchase new equipment. Future growth may be curtailed if this investment remain slow. Conclusion Investors were skeptical back in late 2011/2012 over whether the Heritage Propane acquisition was a good deal. Several ratings agencies downgraded the company’s debt on questions whether the cost (11x EBITDA) and risk of failed execution high. This is part of the reason why AmeriGas’ debt issued to fund the acquisition carried such unfavorable rates. Looking back from today, it appears those fears were largely founded. Investors who are likely salivating at the current 8.5% yield should question whether that yield may remain stagnant in the years to come. Management wants to target 5% annual targets but free cash flow currently cannot support much further growth. I can see expansion if we have a string of cold years in 2016 and 2017 while interest rates remain low. Strong operating results before a debt refinance option opens up could free up some cash flow to support some future dividend raises. Beyond 2018, the source of tens of millions in additional free cashflow to fuel 5% dividend increases each year becomes murky.

COPEL Is Much More Stable Than CEMIG, But The Potential Upside Is Also Lower

Summary COPEL’s business is sound, with slow growth, low debt, a good dividend, good fundamentals and a good, stable historical performance. Due to the situation in Brazil, there is still more downside potential for the stock. CEMIG is a much more risky play, but the upside is also much higher. Introduction I recently wrote an article where I analyzed investment opportunities in Brazil that are listed on the NYSE and gave an overview of the economic situation. I found four interesting companies, of which BrasilAgro (NYSE: LND ) and Brasil Foods S.A. (NYSE: BRFS ) are good, but their P/E ratio is too high. This leaves us with two electrical companies, CEMIG (NYSE: CIG ) and Companhia Paranaense de Energia – COPEL (NYSE: ELP ). I have already written about CEMIG here and here , so in this article, I will analyze COPEL. About ELP ELP is the largest company of the State of Paraná (South Brazil), and serves electricity to 4,370,200 units. The company uses 18 hydroelectric plants that give 99.5% of its own electrical production, 1 thermal plant and 1 wind plant, with total installed capacity of 4,754 MW, a transmission system with 2,302 km of lines and 33 substations, a distribution system which consists of 192,116 km of lines and network of up to 230KV, and an optical telecommunication system. The company was founded in 1954, and has been listed on the NYSE since 1997. The State of Paraná is the major shareholder, with 58% of voting shares. There has been a lot of regulatory turbulence in the energy sector lately, especially with CIG losing 45% of its electricity generation capacity due to lost concessions. Energy prices increased and are currently under the red flag 3 regime, meaning that the electrical utilities sector is under pressure. The result of this is that ELP’s revenues increased 32% in Q2 2015, mostly due to price increases. Operating expenses increased even more, around 38% in the same period. The Business One of the main issues in the sector is that all the assets are mostly under concession from the government, but with the latest news on concessions, where the Federal Audit Court authorized the government to renew for another 30 years the concessions for electricity distributors whose contracts expire between 2015 and 2017, the situation is more stable now as compared to that a month ago. This is good news for ELP, as in the Q2 earnings conference call, the company did not know if its distribution concessions would be prolonged. As for electricity production, the situation with ELP is much more stable than it is with CIG, because ELP has only 5% of electricity production in doubt for 2015, whereas CIG had 45% of production in doubt, and eventually lost it. According to ELP’s CEO , the company will bid to renew the concessions and are pretty sure it will happen. The two plants in question are the Parigot de Souza and Mourão plants. ELP is also developing new projects, building 2,000 km of new distribution lines and developing new wind farms, with three new farms expected to start up in upcoming weeks. Fundamental Analysis The current P/E ratio is 7.91, and the price-to-book value is 0.6. In Table 1, you can see the main fundamental indicators for ELP and their stability in the Brazilian currency. Table 1: ELP Fundamentals 2010-2015 (Source: Morningstar ) In the Brazilian currency, ELP is able to transfer the increase in prices to its customers, which shows it to be a great hedge against inflation. The net income is pretty stable for a regulated electrical company, and it can be assumed with a high degree of certainty that ELP will continue to operate less or more positively in the future. The dividend is also stable, and the company has a policy of paying at least 25% of its net profits in dividends. This means that with the trailing earnings, an investor can expect minimally US$0.25 per share at the current exchange rate. This would give a 3% dividend yield at current prices and exchange rates. The gross margin is slowly deteriorating, but we can expect it to improve as soon as the extraordinary circumstances in the Brazilian energy market pass. Technical Analysis The main issue here is not ELP’s business or its fundamentals, but the volatility of the exchange rate between the US dollar and the Brazilian real. In Figure 1, you can see that an end to the depreciation of the real is nowhere to be seen. Figure 1: Brazilian real per US$1 from 2005 to 2015 (Source: XE.com ) I cannot predict what will happen here in the next few years. Currently, the situation in Brazil is far from stable, but in the period from 2009 to 2011, the real appreciated against the US dollar by 60%. We could say that there is blood on the Brazilian financial markets now, and usually, these are the best times to buy. But the main question is: How low can the real go? On the other hand, if we see an improvement in the political and economic situation in Brazil, the exchange rate trend would quickly switch and create a point of stability at a certain level. This trend reversal could give a 25% currency gain and add an extra 25% to the dollar EPS of ELP. This is a scenario that would easily create a 50% return for international investors. But we would need a crystal ball to know when the bottom will be reached in Brazil. Conclusion If ELP were a European or US company, I would probably buy it at these ratios, expecting a healthy 13% yearly return and a 3-4% dividend that would allow me to repurchase shares. With the uncertain situation in Brazil and the real depreciating at a 10% monthly rate (August and September 2015), I want a much wider margin of safety. The margin of safety that I would look for to feel comfortable investing in ELP would be one that gives me a 15% return even if the real depreciates by another 50%. This means that for US$1, we would get R$6. In such a scenario, ELP’s EPS would be US$0.66, and to get a 15% return, the P/E ratio should be 6.66 – meaning that a safe entry-level stock price for ELP is US$4.4. We are still far from that, but everything is possible considering the current situation. ELP is very stable, and Brazil is very unstable for sure in the short term, but potentially stable in the long term. Such a situation makes me believe that there might be a chance of the stock falling a little bit more, and thus, increasing the safety margin for investors. My advice would be put this company on a watch list, estimate your required rate of return for such an investment, adding to that the potential further depreciation of the real, and thus get to a safe entry price for yourself. Comparison with CIG ELP’s price-to-book ratio is 0.6, and CIG’s is currently at the same level. The P/E ratio is 8 with ELP and 3 for CIG, but with the unclear future earnings stream for CIG due to the loss of the concessions on 40% of its energy production, the difference is justified. I do not see potential spectacular earnings growth with ELP, because it is a stable company that aims for sustainable growth, whereas with CIG, everything is possible due to the management’s more risky approach to business. CIG has the potential to bring EPS to $US1.5 per share that would give a P/E ratio of 1.13 at current prices and a dividend yield of around 40%. The risk-reward ratio is 50% downside and 50% upside with ELP, while with CIG, it is 50-100% downside and 600% upside. I will continue to follow the two companies, and if the divergence between the perception the investor community has about Brazil and the businesses’ results continues to grow, thus lowering the potential downside, I will start buying. So, for now, I will put both companies on a watch list and let you know more in the future.

