Earnings Call Transcript - SPH Q3 2023

Operator, Operator

Good day and welcome to the Suburban Propane Partners Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Davin D’Ambrosio, Vice President and Treasurer. Please go ahead.

Davin D’Ambrosio, Vice President and Treasurer

Thanks, Betsy. Good morning, everyone. Thank you for joining us this morning for our fiscal 2023 third quarter earnings conference call. Joining me this morning are Mike Stivala, our President and Chief Executive Officer; Mike Kuglin, Chief Financial Officer and Chief Accounting Officer; and Steve Boyd, our Chief Operating Officer. This morning, we will review our third quarter financial results, along with our current outlook for the business. Once we conclude our prepared remarks, we will open the session to questions. Our conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended, related to the partnership’s future business expectations and predictions, financial condition, and results of operations. These forward-looking statements involve certain risks and uncertainties. We’ve listed some of the important factors that could cause actual results to differ materially from those discussed in such forward-looking statements, which are referred to as cautionary statements in our earnings press release. While subsequent written and oral forward-looking statements attributable to the partnership or persons acting on its behalf are expressly qualified in their entirety by cautionary statements. Our annual report on Form 10-K for the fiscal year ended September 24th, 2022 and Form 10-Q for the period ended June 24th, 2023, which will be filed by the end of business today, contain additional disclosures regarding forward-looking statements and risk factors. Copies may be obtained by contacting the partnership or SEC. Certain non-GAAP measures will be discussed on this call. We have provided a description of those measures, as well as a discussion of why we believe this information to be useful in our Form 8-K, which was furnished to the SEC this morning. The Form 8-K will be available through a link in the Investor Relations section of our website. At this time, I will turn the call over to Mike Stivala for some opening remarks. Mike?

Mike Stivala, President and CEO

Great. Thanks, Davin. Good morning. Thank you all for joining us today. The fiscal 2023 third quarter was another strong quarter for Suburban Propane, with adjusted EBITDA of $33 million, our highest reported results for any third quarter in our history, and an improvement of nearly $4 million or 13% over the prior year third quarter. Operating results benefited from strong customer demand due to cooler spring temperatures in certain parts of our territories which increased volumes by 3.9%. We also have continued success in our customer base growth and retention initiatives, effective selling price management, and a great job by our operating personnel in managing expenses in a persistent inflationary environment. Additionally, the quarter included contributions from the RNG platform that we acquired at the beginning of the second quarter. Within our developing renewable natural gas or RNG platform, we completed planned upgrades to help optimize plant operations at our Stanfield, Arizona facility, and are now starting to exceed our initial projections for daily production and pipeline injection at that facility. Additionally, at the Stanfield facility, we are making great progress integrating support functions, including onboarding the operating personnel who were previously employed by our third-party operating and maintenance company. This will enhance our operating controls and reduce expenses. We also continued to advance the construction of the RNG production assets at Adirondack Farms in New York, and the capital improvements at the Columbus, Ohio facility, which include enhancements to asset performance and the installation of gas upgraded equipment for RNG production. These two facilities are expected to be constructed and begin to reach run rate capacity by fiscal 2025. During the quarter, we used excess cash flows in a very balanced way to acquire a well-run propane business in a strategic market on the West Coast to support the growth of our core propane business, as well as to fund ongoing capital projects in our RNG operations, to make additional investments in Oberon Fuels, and we also reduced debt by approximately $21 million. As I have stated on a number of occasions on previous quarterly earnings calls, we’re taking a very measured approach to positioning the business for long-term growth and sustainability, leveraging the strength of our core propane business and our 95-year legacy of being a trusted provider of energy to local communities. In a moment, I’ll come back for some closing remarks and provide added color on our strategy initiatives. However, at this point, I’ll turn it over to Mike Kuglin to discuss our third quarter results in more detail. Mike?

