Sprague Resources LP
Q4 2016 Earnings Call Transcript

Published: 10 Mar 2017

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by, welcome to the Sprague Resources' Fourth Quarter and Full Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] We will have a question-and-answer session later and the instructions will be given at that time. Now, I would like to welcome and turn the call to David Glendon, President and CEO.

[David Glendon:]

Thank you, Carmen. Good afternoon, everyone, and welcome to Sprague Resources' fourth quarter 2016 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. 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. You can find a discussion of our use of non-GAAP measures as well as reconciliations between these measures and their most comparable GAAP figures in our earnings press release on Form 8-K with the SEC as well as additional disclosures and reconciliations in the Investor Relations section of our website. A year ago, I communicated a belief that Sprague’s performance checked the box on every metric MLP investors find important. I'm pleased to report today that Sprague continues to wheal that sharply effectively in delivering value for unit holders with another year of solid financial and operational performance under our belt. Although not without challenges, 2016 clearly demonstrated the resiliency of our unique business model. We delivered a third consecutive year of double-digit distribution growth, while maintaining a coverage ratio above 1.6 times. We executed on a strategic acquisition at a first year EBITDA multiple below three times. And we maintain balance sheet strength. Finally, despite unsupported weather in the North East, we met or exceeded our guidance targets, delivering adjusted EBITDA of $109 million for the year. Only $1 million below the $110 million recorded in 2015. I’m also pleased that Sprague has extended our track record of driving meaningful growth through accretive bolt-on acquisitions across all three business segments already in 2017, surpassing our guidance of one to two transactions per year. The three transactions already closed this year represent more than $70 million in capital obligations, with no external equity raise. All while maintaining our permanent leverage ratio at the low end of our target range. Collectively, these three acquisitions are expected to contribute an estimated $6 million to $7 million to 2017 adjusted EBITDA ramping up to $10 million to $13 million annually. The purchase of Global’s natural gas marketing and electricity brokering business continues the consolidation strategy initiated with Metromedia in 2014 and extended to Santa Buckley Energy in 2016. This transaction has approximately 4,000 customer locations, 8 million cubic feet of annual gap demand and 1 billion kilowatt hour of electricity brokerage demand. Our experience integrating the Metromedia and Santa transactions provides confidence in our ability to leverage our supply and logistics capabilities capturing further upside value. In our refined products business, we see the L.E. Belcher acquisition as a natural extension of our terminal network into Western Massachusetts. Having been the exclusive supplier to this facility for nearly two decades, we’re very familiar with the local market dynamics and the opportunities for supply optimization inherent nearly 300,000 barrels of added storage capacity. Additionally, we see the potentials to build on the Belcher legacy of successful wholesale and commercial fuels marketing in the region. Finally, the capital acquisition cements our marketing position in East Providence, allowing us to make growth capital investments and optimize storage at our legacy providence terminal, improving both assets ability to generate more ratable long-term cash flows. Backed by agreements with the credit worthy counterparty our purchase will increase throughput and material handling fees, further mitigating the seasonality of Sprague’s business. I am particularly impressed by the creativity and vision our team demonstrated seeing the potential transformation of these approximate assets. And with their determination in executing the necessary three corner bank shop. This entrepreneurially approach has been central to Sprague’s success for nearly 150 years and remains core to our culture today. I’ll now turn the call over to Gary for a detailed review of our results. Gary?

[Gary Rinaldi:]

