Earnings Call Transcript - SPH Q4 2023

Davin D'Ambrosio, Vice President and Treasurer

Good day, and welcome to the Suburban Propane Partners Fiscal 2023 Full Year and Fourth Quarter Results Conference Call. Please note today's event is being recorded. I'd now like to turn the conference over to Davin D'Ambrosio, Vice President and Treasurer. Please go ahead, sir.

Mike Stivala, President and Chief Executive Officer

Great. Thanks, Davin, and thank you all for joining us this morning. Fiscal year 2023 was another great year for Suburban Propane. In addition to overcoming a challenging weather pattern, with some of the warmest temperatures on record during the most critical months for heat-related demand, that's namely January and February, as well as a persistent inflationary cost environment to deliver strong earnings, we succeeded in accomplishing a number of significant goals in fiscal 2023 that provide further support for our long-term strategic growth initiatives. So let me highlight a few noteworthy accomplishments for fiscal 2023. Through our wholly owned subsidiary, Suburban Renewable Energy LLC, we acquired a platform of RNG production assets from Equilibrium Capital Group, a leading sustainability-driven asset management firm. These assets included a large-scale RNG production facility in Stanfield, Arizona that is currently operating and includes seven anaerobic digesters, manure rights from approximately 55,000 dairy cattle, and connects with an interstate pipeline on-premise; an operating facility in Columbus, Ohio that is currently receiving tipping fees from several large food and beverage providers for processing food waste into fertilizer and biogas; and we have an active development project to upgrade the biogas into pipeline-quality RNG for sales. We formed a partnership with Equilibrium to serve as a long-term platform for the identification, development, and operation of additional RNG projects and currently have a pipeline of potential RNG projects to invest in that are in various stages of evaluation. We have advanced the engineering and construction activities for our anaerobic digester pursuant to an agreement with Adirondack Farms, which is a family-owned dairy farm in Upstate New York, to produce RNG from dairy cow manure, which we expect to be up and running in fiscal 2025. Once all three of these renewable natural gas facilities are operating at run-rate capacity, we will be generating revenues from tipping fees, RNG sales for approximately 850,000 MMBTUs per year, environmental attribute credits, and fertilizer sales. We also continued to support our uncontrolled subsidiaries Oberon Fuels and Independence Hydrogen as they begin to scale their platforms for the production and sale of ultra-low carbon renewable dimethyl ether and clean hydrogen, respectively. During fiscal 2023, we invested additional capital into Oberon Fuels to support the commercialization of rDME as a blend with propane or as a precursor to hydrogen production, and we were the first in the world to begin delivering Propane + rDME at a 4% blend level to our forklift customers in Southern California. We have also invested in a proprietary blend facility in our Anaheim location and are actively testing different blend levels in forklift engines to expand the potential commercial applications for Propane + rDME. In our core propane business, our operating personnel did an excellent job safely delivering outstanding service to our customers and executing on our customer-based growth and retention initiatives. In fact, during fiscal 2023, we were able to deliver organic growth in our customer base, even after excluding the impact of new customers that we acquired in an acquisition. This is a testament to the stability of our platform and the quality of service that our field personnel work so hard to deliver to our customers and local communities every day. We also acquired and successfully integrated a well-run propane business in the strategic market in our Upper Northwest operating territory, which provides excellent synergy potential. And we continue to foster the growth of our greenfield market expansion efforts in seven markets around the country. And from a balance sheet perspective, despite deploying nearly $230 million on investments to support our strategic growth initiatives and capital expansion in our RNG business in 2023, our total debt increased by just $123 million compared to where we ended fiscal 2022 as we were able to utilize excess cash flows to manage our overall leverage profile. Our long-term strategic growth plan is to continue to foster the growth of our core propane business while making strategic investments in the energy transition to lower-carbon renewable energy alternatives. Our core propane business is the engine that helps provide the cash flow to support these strategic investments. And as society transitions to these lower-carbon solutions, Suburban Propane is leveraging our 95-year legacy of an unwavering commitment to safety and excellence in customer service and our reputation as a trusted distributor of energy to local communities in order to position the business for long-term growth and sustainability in a lower-carbon economy. A little later, I'll provide some closing remarks. However, let me turn it over to Mike Kuglin to discuss the full year and fourth quarter results in a little more detail. Mike, over to you.

