Sprague Resources LP
Q3 2016 Earnings Call Transcript

Published: 7 Nov 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Sprague Resources' Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call may be recorded. I would like to introduce your host for today’s conference, Mr. David Glendon, President and Chief Executive Officer. Sir, you may begin.

[David Glendon:]

Thank you, Ranya. Good afternoon, everyone, and welcome to Sprague Resources' third quarter 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. First, some of 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 we make are qualified by the Risk Factors in our most recently filed SEC Form 10-K and future filings with the SEC. Sprague Resources LP undertakes no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. Second, you can find a discussion of our use of non-GAAP measures as well as reconciliation between these measures and their most comparable GAAP figures in our earnings press release on Form 8K with the SEC as well as additional disclosures and reconciliations in the Investor Relations section of our website. I'm very pleased with our third quarter performance which outpaced last year thanks to strong results in our refined products business. Sprague's adjusted gross margin increased $4.4 million, adjusted EBITDA was $6.7 million higher, and we generated $3.7 million more distributable cash flow than we did in the third quarter of 2015. Sprague reported an $8.8 million GAAP net loss for the quarter which includes unrealized derivative losses without the accompanying uplift in our corresponding physical inventory and transportation positions. Ample PADD 1 distillate and gasoline inventories, pressured marketing volumes during the quarter, yet simultaneously set the stage for a supportive market structure while we built inventory, allowing the refined products business to generate 21% more adjusted gross margin in the quarter, compared to last year. Refined products favorable performance was large enough to offset timing differences and materials handling as well as modestly lower results in natural gas. Year-to-date Sprague's business has generated $190 million of adjusted gross margin compared to $205 million in 2015. I want to specifically reference our nine months results this afternoon because I believe they exemplify several important points about Sprague that are worth repeating, before Gary reviews the detailed quarterly comparison. Back in May, I reported that the first quarter's historically warm winter with 25% fewer heating degree days had left the refined products and natural gas adjusted gross margin totals significantly behind their 2015 levels. I reminded listeners that the weather impact was isolated to the quarter, and we reiterated our full year adjusted EBITDA guidance. My confidence then was based in large part on the recognition that Sprague has a stable base business of providing customers with the energy and expertise they rely on, creating the capability to withstand and overcome the occasional warm winters we’ll inevitably encounter and overcome we have. At the end of the first quarter, Sprague's adjusted EBITDA was 18.1 million behind 2015's Q1, a deficit of more than 29%. Today, we reported that our year-over-year deficit has almost completely evaporated. Through September 30th, Sprague has generated adjusted EBITDA of $78.6 million less than 2% below the same three quarters of 2015. By focusing on the block-and-tackle advantages, our asset base affords us maintaining our constant focus on controlling operating expenses and SG&A costs, and successfully executing on the integration of Santa natural gas, our teams closed the gap by nearly $17 million. Over the past six months, Sprague's commercial segments have generated $12.5 million more adjusted gross margin than in the same 2015 period, while simultaneously reducing operating expenses and SG&A costs by $4.1 million. Our ability to recover is a testament to the resilience of Sprague's business model and the driver of my continued optimism in our ability to deliver long-term cash flow growth to our unit holders. In line with our previously issued guidance on October 28th, we raised our quarterly distribution to $0.5625 per unit, a 3% increase over the distribution paid in the second quarter and 12% above a year ago. We expect the current pace of distribution growth to continue at least through 2018, without acquisitions. This guidance is conservative given our strong balance sheet and ability to close meaningfully accretive acquisitions without equity issuance or leverage concerns. We remain steadfast in our belief that consistent distribution growth overtime in combination with conservative balance sheet management will ultimately deliver the highest value for unit holders. We also continue to perceive acquisition and organic growth initiatives with active dialogues for non-auction transactions in each of our business segments. And still believe one or two transactions a year is an appropriate long-term expectation. Outside of M&A, I’m pleased to announce that our materials handing team has recently signed a new services agreement that will bring asphalt handing back to the River Road terminal for the next 25 year. Finally, September marked the one year anniversary of Sprague delivery integrity program, the first and only comprehensive supplier effort in New York City to ensure product quality, safe deliveries and a superior customer experience. Over the past year, our delivery integrity staff conducted random unannounced inspection of more than 600 delivery trucks to ensure adherence to Sprague's strict standards. They also assisted customers preparing to the upcoming heating season by completing over 1,000 voluntary side assessments this summer. Yielding recommendations on how boiler rooms to be made safer, reduce the risk of spills and make deliveries more efficient. Our program has received significant phrase from several New York City agencies. And I’m proud that the efforts and ingenuity of our dedicated employees have once again demonstrated the Sprague success as a result of our willingness to be an innovative leader. Now, I’ll turn the call over to Gary for a more detailed review of our results.

