Earnings Call Transcript - SPH Q1 2022

Operator, Operator

Good morning and welcome to the Suburban Propane Partners, L.P. First 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. This conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, relating to the partnership's future business expectations and predictions in financial conditions and results of operations. These forward-looking statements involve certain risks and uncertainties. The partnership has 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 its earnings press release which can be viewed on the company's website. All subsequent written and oral forward-looking statements attributable to the partnership or persons acting on its behalf are expressly qualified in their entirety by such cautionary statements. 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, Chad. Good morning, everyone. Thank you for joining us this morning for our fiscal 2022 first quarter earnings conference call. Joining me this morning are Mike Stivala, our President and Chief Executive Officer; Mike Kuglin, our Chief Financial Officer and Chief Accounting Officer; and Steve Boyd, our Chief Operating Officer. This morning, we will review our first quarter financial results, along with our current outlook for the business. Once we've concluded our prepared remarks, we will open the session to questions. Our annual report on Form 10-K for the fiscal year ended September 25, 2021; and Form 10-Q for the period ended December 25, 2021, will be filed by the end of business today, contains 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. Form 8-K will be available through a link in the Investor Relations section of our website at suburbanpropane.com. At this point, I will turn the call over to Mike Stivala for some opening remarks. Mike?

Michael Stivala, President and Chief Executive Officer

Great. Thanks, Davin and good morning and thank you all for joining us today. We are very pleased to deliver another solid quarter with an increase in adjusted EBITDA of more than 8% compared to the prior year first quarter. Coming into the first quarter of fiscal 2022, the propane industry was faced with highly publicized concerns over lower U.S. inventories, significantly higher base commodity prices across the entire energy slate and an expectation that consumers could be facing much higher costs to heat their homes and businesses in the impending heating season. In fact, heading into the 2021 and 2022 heating season, U.S. propane inventories were reported at around 20% below the five year average for that time of the year and spot propane prices were at their highest level for November since 2011. However, as our first quarter progressed, a combination of lower than average crop drying demand in the agricultural sector, lower export activity and near-record warm temperatures in the month of December 2021 which muted heat-related demand, all contributed to a near normalization of U.S. propane inventories and a pullback in propane prices by about 33% from their peak levels. At Suburban Propane, we were able to offset the impact of lower heat-related demand during the first quarter and certain inflationary factors driving higher operating costs with effective selling price management and a prudent hedging and risk management strategy in a very volatile commodity price environment. The improvement in earnings is also a testament to the hard work and dedication of our operations personnel in maintaining their focus on delivering outstanding service to our customers while continuing to contend with the challenges of operating the business through the COVID-19 pandemic. And also reflects the positive results from our customer base growth and retention initiatives. In a moment, I'll come back for some closing remarks, including our outlook for the rest of the year. However, at this point, I'd like to turn the call over to Mike Kuglin to discuss the first quarter results in more detail. Mike?