Thank you, David, good afternoon everyone. I am pleased to once again present strong financial and operational results for Sprague. We delivered on our guidance, increased distributions at a double-digit rate, maintained a conservative balance sheet and continue to invest in new assets all financed with internally generated cash flow. These results are a testament to our uniquely diversified business model and ability to deliver strong financial performance and stable cash flows under varying market conditions and weather. Sprague’s adjusted gross margin for the fourth quarter was $69.4 million, a decrease of $1.4 million or 2% compared to the prior year. As strong natural gas performance was offset by weaker results in refined products and marginally lower material handling results. For the full year Sprague’s adjusted gross margin of $259 million were 6% below 2015, as again natural gas was offset by lower refined products margins associated with the decrease in volumes related to the warm first quarter. Adjusted EBITDA for the quarter of $30.4 million was slightly better than the fourth quarter of 2015. For the year adjusted EBITDA of $109 million was marginally down $1.4 million from last year’s record, and finished within our previously issued guidance. For 2017, we estimate that adjusted EBITDA will be between $115 million to $130 million, which incorporates the impact of weather through February, as well as the contribution from our recent acquisitions. Sprague’s operating expenses for the quarter decreased 2% to $16.8 million, despite a 10% increase in the refined products volumes. For the year operating expenses were down $5.6 million or 8% as lower terminal activity in the first quarter led to a reduction in employee related costs in repairs and maintenance expenses. OpEx for the year was at the low end of our guidance as we - and we expect 2017 operating expenses to range between $69 million and $74 million. SG&A expenses decreased 5% to $22.2 million in the fourth quarter. For the full year SG&A expenses were materially lower by $10.1 million or 11%. This was primarily driven by a decrease in employee related costs including sales commission, as well as a reduction in incentive compensation based on the lower distributable cash flow for the year. In addition, professional fees and acquisition related expenses were also significantly down year-over-year. We expect that 2017 SG&A expenses will range between $90 million and $95 million. In 2016, cash interest of $23.2 million declined modestly versus last year and we expect cash interest to be between $26 million and $30 million this year. Maintenance CapEx increased $600,000 to $2.3 million for the fourth quarter, primarily resulting from project timing differences. Maintenance CapEx for the full year of $9.4 million was $500,000 higher than 2015. For 2017, we expect maintenance CapEx to range between $14 million and $17 million. Although acquisitions form a cornerstone of growth strategy, we will continually make significant investments in organic growth projects, which this year will total between $19 million and $22 million. At our River Road terminal a $3 million investment in an asphalt storage conversion project is almost complete, which is in support of a significant materials handling contract. In addition, an $8 million investment in our recently acquired East Providence Terminal will covert distilled storage to gasoline backed by 10 year throughput agreement with the creditworthy counterparty. And $3 million would be invested in our Providence Terminal to covert distilled and heavy fuel oil storage to handle asphalt also backed by a 10 year throughput agreement. These expansion capital projects will increase cash flow ratably and further mitigate the weather impact on our business. For the year distributable cash flow of $79.1 million was $10.6 million below the prior year. This was primarily driven by the positive adjustments to DCF in 2015. More specifically higher incentive compensation paid in units acquisition expenses related to the three transactions that closed in the fourth quarter of 2014 and the non-cash write downs of [indiscernible] bottoms related to the decline in oil prices during the year. Despite the lower DCF Sprague's distribution coverage for the year remained strong at 1.6 times. Based on the strength of Sprague's balance sheet and strong liquidity in both the working capital and acquisition facilities, we remain well positioned from a financing perspective with significant flexibility to capitalize and execute on accretive transactions. As of the year-end liquidity in our working capital facility was $184 million with working capital debt averaging $259 million over the trailing 12 months. And available liquidity in our acquisition facility was $305 million at year-end. As we enter 2017, and after closing on the three recent transactions, over $247 million of acquisition liquidity remains. Since our IPO Sprague has generated approximately $115 million of distributable cash flow in excess of distributions, which was used to fund expansion capital projects and acquisitions. We ended 2016 with a permanent leverage ratio of 2.3 times below our long-term target of 2.5 to 3.5 times. With a strong balance sheet and low leverage we have significant optimality to execute on strategic transactions while managing to a long-term optimal capital structure. Now turning to the business segments, refined product sales volumes for the quarter increased by 37 million gallons or 10% giving more normal weather in the Northeast for the full year, refined product sales volumes declined by 17% to 1.4 billion gallons primarily due to the unsupported weather early in the year. Refined products adjusted gross margin for the fourth quarter decreased by $7.8 million to $38.5 million, primarily relating to the retroactive reinstatement for the biodiesel tax credit in December 2015. Weaker heating oil spreads and basis [ph] appreciation relative to last year also impacted the quarter's results. For the year, refined product's adjusted gross margin of $143 million declined 16% consistent with the sales volume decline for the year. Despite the decrease in refined products volume Sprague's market position remains strong and our unit margin held a trend that we believe will continue. We're excited about the ongoing growth in our natural gas business, the Santa Energy acquisition has far exceeded expectations that established in our initial evaluation economics. And we remain optimistic regarding the potential for the recent Global transaction. Natural gas sales volumes increased 20% for the quarter and 9% for the year to 61.7 billion cubic feet, primarily resulting from the Santa acquisition. Natural gas adjusted gross margin rose $8.3 million to $18.7 million in the fourth quarter compared to a year ago. This increase is a result of the strong contribution from the Santa acquisition, as well as the positive impact on basis gains to supply optimization opportunities. For the year healthy increases in both volumes and unit margins combined to increase the natural gas adjusted gross margin by 22% to $62.4 million. Natural gas unit margins for the year also increased by 13% to a little over $1 per dekatherm. The Santa acquisition logistics optimization and an increase in evaluation of forward contracts related to narrowing credit spreads all combined to drive the full year out performance. In Sprague's material handling business adjusted gross margin of $9.9 million for the fourth quarter was down $1.8 million compared to 2015. Decreased dry bulk activity related to Wills borough [ph] accounted for a majority of the decline, as inventory levels coming into the quarter were near full capacity due to the mild winter experience last year. Windmill handling and pulp export activity each accounted for a modest reduction, which was offset by an increase in gypsum handling. Adjusted gross margins for the full year $45.7 million was slightly higher than last year demonstrating the grossification and liability of the cash flows that exist within this business segment. The heavy oil storage agreement secured in late 2015 Kildair along with an increase in Sprague’s construction related bulk handling activity was partially offset by lower salt [ph] handling, pulp exports and windmill activity in 2016. Overall our performance this year highlights the benefits of Sprague's diversified business model. The ongoing margin expansion towards more fixed and ratable cash flows and the strength and reliability of our distributable cash flow and coverage. Sprague has delivers consistent financial and operation performance through volatile market conditions, extreme weather changes and rapidly changing price environments. We are confident that during 2017 Sprague will deliver full year adjusted EBITDA within the previously stated range of $115 million to $130 million, while maintaining distribution coverage in excess of 1.4 times. Adding to the 11 consecutive quarters of distribution growth that has Sprague has delivered we are extending our guidance to increase distributions by $0.015 per unit per quarter until the end of 2019, which does not account for the impact of any future acquisitions. At the same time, we expect to maintain permanent leverage within our long-term target of 2.5 to 3.5 times and our capacity and flexibility to capitalize on accretive acquisitions position Sprague for continued success well into the future. This concludes my remarks I’ll let Dave wrap-up before we take questions.