[Gary Rinaldi:]

Thank you, David, good afternoon everyone. Sprague’s total adjusted gross margin for the third quarter was $54.8 million, an increase of $4.4 million or 9% over last year, as strong refined product results more than offset modestly weaker materials handling and natural gas results. Adjusted EBITDA increased $6.7 million to $19.3 million, as lower operating expenses bolstered stronger adjusted gross margin performance by the business. Sprague’s operating expenses decreased $2.1 million or 12% to $15.7 million reflecting reduced repairs and maintenance expense across our terminal system, lower variable employee-related cost and a reduction in insurance expense partially offset by higher property taxes. As David alluded to earlier, our operation team has focused their efforts over the past six months, on reducing operating expenses where possible, and successfully delivered more than $3.3 million in reduced expenditures. We expect our full year 2016 operating expenses to come in at the low end of our $65 million to $70 million guidance range, assuming no new terminal acquisition. Sprague’s SG&A costs decreased $159,000 or 1% to $19.27 million in the third quarter. Lower M&A related expenses and professional fees associated with our three late 2014 acquisitions more than offset the slightly higher incentive compensation expense as a result of the quarter's higher adjusted earnings. Similar to our operating expense guidance, we believe full year 2016 SG&A expenses will finish the year at the low end of our $85 million to $90 million guidance range. Sprague generated $11 million of distributable cash flow in the third quarter, $3.7 million more than last year. Our coverage for the quarter was 0.9 times, which is consistent with our expectations to see coverage ratios lower than one-times in the second and third quarters. In the first nine months of 2016, Sprague has delivered $56.4 million of DCF generating distribution coverage of 1.6 times. Sprague has already generated enough distributable cash flow to cover full year 2016 distributions by 1.2 times. And on a trailing 12 month basis, Sprague's coverage is 1.8 times. Sprague's cash interest expense increased 5% compared to a year ago driven by the increased capacity of our acquisition facility in the first quarter as well as carrying higher levels of inventory in the current favorable market structure. If commodity prices remain near current levels, we continue to believe that full year cash interest expense will range between $22 million and $26 million. Maintenance CapEx increased $1.2 million due to the timing of certain capital projects. As of September 30th, Sprague's maintenance CapEx was running $100,000 less than a year ago. We are still managing full year 2016 maintenance CapEx between $8 million and $11 million and full year expansion CapEx is expected to end the year in the upper half of our $5 million to $8 million guidance range. As we enter the last two months of the year, I'm pleased to report that Sprague's balance sheet continues to put us in a strong position for completing accretive transactions which will drive our cash flow growth. Sprague's liquidity and its working capital facility was $127 million as of September 30th, and our working capital of debt has averaged $265 million over the trailing four quarter period. The trailing average working capital that is important due to the seasonal nature of our working capital requirements, which impacts leverage and enterprise value to EBITDA metrics depending on the time of year chosen for the calculation. While we certainly managed our working capital requirements tightly, we manage our business and our credit facility by focusing the leverage discussion on permanent debt, which relates to the acquisition facility. This is due to the fact that our working capital requirement fluctuates seasonally are impacted by energy price levels and are collateralized with self-liquidating current assets. Liquidity in our acquisition facility was $288 million at the end of the third quarter before accordions. Sprague's permanent leverage ratio of 2.4 times remains slightly below the low end of our long-term leverage target of 2.5 to 3.5 times. We intend to reduce permanent debt further with excess distributable cash flow later this year providing additional liquidity to finance growth opportunities. Our strong distributable cash flow has enabled us to pay for all of the third party acquisitions since the IPO with internally generated cash. This is inclusive of a three year distribution CAGR of 11%. Sprague's execution has enabled us to grow strategically while simultaneously de-levering the balance sheet and grow distributions to unit holders at a double digit pace. As David indicated earlier, our