Michael Kuglin, Chief Financial Officer and Chief Accounting Officer

Thanks, Mike and good morning, everyone. To be consistent with previous reporting, as I discuss our first quarter results, I'm excluding the impact of unrealized mark-to-market adjustments on our commodity hedges which resulted in an unrealized loss of $33.5 million in the first quarter compared to an unrealized gain of $4.9 million in the prior year. This large unrealized loss on mark-to-market adjustments on our commodity hedges, primarily reflects the reversal of previously reported unrealized gains at the end of the prior fiscal year as a portion of those unrealized gains were realized during the first quarter of fiscal 2022. Excluding these items, as well as the noncash equity and earnings from Oberon Fuels, which is an unconsolidated affiliate, net income for the first quarter was $55.4 million or $0.88 per common unit compared to net income of $33.4 million or $0.53 per common unit in the prior year. Adjusted EBITDA of $86.5 million for the first quarter improved by $6.5 million or 8.1% compared to the prior year first quarter. As Mike mentioned, the improvement in earnings was driven by several factors but most significantly from solid margin management, the favorable impact of commodity hedges that matured during the period and the benefit from continued positive trends in customer base growth. These factors more than offset lower heat-related customer demand and inflationary pressure, along with much of our operating and general and administrative expenses. Retail propane gallons sold in the first quarter were 105.3 million gallons which was 5.7% lower than the prior year. Volumes sold were negatively impacted by widespread unseasonably warm temperatures, especially during the critical month of December, as well as lower demand for outdoor temporary heat and lower agricultural demand for crop growing given the low moisture content. With respect to the weather, average temperatures for the first quarter were 16% warmer than normal and 3% warmer than the prior year first quarter. Average temperatures during the month of December 2021, which is the most critical month for heat-related demand in the first quarter, were 14% warmer than normal and 5% warmer than December 2020. From a commodity perspective; as we reported on our last call, wholesale propane prices were elevated coming into fiscal 2022 and continued to rise for the first six weeks of the quarter as the nation's inventory levels were tracking well below historical averages for that time of the year. However, as Mike mentioned, as we progressed through the quarter, inventory levels improved due to solid production outpacing soft domestic demand and a slight pullback in exports. Overall, average wholesale prices for the first quarter were $1.25 per gallon, basis Mont Belvieu which was nearly 120% higher than the prior year first quarter and 7% higher than the prior sequential quarter. Excluding the impact of the mark-to-market adjustments on our commodity hedges that I mentioned earlier, total gross margin of $212.6 million for the first quarter increased $15.6 million or 7.9% compared to the prior year. The improvement in gross margin was driven by effective selling price management during a volatile commodity price environment and from the favorable impact of commodity hedges that matured during the period. Consistent with past practices, our hedging and risk management activities are intended to reduce the effect of price volatility associated with forecasted purchases of propane and propane sold on a fixed price basis. The commodity hedges that matured during the first quarter of fiscal 2022 were principally comprised of net-long positions purchased in fiscal 2021 that were favorably impacted by the significant rise in commodity prices. With respect to expenses, combined operating and G&A expenses of $125.5 million for the first quarter increased $9.4 million or 8.1% compared to the prior year, primarily due to higher payroll and benefit-related expenses and higher vehicle lease and operating costs. Compensation and benefit costs, along with vehicle and other operating costs, have all experienced some inflationary effects in the competitive environment for qualified staff as well as broader impacts on energy, steel, vehicles, and other costs. Net interest expense of $15.3 million for the first quarter was $2.8 million or 15.6% lower than the prior year, resulting from the refinancing of two tranches of senior notes at lower rates in the third quarter of the prior fiscal year as well as a lower average level of outstanding debt. Total capital spending for the quarter of $10.7 million was $4.9 million higher than the prior year. Capital spending during the quarter includes the acquisition of several properties to support greenfield expansion efforts in various growth markets, as well as tank and cylinder purchases to support customer growth. And turning to our balance sheet. Given the seasonal nature of our business, we typically borrow under our revolving credit facility during the first quarter to help fund a portion of our seasonal working capital needs. With that said, we borrowed approximately $44 million under the revolver during the first quarter, which is comparable to historical levels but slightly higher than the prior year first quarter due to the impact of higher commodity prices. Despite the borrowings to fund our working capital requirements, our total debt outstanding as of December 2021 was $73 million lower than December 2020, given the significant reduction in debt during the prior fiscal year. At the end of the first quarter, our consolidated leverage ratio for the trailing 12-month period was 4.02x, which is roughly flat to what we reported for fiscal 2021 and reflects a significant improvement from where we ended the prior year first quarter and is certainly well within our debt covenant requirement of 5.75x. Our working capital needs typically peak towards the end of the heating season, late February or early March time frame. After which, we expect to continue generating excess cash flows. We will continue to remain focused on utilizing excess cash flows to further strengthen the balance sheet and, as opportunities arise, to fund strategic growth. We have more than ample borrowing capacity under our revolver to fund our remaining working capital needs for the heating season as well as to support our strategic growth initiatives.