Mike Kuglin, CFO and Chief Accounting Officer

Thanks, Mike, and good morning, everyone. To be consistent with previous reporting, as I discuss our third quarter results, I’m excluding the impact of unrealized mark-to-market adjustments on our commodity hedges, which resulted in an unrealized loss of $3 million for the third quarter compared to an unrealized loss of $900,000 in the prior year, along with certain other non-cash items and acquisition-related transaction costs. Given the seasonal nature of our business, we typically experience a net loss in the third quarter of our fiscal year. With that said, the net loss for the third quarter was $1.5 million or $2.00 per common unit compared to breakeven in the prior year. Adjusted EBITDA for the third quarter increased $3.8 million or 13.2% to $33 million compared to $29.2 million in the prior year. As Mike mentioned, the improvement in earnings was driven by cooler spring temperatures and organic growth in our customer base that contributed higher volumes sold along with the contribution from the RNG production facilities acquired at the beginning of the second quarter. Retail propane gallons sold in the third quarter were 78.5 million gallons, which was 3.9% higher than the prior year, primarily due to cooler weather in certain markets and favorable customer base trends. While average temperatures, as measured in heating degree days, were 4% warmer than normal and comparable to the prior year third quarter, we experienced cooler spring temperatures in much of our territories in the West and certain portions of the Northeast, contributing to an increase in heat-related demand. From a commodity perspective, propane inventory levels in the US remained elevated during the third quarter and contributed to declines in wholesale prices compared to their prior year third quarter. According to the Energy Information Administration, US propane inventories at the end of June 2023 were at 79.5 million barrels, which was 47% higher than June 2022 levels and 18% higher than historical averages for that time of the year. As a result of the increase in inventories and other factors, average wholesale prices for the third quarter of $0.68 per gallon, as based on Mont Belvieu, decreased 46% compared to their prior year third quarter. Excluding the impact of the mark-to-market adjustments on our commodity hedges that I mentioned earlier, total gross margin of $171.1 million for the third quarter increased $10.8 million or 6.7% compared to the prior year, primarily due to higher volumes sold and margin contribution from the RNG assets. Excluding the impact of the unrealized mark-to-market adjustments, propane unit margins for the third quarter were flat compared to their prior year, as effective selling price management during our period of declining commodity prices offset a less favorable benefit on commodity hedges that matured during the period. With respect to expenses, combined operating and G&A expenses of $137.4 million for the third quarter increased $7.4 million or 5.7% compared to the prior year, primarily due to higher variable operating costs as part of the increase in volumes sold, continued impact of inflation on payroll and vehicle lease and repair costs albeit at a moderating pace, as well as the operating costs associated with the new RNG assets. Net interest expense of $18.7 million for the third quarter was $3.7 million higher than the prior year due to a higher level of average outstanding borrowings under our revolving credit facility to fund the RNG acquisition in the second quarter, coupled with higher benchmark interest rates for borrowings under the revolver, as well as the impact of the $80.6 million in green bonds assumed in the RNG acquisition. Total capital spending for the quarter of $9.4 million was $1.6 million lower than the prior year, primarily due to a lower level of spending on propane tanks and cylinders as we leverage the inventory on hand and more than offset capital growth associated with the expansion and upgrade of the RNG production facility in Stanfield, Arizona, and the ongoing construction of the RNG facility at Adirondack Farms, which is expected to be completed by December 2024. Overall, capital spending on the RNG projects is expected to range between $5 million and $10 million in fiscal 2023 and between $25 million to $35 million in fiscal 2024, excluding the benefit of potential investment cash credits. Turning to our balance sheet. As Mike mentioned, during the third quarter, we repaid $20.5 million of borrowings under the revolver with cash flows from operating activities. On a fiscal year-to-date basis, we’ve repaid $45 million of the $115 million borrowed under the revolver to fund the RNG acquisition. As a result of the increase in earnings and debt repayment during the third quarter, our consolidated leverage ratio for the trailing 12-month period ended June 2023 improved to 4.36 times compared to 4.43 times at the end of the second quarter. Although the leverage metric is elevated relative to our historical levels and our target level of 3.5 times, we remain well within our debt covenant requirement of 5.75 times. Factoring in the projected run rate EBITDA contributions from the RNG assets, the pro forma consolidated leverage ratio approaches 4 times. We will continue to remain focused on utilizing excess cash flows to fund the planned growth capital within the RNG platform, as well as to strengthen the balance sheet. And as opportunities arise, to fund strategic growth of our core propane business and the renewable energy portfolio. We have more than ample borrowing capacity under our revolver to support our capital expansion plans and ongoing strategic growth initiatives. As we continue to focus on the execution of our long-term strategic goals, we will also stay focused on maintaining a strong balance sheet.