belief in Sprague's investment proposition is rooted in the ability to deliver strong long-term results that more than compensate for our seasonal cash flow profile and occasional weather exposure. Now, turning to our business segment, refined products sales volumes decreased 50 million gallons or 17% compared to the third quarter of 2015. Net sales decreased 28% to $351 million as a result of lower volumes and commodity prices year over year. High unbranded gasoline supply in the northeast limited our opportunity to make profitable sales while distillate volumes were challenged by increased competition from marketers unable to take advantages of contango economics, which is afforded only to those who have owned or leased storage capacity. Refined products adjusted gross margin increased $6.8 million or 21% to $38.7 million. This was driven by the improved market structure for carrying inventory as well as basis gains in several distillate products compared to a year ago. The quarter was a good example of the benefits accrued to Sprague by ownership of our own storage assets, and control of the supply chain to customers, which allowed us to increase the amount of inventory held and take advantage of the contango economics. The third quarter also bought the completion of the expansion capital project in Rensselaer, which will increase our product offering to customers in Vermont, Massachusetts as well as offer increased amounts of bio-blended heating oil and diesel fuel to our New York customers. In natural gas, our sales volumes increased 1.3 billion cubic feet or 12% compared to the third quarter of 2015 due to the acquisition of Santa Buckley’s natural gas assets earlier this year. Net sales increased $3.3 million as a result of higher volumes with only marginally lower gas prices. Natural gas adjusted gross margin decrease $1.7 million compared to 2015, as extended maintenance on the Algonquin pipeline system, increased our supply cost to serve customers and reduced optimization opportunities relative to a year ago. In addition, moderate basis losses on our physical hedge positions impacted the quarters result. Our natural gas business continues to execute successfully on its growth strategy. Results from the Santa acquisition have been better than we initially forecasted, we’re supplying 17% more meters with gas year-over-year and unit margins continues to grow, relative to the historic average. We expect to sell more natural gas to customers in 2016 than we ever have before. Finally, materials handling adjusted gross margin declined $722,000 or 6% to $11.3 million in the third quarter. Third quarter results were driven by timing differences and windmill handling activities. Lower demand for pulp export services and reduced vacuum gas oil storage. This was partially offset by higher asphalt throughput activity, increased heavy fuel oil storage, and furnace slag handling. I’m also please to announce that we recently signed a new agreement to bring asphalt handling back to our River Road terminal. The $4.4 million expansion capital project will convert two existing tanks and one out of service tank to asphalt storage, supporting new agreements 25 year tenure, exemplifying the ability for our fee base business to continue to grow organically. We remained confident the Sprague's full year adjusted EBITDA will total between $105 million and $120 million and yield distribution coverage between 1.6 and 1.7 times. We not only expect to continue increasing our distribution through at least 2018, but believe we can do so while also maintaining low permanent leverage. Please note that this guidance is based on assumptions of normal weather, market structure conditions, and does not include contributions from any acquisitions Sprague may make. Sprague’s performance provides one of the more compelling investment propositions in the MLP sector regardless of the valuation approach taken. In three years, Sprague has delivered 10 consecutive quarters of consistent distribution growth completed and integrated 5 strategically important accretive acquisitions, de-lever the balance sheet to less the 2.5 times adjusted EBITDA and maintained coverage in excess of 1.5 times. This all while growing distributions by a compound annual growth rate of 11%. In addition, we’ve addressed cash flow security and stability concerns by performing well through both extensively warm and cold weather conditions as well as high and low commodity price environments. We have confidence Sprague will continue the strong financial and operational performance into the future. This concludes our remarks, and we can open it up for questions. Thank you.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Justin Jenkins from Raymond James. Your line is now open.

