Sprague Resources LP
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Sprague Resources’ Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded. I’ll now turn the call over to your host David Glendon. Please go ahead.

[David Glendon:]

Thank you, Stephanie. Good afternoon everyone and welcome to the Sprague Resources third quarter 2015 conference call. Joining me today are Gary Rinaldi, our Chief Operating Officer and Chief Financial Officer; John Moore, our Vice President and Chief Accounting Officer; and Paul Scoff, our Vice President and General Counsel. Following my introductory remarks, Gary will review our financial results. I'll then open the call to questions. As a reminder, today's call will include forward-looking statements. While Sprague believes these statements to be reasonable as of today's date, future results are subject to many risks and uncertainties that are difficult to predict and outside of management's control. Any forward-looking statements are qualified by the Risk Factors in our most recently filed SEC Form 10-K, our Form 10-Q for the period ending June 30, 2015 and future filings with the SEC. Sprague undertakes no obligation to publicly update or revise any forward-looking statements. Also we adjust our GAAP results for the unrealized portion of our derivative hedges and report adjusted EBITDA and adjusted gross margin. Discussion of our use of non-GAAP measures and reconciliations between non-GAAP measures and their most comparable GAAP figures are found in our press release filed with the SEC or in the Investor Relations section of Sprague's website. With these third quarter results we believe Sprague remains in a unique position among the universe of MLPs. On Page 2 achieve strong EBIT and DCF growth with growing distributions high coverage and modest leverage. Adjusted gross margin in the first three quarters of 2015 with 17% above its comparable 2014 period, adjusted EBITDA was 6% higher and distributable cash flow is $8 million or 15% higher than the same period in 2014. Each of our business segments have contributed to this outstanding performance. In the first nine months of 2015 we've grown refine product sales volumes 9% by capitalizing on the strategic purchase of the Castle business and continuing our expansion of sales of ultralow sulfur heating fuel in the New York City metropolitan area. Offsetting residual fuel declines in generating a 22% higher adjusted gross margin versus a year ago. In advance of the winter weather our refined products customers are finalizing supply contracts with us and we're capturing higher volume commitments for many of them. We attribute their customer loyalty to our ability to keep them supplied and difficult weather conditions. Into load their truck quickly and efficiently other terminals driving their own productivity metrics. Natural gas volumes for the first nine months of the year of growing 12% and well adjusted gross margin relative to 2014 is lagging year ago levels by 5% primarily due to more subdued cash market volatility in the first quarter of 2015. Our result still represent a 43% improvement over the first nine months of 2013 a more normal year for weather demand. In addition our first year results generated from the Metromedia assets have exceeded the initial business case we set forth. In our systems integration efforts and consolidation of utility poles have is entering the coming winter and better position to leverage our logistics expertise. In the optimization opportunities it affords across a much larger customer base. Our material handling business continues to prove how valuable leveraging our proprietary terminal infrastructure is to Sprague's performance. Materials Handling adjusted gross margin for the three months ended September 30 was 23% higher than the same period last year and accounted for nearly all of the quarters year-over-year increase in total adjusted gross margin. For the year-to-date Material Handling is contributed 26% greater adjusted gross margin. Thanks to returns on multiple expansion capital investments we've made across our terminal system in recent years. Throughout our terminal network operators stand ready to serve customers by ensuring ships can bringing assault needed to rebuild inventories depleted by last winter storms or keep the terminals free of ice and snow so heating oil retailers can load safely and efficiently. Turning briefly to the acquisition outlook we’ve been clear about our strategy of combining organic growth with strategic M&A at a pace and valuation that allows Sprague to maintain double-digit percentage annual distribution growth, while we’re not in a position to provide clarity on specific prospects, I can tell you that Sprague's transition to an MLP that’s undoubtedly improved our ability to grow through acquisition by opening more doors for discussion and lowering our cost of capital. Having said that a recent participation in several public auctions has indicated the valuations are not necessarily reflective of the continued weakness in MLP equity capital markets, we’ll maintain our disciplined approach to acquisitions with continued emphasis on non-auction properties. Within that context we continue to see opportunities to execute on strategic and accretive M&A in each of our respective business segment. Before I turn the call over to Gary for more detailed review of the quarter I want to reiterate our belief that our long history of growth in Sprague's diversified midstream business model providing energy and materials handling services to commercial and industrial customers continues to offer compelling value proposition to MLP investors. We are looking forward to leveraging investments we made this summer and serving an expanded customer base this coming winter season, continuing to prove ourselves as the energy and materials handling supplier of choice to our customers. Gary?