Mike Stivala, President and CEO

Thanks, Mike. As announced on July 20th, our Board of Supervisors declared our quarterly distribution of $0.325 per common unit in respect of our third quarter of fiscal 2023. That equates to an annualized rate of $1.30 per common unit. Our quarterly distribution will be paid on August 8th to our unitholders of record as of August 1st. Our distribution coverage continues to remain very strong at 2.27 times for the trailing 12 months ended June 2023. Just a few closing remarks. When we launched Go Green with Suburban Propane corporate pillar in 2019, it highlighted our strategic focus on advocating for the inherent clean qualities of propane as a versatile energy solution to lowering the carbon footprint across multiple sectors of the economy while also investing in innovative technologies and businesses that can help accelerate the energy transition to achieve aggressive low-carbon standards. Since that time, we have made initial manageable investments in developing stage companies like Oberon Fuels and Independence Hydrogen, that can benefit from Suburban’s deep logistics expertise, support infrastructure across multiple operational and back-office functions and strategic vision for developing commercial energy markets. While also providing Suburban Propane with a platform and exposure to potentially disruptive technologies or novel business processes in the transition to renewable energy. With our assistance, both companies are making good progress toward their commercialization efforts. Most recently, we have begun to build out an RNG platform that Suburban Propane owns outright through our wholly-owned subsidiary, Suburban Renewable Energy. The current portfolio of RNG-producing facilities is diversified by geography, feedstock, offtake, qualifying environmental credit attributes, and eligibility for investment and production tax credits. As I stated in my opening remarks, the Stanfield, Arizona facility is currently producing and injecting RNG into a pipeline interconnect adjacent to the facility and through enhancements to the processing is exceeding our initial projections for daily volume injection. The Columbus and Adirondack facilities are undergoing planned construction and upgrading, and as such, we’ll begin flowing RNG toward the end of fiscal 2024 or the beginning of fiscal 2025. We also have a number of additional RNG acquisition or development opportunities in our pipeline that are in various stages of evaluation. In conclusion, we are very much focused on continuing to foster the growth of our core propane business, because it is the strength and stability of our propane business that helps provide the cash flow to support our investments in the energy transition. As I mentioned, we are making strategic investments in ongoing energy transition to lower carbon renewable energy alternatives in order to set the business up for the future. In an effort to create long-term value for our employees, our value to unitholders and other stakeholders. We’re taking a very measured and disciplined approach in the execution of our strategic growth plans while also staying focused on maintaining a strong balance sheet, which provides support for our long-term sustainability as an organization, and access to capital to fund the opportunistic growth. Finally, I want to take this opportunity to thank the more than 3,200 employees at Suburban Propane for their hard work and unwavering focus on the safety and comfort of our customers and the communities we serve and to welcome the new employees that are supporting the operations and growth of the RNG business. Thank you all for all that you do every day. And as always, we appreciate your support and attention this morning and now we’ll open the call up to questions. And Betsy, if you wouldn’t mind helping us with that?

Operator, Operator

We will now begin the question-and-answer session. The first question today comes from Gabe Moreen from Mizuho. Please go ahead.

Gabe Moreen, Analyst

Good morning, everyone.

Mike Stivala, President and CEO

Good morning, Gabe.

Gabe Moreen, Analyst

Maybe I can start off. I think Mike made some comments about the moderating inflationary environment. Maybe you could elaborate on that and kind of what you’re seeing out there or what your expectations may be on what kind of inflation rate we may be facing from an OpEx standpoint heading into next year?

Mike Kuglin, CFO and Chief Accounting Officer

Yes. One of the biggest drivers behind the increase in expenses was in payroll. It was most pronounced, I guess – we would say, we saw in 2022, and then throughout 2023, but the rate of increase is certainly coming down and certainly not flat lining, but the rate of increase is certainly moderating compared to what we experienced in the last 18 to 24 months. Outside of that, I’d say vehicle expenses have been pretty elevated in the last couple of years. And as we look forward, they remain elevated, but the rate of increase is starting to come down a bit.

Gabe Moreen, Analyst

Thanks, Mike. And then, maybe if I can ask about potential RNG acquisitions. There you mentioned looking at additional opportunities. Can you just talk about how active the pipeline is? Are there anything potentially eminent here? And then, how you allocate capital to more RNG right now versus doing additional propane acquisitions like the one you did on the West Coast?

Mike Stivala, President and CEO

Yeah, there’s nothing eminent, Gabe. You know I think we’re always pretty active in evaluating opportunities now that we have an active portfolio of assets throughout the country. There are lots of opportunities that our team is helping us to operate that business, as well as our strategic corporate development team, that are continuously evaluating different opportunities and building relationships in the space. One other thing we see with our involvement in the RNG platform is a lot of the RNG assets that are out there right now have been sort of in the hands of investors, whether it be private equity or startup companies that bootstrap themselves to create a platform. I think we bring a whole different level of focus on long-term operation of the business, and I think that is giving us an advantage in the conversations we’re having. You know there’s nothing eminent. We’re very deliberate in the way we look at and evaluate these opportunities. We’re going to continue to be patient in that regard. As it relates to allocating capital, you know, same thing with propane. We’re always active, I think the pipeline there has gotten smaller over the years. There seems to be less and less mom-and-pops that come to market in the past two years than I’d say the five years prior to that. But you know we’re always in the market looking at those opportunities, but they have to be in really strategic markets and they have to be at the right multiple. The good thing is that we’re generating excess cash flow from the business. We have capacity to allocate that excess cash flow. You know, I said in my opening remarks, we had a combination of a propane acquisition that was less than $10 million, we continued to fund the capital expansion of the renewable platform, and we also reduced debt by $21 million. So you know that’s sort of the way we like to be opportunistic with the excess cash flow for now while we’re building out this platform.

Gabe Moreen, Analyst

Great. Thanks, Mike. Appreciate it.