[Justin Jenkins:]

Great, thanks and good afternoon guys. I guess maybe I'll start on the commodity front. David you mentioned high inventory levels in your prepared remarks. I'm just curious, happy to hear your thoughts on how recent demand trends have been and how you view the winter season here this year, you know it seems like even if it's an average winter this could be a pretty tailwind relative to last year's results.

[David Glendon:]

I think that's fair Justin, and yes our inventory levels are modestly higher than they were a year ago, and as you pointed out even getting a normal winter would be a significant uptick relative to last year's historically warm winter, which as you recall persistent from November through March. Each one of those months was much warmer than the historical average. So, we do have modestly higher inventory level coming into the season, but just to clarify all of those inventories will be sold well within the heating season. So, I know we've gotten some questions in the past about whether you can have, whether you can take advantage of contango. But you've ultimately got yourself a barrel to realize those gains, and we can sell our system multiple times over throughout the course of the winter.

[Justin Jenkins:]

Perfect that's helpful, and I guess maybe as a follow up there can you talk to any impact if there was any at all, that you guys saw from the colonial outage in September and then again here just week.

[David Glendon:]

Yes, good question. As you know Justin, most of our terminal assets and certainly almost all of our storage is waterborne terminal locations, so while the colonial pipeline outages did cause some near term volatility in supply logistics facilities that really had no meaningful impact on our business, and as you know the recent pipeline outage was repaired as of yesterday. So, we don't anticipate any ongoing challenges.

[Justin Jenkins:]

Perfect and then I guess last one from me maybe on the M&A front, any change there recently in activity levels. I'm guessing the focus is still on privately negotiated deals but has there been any shift in terms of activity or anything related to maybe potential elections or anything?

[David Glendon:]

No, we haven't seen anything there, Justin. We remain quite busy. We're looking at a number of opportunities as I referenced in my prepared remarks, and still think the guidance we provided is applicable to near-term and long-term opportunities.

[Operator:]

And our next question comes from the line of Jeremy Tonet with JPMorgan. Your line is now open.

[Jeremy Tonet:]

Just curious about building pipelines to the Northeast seems to be much more difficult proposition now than it had been in the past, and was just wondering, if you could provide us any updated thoughts on how that could impact your business or opportunities you might be seeing there?

[David Glendon:]

I assume, Jeremy, you're referring to natural gas pipelines in particular.

[Jeremy Tonet:]

That's correct, yes.

[David Glendon:]

Okay, well as you know, I mean, if we roll the tape back a couple of years ago, we are getting a lot of questions about the incremental capacity coming into the Northeast. So, my argument at the time was be careful, those things are going to be delayed in there execution given the challenges that we saw and bringing in additional capacity into New England in particular. I think those forecast that we provided have been proven out by recent developments. And I think as you're well aware given the business we operate in New England and the Northeast, some degree of volatility and constraints in the pipeline system are actually beneficial to our business. So, look, I think, there will still be some incremental capacity that ultimately finds its way into New England, but we've seen that the regulatory environments gone quite challenging for those projects.

[Jeremy Tonet:]

Great, thanks. Then it seems like in the marketplace there's been some conversations about crude-by-rail facilities converting over to product service, given the differentials there don't necessarily support crude-by-rail movement. Just wondering if you've seen much of that and if that would have any impact on your business?

[David Glendon:]

No, Jeremy, we haven’t much of that. As you know the crude-by-rail economics generally don’t work to the East Coast from the Midwest currently, and that’s been the case for the last little while. We haven’t seen much interest in moving in refined products via rail. We do have rail access in several of our systems, but clearly the economics of waterborne transportation trump rail from the Midwest for refined product at this point of time. We expect that to continue.

[Operator:]

[Operator Instructions] And our next question comes from the line of Mike Gyure from Janney. Your line is now open.

[Mike Gyure:]

Can you guys talk a little bit about the refined products margins, maybe the expectation here for the fourth quarter compared to the third quarter? If you see that margin improvement continuing or is that really a function of what you think is going to happen with inventory volumes?

[David Glendon:]

Mike, if you're looking at just the average unit margins for gallon sold versus margin generation for refined product, you will see a blip up in the third quarter, and it’s a function of both the numerator and the denominator changing, right. So, we sold a little bit fewer gallons, but contango economics contributed pretty significantly to the overall gross margin contribution. So, I think you’re seeing a little bit a normally out there in the third quarter, and I wouldn’t suggest to you apply those unit margins on a go forward basis. We expect the fourth quarter to see much more volumes to our system as we get into the heart of the winter. And we do expect that the market structure environment still conducive to holding inventory, but that, again the vast majority of our economics will be borne through the actual physical sales, through the system.

[Mike Gyure:]

Okay. And then, maybe one more on the inventories, I guess with inventory being up -- I think you said slightly on a year-over-year basis in the third quarter, what are you thinking, I guess, as you head into the fourth quarter or into maybe the first quarter of next year as far as inventory? You expect it to be about in line with where it was last year, or above or below?

[David Glendon:]

Yes, I would say on average, again, if the market structures hold that is today, there is a modest incentive to store distillate inventory in particular. So, if that persists, I would expect average inventory levels will maintain slightly higher than last year’s comparable periods.

[Operator:]

And I'm not showing any further questions, I would now like to turn the call back to Mr. David Glendon for any further remarks.

[David Glendon:]

Thanks very much Ranya. Thanks everyone for joining the call today. We look forward to engaging with you in opportunities in the future.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day.