[Gary Rinaldi:]

Thank you, David and good afternoon everyone. Sprague's adjusted gross margin was $50.3 million in the third quarter of 2015 an increase of 5% compared to the year ago quarter. In the first nine months of 2015, our business segments have generated $205 million of adjusted gross margin which is 17% higher than the comparable 2014 period. Third quarter adjusted EBITDA was $12.6 million a decrease of $6 million year-over-year, while the year-to-date adjusted EBITDA has increased $4.9 million or 6% compared to the first three quarters of 2014. Distributable cash flow for the quarter was $7.3 million, 16% higher than the same period last year and was $8 million or 15% higher than last year for the nine months ended September 30, Sprague's operating expenses increased $3.5 million year-over-year to $17.9 million during the third quarter. The year-over-year increase was primarily related to operating expenses at our Bronx, New York terminal acquired in the fourth quarter of 2014. And to a lesser extend higher stockpile expenses related to the material increase in windmill storage activity at our Searsport terminal. Sprague's SG&A cost increased $5 million in the third quarter primarily due to the Castle Oil and Metromedia acquisitions in the fourth quarter of last year and to a lesser extent increased employee-related costs and professional fees. Now turning to our business segments, in refined products sales volumes decreased 11 million gallons or 4% compared to the third quarter of 2014 as lower sales and heavy oil were partially offset by increases in distillate and gasoline volumes. Sprague still managed to generate $31.9 million of adjusted gross margin for the quarter only 1% less than last year this was despite the modest net volume decline and lower cost of market write-downs of asphalt inventory and distillate volumes as well as lower railcars subleasing revenues at Kildair. While weaker heavy oil demand is not surprising, we are pleased with the increase in distillate and gasoline sales during the quarter, those nearly offset the entire heavy oil decline, higher distillate volumes have been driven by last year’s acquisition of the Bronx terminal and the positive customer transition to our wholesale offering of ultra low sulphur fuels at this location as well as our expansion into the locally delivered commercial heating fuels market. Gasoline volumes were higher year-over-year as declining prices and regional refinery interruptions created incremental sales opportunities. For the first nine months of 2015 Sprague's refined products business has generated 22% increase in total adjusted gross margin over the prior year. Due in part to Sprague's growing online marketing presence with 6% more customers execute 11% more transactions across our proprietary Sprague real time pricing platform. Refined products has also poised the benefit from several expansion capital projects underway in the Bronx and at Kildair. First, we will soon begin loading more than 30 types of premium and bio blended distillate products in the Bronx. Thanks to $3 million rack upgrade that automates control systems, reduces loading times for customers and greatly increases the variety of products our teams can market generating incremental volumes and revenues. Second, I am pleased to report that Kildair has begun work on $4.5 million expansion capital project to upgrading converted to light oil storage the two remaining heavy fuel tanks totaling 420,000 barrels which were required in 2011. You may recall in my prior discussion of these two additional tanks in our evaluation of several alternatives for the excess capacity. We expect return associated with the tank conversion to begin in 2016. Both of these investments showcased our focus on continuing to find opportunities to leverage our asset base in new ways and generate incremental distributable cash flow. In our natural gas business, results reflect continued execution of Sprague’s down market strategy servicing smaller volume commercial customers. Third quarter volumes were 2% higher than last year primarily as a result of the Metromedia acquisitions, but also reflecting the fact that we continue to replace large-volume process load account with more numerous with smaller volume customers at higher margins to have limited natural gas demand during this summer. For the quarter natural gas adjusted gross margin was essentially flat decreasing $181,000 compared to the prior year which highlights the underlying strategic shift in our customer base. With the addition of more smaller size basic customers there is a wider variance within unit margins in the first and fourth quarters versus those in the second and third quarters and our smaller size customers generally are not burning much natural gas that Sprague is still incurring transportation demand charges associated with these accounts. Now, one year passed, our acquisition of Metromedia Energy we have substantially growing our downstream customer base