Mike Kuglin, Chief Financial Officer

Thanks, Mike, and good morning, everyone. I'll start by focusing on our full year results, which included 53 weeks of operations in fiscal 2023 compared to 52 weeks in the prior year, and give some color on the fourth quarter toward the end of my remarks. To be consistent with previous reporting, I'm excluding the impact of unrealized noncash mark-to-market adjustments on our commodity hedges, which resulted in an unrealized loss of $3.7 million in fiscal 2023 compared to an unrealized loss of $27.9 million in the prior year, along with certain other noncash items and acquisition-related transaction costs. Excluding these items, net income for fiscal 2023 was $138.4 million or $2.17 per common unit compared to $171.1 million or $2.71 per common unit in the prior year. Adjusted EBITDA for fiscal 2023 was $275 million compared to $291 million in the prior year. As Mike mentioned, our earnings for the fiscal year were impacted by lower heat-related demand resulting from extremely warm weather during the most critical months of the heating season and from the continued impact of inflationary pressures on our expenses. Although those headwinds presented operating challenges, our earnings for the year benefited from organic growth in our customer base, propane unit margin expansion, and contribution from the RNG facilities acquired in December. Retail propane gallons sold in fiscal 2023 were 396 million gallons, which is 1.2% lower than the prior year, primarily due to the impact of warm and inconsistent temperatures throughout the heating season, partially offset by favorable customer base trends. With respect to the weather, average temperatures for fiscal 2023 were 8% warmer than normal and 2% colder than the prior year. Although we experienced an overall increase in heating degree days compared to the prior year, the weather pattern was characterized by extremely warm temperatures during the critical heating months of January and February and were most pronounced in our East Coast and Midwest operating territories. Our operations in the West generally experienced normal to cooler-than-normal temperatures. For the month of January and February, average temperatures were 16% warmer than normal and 11% warmer than the same period last year, and we're on par for the warmest on record for that 2-month period. From a commodity perspective, propane inventory levels in the U.S. were elevated throughout the year and were much improved compared to 2022. According to the Energy Information Administration, U.S. propane inventories at the end of September 2023 were at 101 million barrels, which is 20% higher than September 2022 levels and 11% higher than historical averages for that time of the year. As a result of the increased inventories and other factors, average wholesale prices, basis Mont Belvieu, for fiscal 2023 were $0.75 per gallon, which were 39% lower than the prior year. Excluding the impact of the mark-to-market adjustments on our commodity hedges that I mentioned earlier, total gross margin of $842.7 million for fiscal 2023 increased $25.5 million or 3.1% compared to the prior year, primarily due to higher propane unit margins and margin contribution from the RNG asset acquired in December, from RNG sales and related environmental attributes as well as tipping fees. Excluding the impact of the unrealized mark-to-market adjustments, propane unit margins for fiscal 2023 increased $0.04 per gallon or 2% compared to the prior year, primarily due to effective selling price management during a period of declining commodity prices that helped offset the impact of inflationary pressures on our delivery costs and other expenses. With respect to expenses, combined operating and G&A expenses increased $45.5 million or 8.7% compared to the prior year, primarily due to the impact of inflationary pressures across many areas of the business and, most significantly, within payroll and benefit-related expenses in vehicle lease and repair costs. The comparison of our expenses to the prior year was also impacted by the costs associated with the acquisition and operations of the new RNG assets included within general and administrative expenses for fiscal 2023 or acquisition-related costs of $4.7 million, which were excluded from adjusted EBITDA. Net interest expense of $73.4 million for fiscal 2023 increased $12.7 million compared to 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, which carry an interest rate of 5.5%. Total capital spending for the year was $45 million and reflected $20 million of maintenance CapEx and $25 million of growth. Our growth capital included $3 million 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. For fiscal 2024, capital spending for our propane operations is expected to be consistent with historical levels, which is between $40 million and $45 million, and CapEx for the RNG projects is expected to range between $25 million to $35 million, excluding the benefit of potential investment tax credits. Turning to our fourth quarter results. Given the nature of our fiscal calendar, the fourth quarter of fiscal 2023 included 14 weeks of operations compared to 13 weeks in the prior year. Consistent with the seasonality of our business, we typically report a net loss for the fourth quarter. With that said, excluding the effects of noncash adjustments in both years, we reported a net loss of $33.2 million or $0.52 per common unit, compared to a net loss of $27.1 million or $0.43 per common unit in the prior year. Adjusted EBITDA for the fourth quarter of fiscal 2023 increased slightly to $3 million. Total gross margin increased $15.4 million or 12%, primarily due to an increase in volumes sold, higher unit margins, and an increase in service-related revenues. Combined operating and G&A expenses increased $15.2 million or 12.2% due to higher variable operating costs in support of the increase in volumes sold, the impact of the additional week of operations, costs associated with the operations of the new RNG assets and a continued impact of inflation. And turning to our balance sheet. As Mike mentioned, we invested more than $230 million to fund our strategic growth initiatives during fiscal 2023. Although the investments were initially funded with debt, including borrowings under the revolver and the assumption of the green bonds, our total debt outstanding at the end of the fiscal year reflected an increase of $123 million as we utilized excess cash flow from operating activities to repay revolver borrowings. As a result of the increase in debt, our consolidated leverage ratio at the end of fiscal 2023 was 4.28x. Although the leverage metric has been elevated relative to our historical levels following the RNG acquisition, it has improved in each of the last two quarters as we utilized excess cash flows to repay revolver borrowings, including a repayment of $28 million during the fourth quarter. We remain well within our debt covenant requirement of 5.75x, and as I mentioned last quarter, factoring the projected run rate EBITDA contribution from the RNG assets, the pro forma consolidated leverage ratio approaches 4x.