[David Glendon:]

Thank you, Gary. I’d like to take an opportunity to highlight our safety performance. And I'm pleased to report the achievement of the major milestone within our break bulk material handling business. With hard work and a focus on continuous improvement the break bulk material handling team has achieved a recordable injury frequency of zero, which reflects no ocher reportable injuries within the last 12 months. To help put this in perspective, the comparable industry average frequency for this business is 5.6. We also recent had the opportunity to recognize six bulk terminal operators for 20 years of continuous safe work with Sprague. And I’d like to offer my graduations and appreciation for this achievement. Let's open the call for questions.

[Operator:]

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

[Justin Jenkins:]

Great, thanks, good afternoon guys.

[David Glendon:]

Hey, Justin.

[Gary Rinaldi:]

Hi, Justin.

[Justin Jenkins:]

So, thanks for all the details today on guidance and everything else and on the color on the quarter. I guess maybe I'll start on the M&A front here, clearly a busy start for the year for you guys, I guess I'm just curious on the pipeline for deals now, as we look going forward. And we're also like your thoughts maybe on the organization's capacity to integrate the deals already completed or maybe still pursuing other opportunities that might be out there?

[David Glendon:]

Yes, good question Justin. I think the environment remains and we remain quite active. So we're very pleased to closed on three transactions, which we've been working on throughout 2016 and we still have a pretty full pipeline of activities that we’re considering. And to answer your second question in terms of the integration challenges, it really depends on the business that we've acquired. So if you look at the last three that we've closed on this year, I’d say that two of them are quite easy to integrate the Springfield, L.E. Belcher terminal asset and the Capital Terminal. In both cases we are very familiar with those assets it's been operating out of those in fact we've been the exclusive lesser of the capital terminal. And so it's really a pretty quick and smooth transition to move those into a Sprague system. Within the natural gas business that we acquire from Global clearly there are some challenges there primarily on the integration of systems. There is always human asset challenges in any acquisition, but the systems for natural gas and the ability to interact with all the utilities and moves those utility pools on this break system is about a three to six months transition process. I could state we have a high degree of confidence given that we have effectively done that twice now in the last two years. So - but it does take some time, so that would be an area where it would be a little bit of a challenge to bring a new natural gas marketing business on stream in the next several months or so. But again we feel highly confident in our ability and great all three of these acquisitions while we are looking at new opportunities.