at higher overall margins consistent with our long-term growth strategy and we expect our natural gas results on a full-year basis to reflect the successful execution. Finally, materials handling adjusted gross margin increased $2.2 million or 23% to $12 million as we continue to benefit from higher windmill component handling operations at Searsport, opportunistic stores placed at Kildair and Asphalt handling that came of our acquisition of the Bronx terminal last year. In addition, higher pulp volumes were partially offset by lower newsprint volumes both at our apartment terminal. Our materials handling business continues to grow by attracting new customers and investing in projects which further leverage Sprague’s real estate and terminal workforce. For example, we recently received approval to provide bulk handling services to a new scrap metal customers in Searsport and our ability to accommodate utility scale window handling projects also in Searsport was largely due to the completion of our $900,000 investment upgrading and expanding storage pads of the terminal, making Sprague a critical logistical component for multiple projects throughout our footprint. Our materials handling investments will continue in 2016 specifically River Road where we will invest $800,000 to upgrade the [indiscernible] structure to support heavy equipment allowing Sprague current customers, additional flexibility and the potential for us to attract new customers that we could not service before the investment. Turning now to our balance sheet. Sprague's permanent leverage of 2.8 times or trailing 12-month adjusted EBITDA remains within our long-term target of between 2 to 3 times. Sprague's available working capital liquidity was $214 million as of September 30 and $94 million of capacity remains in our acquisition facility. Similar to last year we expect to pay down a portion of our acquisition debt later this year with excess cash flow naturally deleveraging Sprague's balance sheet. As David mentioned earlier, we are actively working on multiple acquisition possibilities and have liquidity within our credit facility and associate accordions to finance them. Making strategic acquisitions in each business segment while maintaining conservative leverage and generating high coverage without equity issuance reflects the strength of Sprague’s balance sheet. But as even more notable given that is occurred over a period of time when energy prices decline substantially. As we have said on this call in the past Sprague’s discipline hedging strategies in conjunction with the risk controls their monetary them provide visibility into the impact of our decisions in our business. Year-to-date visibility to observe and adjust the effect of changing market dynamics as a lot of business to produce outstanding results even in the midst of volatile and lower energy prices. Sprague’s distributable cash flow is $7.3 million in the third quarter compared to $6.2 million a year ago. The 16% positive year-over-year variance is primarily due to the distributable cash flow generated at Kildair lower cash taxes as well as the add back for the mentioned non-cash tank volume inventory right down. Sprague’s third quarter distributable cash flow produces the seasonally expected coverage of 0.7 times for the quarter in a healthy two times on a trillion 12 month basis. As we enter the fourth quarter we expect to our strong performance to continue and our reconfirming a previous full year adjusted EBITDA guidance between $105 million and $120 million. With most of our seasonal maintenance we are completed total maintenance CapEx for the year should be between $7 million and $10 million and assuming oil prices remain the current range we believe our cash interest expense range between $23 million and $26 million. Incentive compensation to be paid in units also continues to be in line with last year. We continue to discuss the pace of distribution growth with the board and they remain supportive of our near-term guidance of $1.05 per unit quarterly increases as well as a long-term guidance the Sprague will delivery unitholders double-digit percentage annual distribution growth over time. Please note that this guidance is based on assumptions of normal whether and market structure of conditions. And finally the third quarter once again demonstrated our criminal operators and drivers ability to safely execute their duties. The performance is particularly notable and lighter the significant third quarter Materials Handling activity at both Portland and Searsport, but we set records. For [indiscernible] volumes and completed the safe transshipment of 61 complete Windmill units through Searsport and less than a six-month period. In addition we recognized 13 Sprague Fleet drivers during the national driver appreciation week with safety awards including two to work for 14 years without preventable motor vehicle accident. This concludes my remarks. I'll let David wrap up before we take questions. David?