Who Wants SCHC? I’m Trying To Buy Some

Summary The Schwab International Small-Cap Equity ETF is getting very appealing again as it is dipping much lower amid international fears. I’ve been admiring this ETF for a while but couldn’t get the right entry price, I have a limit order pending. The ETF has a large volume of small-cap securities that are difficult to acquire for your portfolio which enhances diversification. The international equity allocations are fairly diversified. I wouldn’t mind even more diversification, but this is certainly good. I see a reasonable allocation of around 3% to 5% of the portfolio value to SCHC. I’m also using SCHF for part of my international position. The Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) is one of the ETFs I have been keeping an eye on over the last month or two. On September 22nd, 2015, I put in a limit buy order for some shares. I’m still waiting to see if the price drops far enough to trigger the order, but it is “good til cancelled” and the standard period is 60 days until it would automatically cancel. Why I like SCHC The Schwab International Small-Cap Equity ETF is a fairly nice fit the diversified equity portfolio. While there are many options for international exposure, there are only a few of them that focus on the small-cap international market. Quite a few years ago there was a theory that small capitalization companies were capable of delivering superior performance because a lack of coverage by analysts would result in less efficient pricing and therefore higher risk premiums could be demanded. With the advent of total market indexes and broad market indexes, the demand for small cap companies increased and it was capable to effectively diversify the risk. International markets tend to be less developed than the U.S. financial market and I believe we may witness the same kind of performance in those markets. As more research is done and risk premiums are reduced, the international small-cap market may see some fairly solid performance. Heads I Win, Tails We Tie If my theory fails to pan out, there is still a benefit to SCHC that qualifies as “good enough”. Because the fund is focused on small-cap holdings it has very little overlap with other major international funds. I already use the Schwab International Equity ETF (NYSEARCA: SCHF ) for part of my international exposure. While there may be some solid correlation in returns due to similar risk factors for international markets, the individual holdings are very different. By adding a small position in SCHC to my international holdings I’m hoping to gain a slight amount of additional diversification. If SCHC simply matches SCHF for total return over the next few years but excels in different quarters, there will still be some benefits to be had from rebalancing the positions. These are probably going to be limited to fairly minor gains, but minor gains rather than a loss is a perfectly acceptable outcome to me. Volume of Holdings SCHC has a fairly impressive 1,666 holdings to go with an expense ratio of .18%. Since the expense ratio remains under .20%, it isn’t high enough to really chase me off and it feels reasonable when considering the sheer volume of international small-cap holdings. These are not the most liquid and easiest to acquire securities. All in all, I feel that I’m getting some value out of paying that ratio. Geography The following map breaks down the geographic allocations of the fund: (click to enlarge) I wouldn’t mind seeing slightly larger allocations to the smaller sections, but this is certainly a reasonable diversified batch. The top 3 countries are on different continents, which is a refreshing change from some of the “international” ETFs that place almost all of the equity in Europe. I have no issue with holding equity in European countries, but I’m buying these funds for diversification so seeing a strong mix of different markets is very favorable. Ideal Allocation I like SCHC as an allocation for 3% to 5% of my portfolio. I would still aim to keep a significant portion of the international equity allocation in the larger capitalization markets that may be more resilient to a sell off. If the markets really turn south and SCHC does sell off, I would want to keep increasing my allocations to take advantage of fear based selling. I think the best way to do that may be to just set ranges for where I want the position to be within the portfolio and to rebalance whenever it gets too high or too low. Since the ETF is free to trade from Schwab accounts, I can rebalance without much concern. What Goes with SCHC? Naturally investors will want a core position in domestic equity funds, but SCHC also benefits from being in a portfolio with long duration treasury securities. Those securities have a negative correlation with SCHC and would be ideal for a portfolio that includes rebalancing. Conclusion After another day of fear drove market prices around $28.50 per share, it seemed worth tagging on a limit buy order and seeing if I’d be able to snag some shares of this ETF. I’ve liked it for a while but didn’t have an order ready and waiting on the August 24th event where so many funds went on incredible sales. Now that we are seeing another attractive entry range, I have an order waiting to scoop up some shares. Disclosure: I am/we are long SCHF. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.