Mike Stivala, President and CEO

Thanks, Gabe.

Operator, Operator

The next question comes from James Spicer with TD Securities. Please go ahead.

James Spicer, Analyst

Hey, good morning. In your prepared remarks you mentioned the pro forma leverage factored in projected run rate EBITDA contributions from your RNG business. Just wondering what you’re assuming there or thinking about in terms of EBITDA contributions and then more broadly how we should be thinking about build multiples for your various RNG projects?

Mike Stivala, President and CEO

Yeah I mean I think you can do the math. You know, we’re at 4.3 times now and I say we’re approaching 4 times. You could do the math on how that means in terms of the incremental EBITDA that we have. We haven’t – I mean we’re not out there projecting what the contributions going to be, that’s not our style; we don’t typically give guidance like that. So that’s the guidance we’re giving that when you look at it on that basis and the way we looked at the deal before we did it, it was on the pro forma basis to get us closer to 4 times. So that’s the way we’re you know that the leverage is shaking out. As far as your second question. Remind me what your second question was?

James Spicer, Analyst

Yeah, yeah it was just on the build –

Mike Stivala, President and CEO

Build multiples, yeah the build multiples.

James Spicer, Analyst

Yeah.

Mike Stivala, President and CEO

Sorry. So, yeah on build multiples, you know obviously we’re still in the early stages here of renewable energy investments. I think build multiples are probably going to be in the high single digits is kind of where we’re thinking about it at this stage. And that’s what we expect in our Adirondack Farms facility. As we think about the future deployment of capital for actually constructing assets, you know build multiples should be in that mid to high single digits.

James Spicer, Analyst

Okay, that’s helpful. Can you also remind me kind of where you are on CapEx at this point relative to your full year budget?

Mike Kuglin, CFO and Chief Accounting Officer

Yeah. So on the propane side, we would typically expect to see CapEx running between $35 million to $45 million. We came in at around $45 million last year given the elevated cost of steel and that translates to our tanks and cylinder purchases. I would expect a similar number this year on a full year basis around $45 million. In addition to that, this year we’d expect to see somewhere between an additional $5 million to $10 million associated with the build-out of the RNG assets.

James Spicer, Analyst

Okay, that includes both maintenance and growth CapEx?

Mike Kuglin, CFO and Chief Accounting Officer

That’s correct.

James Spicer, Analyst

Okay. Thank you very much.

Mike Stivala, President and CEO

Thanks, James.

Operator, Operator

The next question comes from Ned Baramov with Wells Fargo. Please go ahead.

Ned Baramov, Analyst

Hey, good morning. Thanks for taking the questions – hi. So it seems the Arizona RNG facility is tracking ahead of your internal volume expectations. Can you maybe touch on what is driving the outperformance there? And is there any potential additional upside?

Mike Stivala, President and CEO

So there the performance is really from some of the capital that we deployed to enhance the performance of the digester itself and the ability to get more yield out of the feedstock that we’re bringing in. Growth from here, there are still some opportunities for expansion without putting in more capital, meaning bringing in more feedstock both from other farms that are locally situated in the area that are not currently sending their materials to our facility. We also take in local biomass as biosolids in our D5 oriented digester as well. So there are some opportunities to increase the amount of feedstock we’re bringing in both of these streams so that we can increase the amount of production. That’s going to take a bit of time. What we focused on since we’ve owned the assets for the past six months is really performance of the assets themselves, enhancing the – streamlining the business, enhancing the actual performance of the digesters, and working through some challenges they had prior to our ownership. Now, we’ve worked all that out and are really seeing great performance of those assets.

Ned Baramov, Analyst

Got it. And my second question, can you provide more detail on your most recent propane acquisition on the West Coast, size up the – any details behind the process, synergy potential, etc.?

Mike Stivala, President and CEO

It’s relatively small, Ned. You know I said it, I think in my first answer. It’s less than $10 million of a purchase price. So, you know it’s not a significant contributor. But it is something that the way we look at propane acquisitions, they have to be in really good markets where we see opportunities either through synergies or because of the population growth or other growth that that market is experiencing. This particular one sits right in the middle of a really good territory of ours in the upper Northwest that’s going to generate good synergies for us and gives our team up there an opportunity to take one other competitor out and expand their market share while also putting in our operating platform to drive the synergies. So, yeah it’s not a big deal. Not a big acquisition, but it’s important for our operations on the West Coast and it’s the right kind of deal for us to be doing to continue to see growth in the propane business. Great. Thanks, Ned.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Stivala for any closing remarks.

Mike Stivala, President and CEO

Great. Thanks, Betsy. Thank you all again for joining us this morning. Appreciate your attention. Enjoy the rest of your summer. Please be safe out there. We look forward to talking to you in November as we close out another great fiscal year for Suburban Propane. So, thank you again.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.