[David Glendon:]

Thank you, Gary. I also want to thank all of the employees for their outstanding efforts in the first nine months of 2015 and their hard work preparing for the winter ahead. I look forward to sharing the results of those efforts with unitholders in the New Year. We are now happy to answer any questions on the call.

[Operator:]

[Operator Instructions] Our first question comes from the Gabe Moreen with Bank of America Merrill Lynch. Your line is open.

[Gabe Moreen:]

Hi, good morning and good afternoon everyone. Just a couple of questions for me one is in terms of the M&A market out there just curious on your comments around multiples and pretty high up there is that, in terms of what you're looking and what’s you are working at the moment. Are you looking internally stuff in your comment supply there are you still looking kind of books of business on the natural gas marketing side even seen competition their, so just curious you can elaborate a bit?

[David Glendon:]

Is there another question or do you want to handle that one first Gabe.

[Gabe Moreen:]

You can take that one.

[David Glendon:]

All right thanks. So my reference to public processes was primarily related to terminal acquisition and properties that have been out in the action process and those multiples remain quite high. Our activities are in all three of our business areas Gabe so we are looking – are currently looking at opportunities both in private terminals, but as well as books of business in the natural gas market and in Material Handling opportunity. So that we remain active in all three, but my comments we are really referencing terminal based acquisitions.

[Gabe Moreen:]

Got it, thanks David and then just talk to the comment on Kildair in terms of some of those railcars I think under utilization there given spreads. Can you just talk about kind of how that works are anything you can kind do there that front?

[Gary Rinaldi:]

Hi, Gabe this is Gary. Historically Kildair was – is a bit long railcars in last couple of years I think at the end of 2014, we’ve subleased out a number of those railcars as you probably recall rail rates expanded considerably. So it’s very profitable to sublease the incremental railcars and the contract with - at the end of last year, we are still subleasing the railcars that were long but more at our least cost this year, so year-over-year there is a difference there.

[Gabe Moreen:]

Got it. Is it just something Gary where all over time, you’ll just let those leases drop…

[Gary Rinaldi:]

Yes, that’s correct, absolutely.

[Gabe Moreen:]

Okay, great. That’s all I had. Thanks everyone.

[Gary Rinaldi:]

All right. Thanks, Gabe.

[Operator:]

Our next question comes from Jeremy Tonet with JPMorgan. Your line is open.

[Andrew Burd:]

Hi, good afternoon, it’s actually Andy here for Jeremy. Question regarding the Materials Handling strength, can you help quantify how much of that roughly to spend the Windmill component that Searsport and how much of that opportunity is left?

[David Glendon:]

We don’t breakdown specific activity by kind of component project by product but a material part of the increase quarter-over-quarter was related to windmill component activity, one. Two is there was some opportunistic sort of the activity at Kildair. And the three is the pulp activity in Portland. But there is a lot of offsetting positives and negatives we have over 30 different products that we handle from a materials handling standpoint as far as the future windmill component activity we expected to remain strong for the foreseeable future relates to the producer tax credit, which historically has had to be reenactment every year or reenacted every year and now it’s changed, where if you got activity the producer tax credit remains in place and that’s been a big boost to the industry and to us also and we expect to be number of the contracts moving forward into the next year or two.

[Andrew Burd:]

Great, thank you. And then on the Kildair expansion or conversion I guess, sorry if I missed it. Are those tanks contracted to third parties and roughly how many barrels?

[David Glendon:]

It’s just kind of the reminder we acquired seven tanks back in 2011 and we converted five of those tanks, these are heavy oil tanks we converted five to crude storage and then we had still have the two remaining tanks that were not being utilized total of 420,000 barrels, those are the tanks we are converting to the wider end fuels and it is supported by a supply contract, two year supply contract. But I can't get into more specifics on the contract.

[Andrew Burd:]

No, no, that’s great, thanks. And then last question is sort of back on the M&A. Regarding the auctions that you’ve seen are the high valuations would you say more reflective of a very active bidding pool with ample access to capital or is this more unwilling sellers at certain valuations and they are being pretty firm on that front?

[David Glendon:]

Candidly, under we’ve seen a little bit of both and I think the pool of active bidders for some of these assets has expanded into the private activity space as well. So in addition to the traditional strategics we’ve seen pretty high level of activity from private equity firms but we have seen both, so we’ve seen things going at relatively high multiples but also sellers in some cases backing off from the process when they weren’t receiving those MI multiples.

[Andrew Burd:]

That’s helpful. Thank you.

[Operator:]

Our next question comes from Justin Jenkins with Raymond James. Your line is open.

[Justin Jenkins:]

Great, thanks guys. Good afternoon. Just a quick macro question from me if I could, so David you touched on this a bit in your prepared remarks. But just curious on how you guys see the refined product environment heading into the winter seems like there is a bit of concern out there as it relates to elevated distillate inventories. So any color on - how that might affect in volumes and margins, pretty helpful.