Michael Stivala, President and Chief Executive Officer

Thanks, Mike. As announced on January 20, our Board of Supervisors declared our quarterly distribution of $0.325 per common unit in respect of our first quarter of fiscal 2022, which equates to an annualized rate of $1.30 per common unit. Our quarterly distribution will be paid on February 8 to our unitholders of record as of February 1. Our distribution coverage continues to remain strong at 2.6x based on our trailing 12-month distributable cash flow at the end of the quarter. Looking ahead, while weather at the beginning of this year's heating season was unseasonably warm, particularly in the month of December, much of the heating season is still ahead. In fact, weather in the early part of our fiscal second quarter has shifted to more seasonable and in many parts of the country, colder than normal temperatures. With the arrival of colder temperatures and increased heating demand, propane prices have started to rise, increasing more than 15% in just the past three weeks. Our people and our operating platform are extremely well positioned to respond to the increasing customer demand while adhering to the highest standards for safety, including our continuing protocols associated with COVID-19. I'm very proud of how our people have continued to be resilient in the face of the ongoing challenges from the pandemic, whether in their personal lives or as a result of changes in how we operate. They remain dedicated to providing outstanding service to our customers and local communities, especially when they need us most. On the strategic front, we continue to make progress, along with our minority-owned subsidiary, Oberon Fuels, toward the commercialization of low-carbon renewable dimethyl ether which, as a blend with propane, will significantly reduce its carbon intensity. Our initial focus is to offer the blended product in the forklift and over-the-road auto gas markets. And as we talk to existing and prospective customers, we have received some very positive interest for this new product. And we have recently begun to construct the blending infrastructure needed to support future handling and sale of the new product. In addition to fostering our investment in Oberon, we continue to seek additional investment opportunities in other exciting new technologies as we look to execute on our stated strategic goal of building out a renewable energy platform. Given our long legacy of being a trusted energy provider to local communities, we are very well situated and excited to support the country's energy transition to a sustainable energy future, both given the clean qualities of propane as a destination fuel but also through our efforts to identify and invest in other innovative solutions to lower greenhouse gas emissions across multiple corners of the energy sector. And finally, I'd like to once again thank all of the more than 3,100 employees at Suburban Propane for their unwavering focus on the safety and comfort of our customers and the communities we serve. And as always, we appreciate your support and attention this morning. And we'll now open the call for questions. And Chad, if you wouldn't mind helping us with that?

Operator, Operator

Certainly. With that we will begin with the question-and-answer session. And the first question will come from Ned Baramov with Wells Fargo. Please go ahead.

Ned Baramov, Analyst

Hi, good morning. Thanks for taking the questions.

Michael Stivala, President and Chief Executive Officer

Good morning.

Ned Baramov, Analyst

Could you provide more details on the acquisition of properties in new markets that you noted in your prepared remarks, Mike? And more specifically, do you anticipate additional spending in these areas?

Michael Stivala, President and Chief Executive Officer

So we've talked a lot about not only being somewhat active in the propane M&A market but even more importantly, identifying very strategic markets across the United States, where we may not have a big enough presence or maybe we don't have a presence at all, that's just outside of our current delivery radius but that has experienced strategic growth opportunities because of maybe population migration or just changing behaviors in that particular market, where we believe that our service capability belongs in that market to serve the customers. And so we have a number of greenfield expansions across many different parts of the country. And the acquisitions of properties was to obviously build out the infrastructure to support those local markets with storage and a depot to house our trucks and people that are going to go after those new markets. As far as future spending, most of the spending for the active greenfields that we have going on right now is pretty much behind us in terms of buying up properties and the necessary assets to get started in those markets. From here, the cost is really just getting out there and marketing the great Suburban Propane brand to those markets.