[Gary Rinaldi:]

And Justin this is Gary. We would have acquired eight acquisitions in the last three years including these three. So there has been a lot of lessons learned going back to the end of 2014, 2015 that benefits us as we move forward on these more recent acquisitions.

[Justin Jenkins:]

Great, that’s really helpful. And I guess maybe changing gears on the regulatory environment, it seems like things are trending in at least a better direction there recently. Any thoughts maybe on incremental opportunities that challenges for Sprague maybe on the natural gas front more so, if we see more of these projects in the Northeast enter construction and reach completion?

[David Glendon:]

Yeah, good point Jus, I think yes I mean the regulatory environment as looks more favorable for energy projects in general. I would say there is not direct benefit to us necessarily from that given the nature of our business. And you have heard in the past say from a natural gas pipeline capacity in the North East perspective. We don’t mind the inherent volatility associate with being at the end of the pipeline and being and in strange environment, but we do expect there to be some capacity constructed in the five year time horizon the Northeast clearly need some additional capacity. But candidly I would expect there to continue to be some degree of constraint in the Northeast gas markets.

[Justin Jenkins:]

Right, okay, great. And then if I could squeeze one more in. seems like further the 2017 guide even if you back out the expected contribution from the acquired assets just recently here seems like the midpoint would still show growth relative to last year even if we have had a reasonably tough start to the year from a weather perspective again in 2017. I guess maybe if you could provide a little more color on what you have seen so far in 2017 and maybe the push on what to expect throughout the year?

[David Glendon:]

I think you have characterized it effectively, Justin, Jan-Feb of 2017 was remarkably even a little warmer than Jan-Feb of 2016, but I am quite pleased to report that winter has arrived in the Northeast today. So we are all quite bullish on the prospects for March. So, yes I think you’ve characterized appropriately we obviously factor in the fact that we have had a warm Jan and Feb in proving that guidance. But yes the quarter business if you will is expected to be up modestly.

[Gary Rinaldi:]

And also Dave thanks. And also we are forecasting obviously a normal November, December from a weather standpoint. We have a bit of a uplift in our materials handling business related to the asphalt extension project at River Road terminal and we are expecting strong results at Kildair relating to asphalt - related to asphalt marketing and the MGO project that was in operation for five months last year and 12 months in 2017. And also continued focus on cost management and the synergies related to the past acquisitions that we have done, we will continue to drive our cost base down.

[Justin Jenkins:]

Great, appreciate all the color today, guys and have a good weekend.

[David Glendon:]

Thank you, you too Justin.

[Operator:]

Thank you. And our next question comes from the line of Jeremy Tonet with JPMorgan.

[Unidentified Analyst:]

Yeah this is Charlie in for Jeremy actually. Lot of my questions there were answered, but just still on the M&A front real quick, obviously a lot less in acquisition facility, coverage is good, leverage is good, just kind of more so focusing on the nat gas side do you see yourself kind of pushing that footprint further South now that you’ve really bolstered your current footprint in the Northeast? And then secondly just - secondary question separate from that, just you noted $6 million to $7 million in 2017 that are coming from those acquisitions and then eventually ramps up to $10 million to $12 million. Just trying to understand the delta there, I know that driven by the minimum volume increases at the capital terminal. Just trying to understand the increment there and how would basically - how long will it take to get to that $10 million to $12 million mark?

[David Glendon:]

Yes, you are absolutely right. The vast majority of the delta between the near-term forecast and the ramp up is associated with the capital terminal and the conversion to gasoline and asphalt there. It’s a - overall it’s a four to five year ramp up horizon that we will see that full benefit. There is also some benefit from just as Gary mentioned earlier, synergistic realization across each of the acquisitions.