[David Glendon:]

Yes, I think there is a number – good question Justin. There is a number of things going on that we're always trying to prepare for between the supply and demand picture and then candidly the weather picture as well. So you are seeing elevated levels of distillate storage in this country and globally. And what you’ve seen associated with that is a return of more incentive to store barrels, so you’ve seen a carry structure emerged in the - on the NYMEX for distillates, which has some incremental benefit to us as well. But then of course on the flipside of that you would expect to see potentially more competition at the rack given that everybody is coming into the season relatively for storage. So I can't really prognosticate exactly how that’s going to shakeout, but I’d say in the near-term its leading some incremental opportunities to put barrels into storage at compelling economics.

[Justin Jenkins:]

Okay, it’s very helpful. Thanks.

[Operator:]

Our next question comes from Nathan Judge with Janney. Your line is open.

[Nathan Judge:]

Good afternoon and thanks for taking the question. And just as you talked about resid, you are converting use more, excuse me less resid and using and putting through more distillate and gasoline, just kind of interested on the margins is there a different spread on what you get on the resid versus the other products?

[David Glendon:]

Very good question Nathan. It really depends market by market so there are some markets in which are residual fuel margins tend to be higher than either distillate or gasoline and there are some in which they tend to be a little bit lowers. So it’s really a market by market question, but I would say as a rule of thumb or in general the highest margins come from a sale of a barrel of residual fuel followed by distillate, it’s followed by gasoline. But one point just to make clear this doesn't involve other than the conversion of tanks at Kildair, it's not that there were swapping tanks between distillates and residual fuel across the system, again outside of the conversion process that Gary talked about.

[Nathan Judge:]

But with the capital expansions that you're spending on the Bronx wouldn't it be fair to assume that you're going to seeing more volumes of distillate and gasoline or is that…

[David Glendon:]

Yes, good question Nathan. No you won't see any gasoline going through the Bronx, what you’ve seen is that capital we are spending is doing two things so we have seen in New York that there's been a move from six oil, the true heavy fuel blended for oils. So six oil volumes being displaced by four oil which candidly the margins on those two products are pretty much similar. So there's no change there. What we are doing at the racks is really to involve or to allow more blending of kerosene, biofuels and diesel to expand our business in those segments of the market place in the New York city market. And significant improvements at the rack to allow for both greater controls and faster throughput at what is a terrific rack infrastructure, but needed investment in automation and additional flexibility.

[Nathan Judge:]

Right and could you quantify how much you're spending roughly on each?

[David Glendon:]

On each we spent about $3 million in the Bronx terminal over the course of the summer and fall. And some tank changes, some additive changes primarily at the rack investment.

[Nathan Judge:]

And in Kildair the conversion there how much do you expect to spend?

[Gary Rinaldi:]

$4.5 million Nathan.

[Nathan Judge:]

Okay, is there a reasonable or some kind of guidance is what we should expect as far as return on that?

[Gary Rinaldi:]

We are looking at about a two-year payback on that investment, okay.

[Nathan Judge:]

Thank you, that's very helpful.

[Operator:]

[Operator Instructions] Our next question comes from [Lynn Chen with Heights]. Your line is open.

[Unidentified Analyst:]

Hi good afternoon, and thanks for taking my question. I just want to clarify what I heard from the call is that Sprague hasn’t healthy balance sheet and low debt-to-EBITDA leverage so that if the MLP market is not improving from the current status. So Sprague have enough liquidity and also capacity to fund its own CapEx and was not to tuck-in to public equity market?

[Gary Rinaldi:]

Yes, Lynn. Hi, this is Gary. We don’t need to accept the equity markets in the near to medium term, we are actually delevering as you noted our permanent leverage is currently stands at 2.8 times, is going to improve in the fourth quarter as we paid down our acquisition line with excess cash flow, you may recall we did that last year in the fourth quarter about $35 million, we expected to do something similar this year on December, we got strong liquidity, we got $215 million of liquidity in our working capital facility, we’ve got another $95 million of liquidity in our acquisition line, which will improve when we paydown the acquisition line with the excess cash flow, we’ve got about $400 million in accordion $200 million for working capital, $200 million for the acquisition line. So we have plenty of liquidity and capacity to finance medium-size acquisitions in the near to medium term. At some point we’ll be accessing the equity market where the markets are more supportive as well as maybe tied to a larger – more material transaction.

[Unidentified Analyst:]

Great, thank you very much.

[Gary Rinaldi:]

Sure, thanks. End of Q&A

[Operator:]

Thank you, ladies and gentlemen. That does conclude the Q&A session and today’s conference call. You may all disconnect. And everyone have a great day.