Ned Baramov, Analyst

Got it. That's helpful. And then second question, could you talk about inflationary effects on your combined OpEx and SG&A? And do you expect additional increases for the remainder of fiscal 2022?

Michael Stivala, President and Chief Executive Officer

There is certainly a significant amount of attention on the challenges posed by driver shortages in industries that rely on CDL drivers, including ours. This morning, I noticed that a New Jersey Transit bus was offering a $6,000 signing bonus for drivers, highlighting how competitive the market is for qualified personnel. This situation has contributed to inflationary pressures on our business. We've seen some of the largest compensation increases in recent years, which is positive as it helps us retain and attract high-quality drivers, although it does come at a higher cost. Additionally, prices for essential materials, like steel for our tanks and new trucks, have risen due to supply chain issues and the increased cost of base commodities. Fuel prices for gasoline and diesel, which are critical for our operations, have also significantly increased. These are significant inflationary impacts affecting us, some of which may become permanent in our cost structure, while others will depend on market conditions in the months or year ahead. On a positive note, we have effectively managed our operations, maintaining a lean platform. We are recognized as one of the most efficient operators in the industry, which allows us to continue succeeding in this challenging environment while others may face difficulties. Additionally, we have managed our selling prices effectively, ensuring our margins remain strong enough to cover the rising costs in this competitive propane industry.

Ned Baramov, Analyst

Great. Thanks for all the color. That's all I had.

Michael Stivala, President and Chief Executive Officer

Great. Thank you, Ned.

Operator, Operator

And we do have a question and that comes from James Spicer with TD Securities. Please go ahead.

James Spicer, Analyst

Hi, good morning. You guys have done a great job of reducing leverage over the past year or so. Can you just remind us what your target is on the leverage side and how you think about priorities between continued deleveraging versus investments back in the business versus dividend increases?

Michael Stivala, President and Chief Executive Officer

Our goal is to reduce our leverage metric to the mid-3x range. We finished fiscal 2021 at just under 4x, but with increased borrowings for working capital in the first quarter, it rose slightly to just over 4x. As we move past the peak working capital, we expect to fall below 4x as the year continues. Given our operating platform and the potential earnings of the business, we anticipate generating between $70 million and $100 million in excess cash flow. We will make decisions on the best use of this cash based on available opportunities. We aim to invest in renewable energy technologies and are actively exploring various opportunities in different sectors of renewable energy, although not all of them may be successful. If some of these opportunities come through, our excess cash flow will allow us the flexibility to fund acquisitions without borrowing. If we do not pursue those acquisitions, any excess cash flow will be directed toward debt reduction to help us reach our goal. Additionally, as we grow the business through investments in innovative technologies, we will create more opportunities for incremental cash flow in the future, which will be available for increasing distributions. Our priority is to create value for our unitholders through various means, including strengthening our balance sheet, strategically deploying capital to enhance our renewable platform, and continuing to generate excess cash flow in the propane business while growing that segment as well. We remain focused on all these aspects and, as we execute our plans, we will have more chances to revisit our distribution policy.

James Spicer, Analyst

Okay, great. That's very helpful. And just one more, if I could. I know your 2027 notes are callable in March, have you guys thought at all about the timing on refinancing them?

Michael Kuglin, Chief Financial Officer and Chief Accounting Officer

Yes. I mean, if you look at our history, we've always been pretty active with refinancing the bonds at the appropriate time. So it's something that we'll continue to look at but we certainly are not going to foreshadow when we are going to possibly do that.

James Spicer, Analyst

Yes, understand. Thanks very much.

Operator, Operator

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

Michael Stivala, President and Chief Executive Officer

Great. Thank you, Chad and thank you all for joining us again. I hope you all stay safe and warm and we look forward to talking with you again after our second quarter earnings in early May. So, thank you, again. I appreciate your time.

Operator, Operator

And thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.