[Unidentified Analyst:]

Is that 4 to 5 I mean should I just think about that as pretty balanced and sequential?

[David Glendon:]

Yeah I think that's a fair way of extrapolating the cash flows.

[Unidentified Analyst:]

Okay, great. And…

[David Glendon:]

And second question sorry or your first question that I didn't answer was natural gas expansion beyond the current footprint. The short answer is yes we're looking at opportunities we'll continue to look at opportunities. And candidly while we love the fill-in nature of the Northeast acquisitions we've made there limited appropriate targets within the Northeast. So our sites will turn more to adjacent marketplaces.

[Gary Rinaldi:]

Both sound and west stepping out geographically.

[Unidentified Analyst:]

Great, thanks.

[Gary Rinaldi:]

You bet.

[Operator:]

Thank you. And our next question comes from the line of Mike Gyure from Janney. Please go ahead.

[Mike Gyure:]

Yeah thanks. Could you talk a little bit about the SG&A increase I think were gone from about $84 million I think you said on the guidance between $90 million to $95 million I assume also that as acquisition related. But maybe can you talk about the structure or maybe the cost structure of the acquisitions if that’s really driving there and kind of what’s your…

[Gary Rinaldi:]

The primary driver of the SG&A increase relates once to the - primarily to the global natural gas acquisition from a sales force standpoint. Number two is with higher distributable cash flow related to the uplift in earnings there will be increase in incentive compensation and those are the two primary drivers.

[Mike Gyure:]

Okay, great. And then can you talk a little bit about the growth projects asphalt expansion I think you said River Road kind of what you are thinking you're dealing there?

[David Glendon:]

Sure you’ve seen in the guidance a big increase in our expansion capital and growth project from prior years. We've got - our guidance is $19 million to $22 million in 2017 that really relates to four specific projects. One is with the capital acquisition the conversion in East Providence gasoline in our own Providence Terminal conversion to asphalt. And then River Road we have asphalt expansion project and at Kildair we've got 12 months of the MGO type conversion project. Some of the Kildair project and specifically started last year and is into this year. So we've got about $19 million of expansion CapEx heading 2019 with an uplift in EBITDA between $5 million and $6 million growing to $7 million to $8 million in 2018. And we’ll continue to grow a bit after that related to the step up in the minimums related to the East Providence project.

[Mike Gyure:]

Great, thank you.

[David Glendon:]

Welcome. Thanks, Mike.

[Operator:]

Thank you. And our next question comes from the line of Lin Chan with Hike [ph]. Please go ahead.

[Unidentified Analyst:]

Hey, good afternoon. I just want to ask about the margin for refined products I understand last quarter was lower year-over-year due to the biodiesel tax credit. But how should I think about the rising crude price has any impact on your margin?

[David Glendon:]

Yes good question Lin, I’d say we've certainly encourage you to look at it on an annualized basis in both businesses, natural gas and refined products because there is some noise quarter-to-quarter. So if you look at annualized refined product unit margins it's pretty consistent year-over-year at almost exactly parity year-over-year and we expect that those average unit margin levels to hold going forward as well. So as you know we're agnostic that crude pricing really has a derivative effect to us on our capital and interest charges, but it doesn't really directly affect the unit margin realization in the business.

[Unidentified Analyst:]

Great. And also maybe I missed that, but what was the reason for last quarter's material handling is lower also.

[Gary Rinaldi:]

Hi Lin, it's Gary. It primarily relates to a drop in salt activity year-over-year. And that was partially offset by the increase in gypsum. But salt was down in 2016 throughout the whole year relative to '15 as we came out of '15 with high inventories then with lack of weather our salt activity was down. We're expecting salt to be up materially in 2017.

[David Glendon:]

Yes, so the winter hasn't been particularly compelling from a degree days perspective there has been more storms in the Northeast this year, which cuts it - which adds to salt usage.

[Unidentified Analyst:]

Great, thank you very much.

[David Glendon:]

You’re welcome, Lin.

[Operator:]

And thank you. And I'm not seeing any other questions in the queue. I would like to turn the call back to management for final remarks.

[David Glendon:]

Thanks very much Carmen. We appreciate everybody making the timing to join us this afternoon. And look forward to updating you in future calls. Have a great weekend everybody.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. And you may all disconnect. Have a wonderful day.