Mike Stivala, President and Chief Executive Officer

Thank you, Mike. As shared in our October 26 press release, our Board of Supervisors has declared a quarterly distribution of $0.325 per common unit for the fourth quarter of fiscal 2023, which translates to an annualized rate of $1.30 per common unit. This quarterly distribution will be paid on November 14 to unitholders of record as of November 7. I would like to make a few closing remarks about our long-term strategy. Our organization’s longevity can be attributed to the hard work and commitment of our employees, who are driven by our three corporate pillars: our commitment to excellence in safety and customer service, our dedication to giving back to local communities through our SuburbanCares platform, and our focus on innovation for the future via the Go Green with Suburban Propane initiative. Over our 95-year history, we have solidified our role as a trusted local energy provider, maintaining the highest standards for safety, customer satisfaction, and reliability. Suburban Propane continues its legacy as a leader in the U.S. propane industry through a comprehensive growth strategy that leverages the low-carbon benefits of propane and our investments in innovative renewable energy products and technologies via our Suburban Renewable Energy subsidiary. The energy sector is currently witnessing a shift toward cleaner energy alternatives. While propane remains a dependable, affordable, and domestically produced clean energy source, Suburban Propane will continue to enhance our well-established legacy and core strengths, making strategic investments in both the propane sector and renewable energy alternatives for businesses and communities nationwide. We are dedicated to providing solutions that mitigate the long-term impacts of climate change, positioning Suburban Propane for sustained growth and sustainability, while creating career development opportunities for our employees and long-term value for all stakeholders. I want to express my gratitude to our over 3,300 employees for contributing to another successful year for Suburban Propane in fiscal 2023. I hope you and your families stay safe and healthy, and I wish everyone a happy holiday season. Thank you for your support and attention this morning. We will now open the call for questions.

Operator, Operator

Today's first question comes from Gabe Moreen with Mizuho. Please go ahead.

Gabe Moreen, Analyst

Good morning, everyone. I have a couple of questions. First, I'd like to know your expectations for O&M growth. I understand that last year's growth of around 9% was partly inorganic. I’m curious about what you’re observing and your expectations for FY '24 regarding O&M and G&A.

Mike Kuglin, Chief Financial Officer

Given the ongoing inflation across the country, I anticipate expenses will continue to rise. While the percentage increase is beginning to moderate, it is not disappearing. Volumes will significantly affect our operating expenses. I expect the overall net increase in expenses to be less than what we've seen in the past couple of years, but ultimately, expenses will be influenced by the expected volumes.

Gabe Moreen, Analyst

Great. Thanks Mike. And then I think there was a pretty decent step-up in your equity earnings this quarter. Can you just speak to that a little bit about whether that was Oberon, Independence Hydrogen, maybe where that was coming from?

Mike Kuglin, Chief Financial Officer

Yes. It was related to Oberon, nothing unusual, just us picking up our equity and earnings of the sub.

Gabe Moreen, Analyst

Thanks Mike. And maybe if I can just ask a bigger question. Think you talked about investing in both propane and RNG. Clearly, there's one of your competitors out there that's undergoing a strategic review of its propane operations. Can you just talk about interest in scaling and propane versus making more of those RNG investments and how you think about kind of allocating capital on both sides, particularly with some of the stuff out there that might be out there in the market at the moment?

Mike Stivala, President and Chief Executive Officer

Our long-term strategy is clear. We are fully committed to our core propane business and have made several small acquisitions in strategic markets at favorable valuations in recent years. Additionally, we are focused on the energy transition, as demonstrated by our investments in RNG and our involvement in clean hydrogen production and distribution through Independence Hydrogen and other opportunities. We believe that in the long run, we are building a growth platform. Propane is an excellent business that generates the cash flow necessary for our investments, and we have a solid operation backed by decades of experience. There are promising prospects ahead for the propane industry, although it has faced challenges due to weather variability and a mature competitive landscape with limited growth opportunities. Our strategic growth aims to establish a robust platform that positions the business for the next 95 years, with propane playing a key role as it remains a clean energy source. However, we recognize the development of alternatives like renewable natural gas and hydrogen, especially given significant government investments in hydrogen infrastructure. Therefore, our approach combines continuing growth in propane while also establishing a growth framework that could enhance returns for our unitholders through distribution growth and potentially lead to a reevaluation of the risk profile of the propane industry, ultimately generating long-term value for shareholders. That is our strategy. I won’t comment on the strategic direction of one of our competitors; they have made their intentions clear and have faced challenges in recent years. I’ll leave it at that.

Gabe Moreen, Analyst

Appreciate it. Thanks Mike.

Operator, Operator

And everyone, that concludes our question-and-answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Mike Stivala, President and Chief Executive Officer

Great. Thanks, Rocco. I appreciate your help today. And again, appreciate everybody's support and attention. I really do wish you all a happy holiday season. We look forward to talking with you again in early February after our first-quarter results. Thank you.

Operator, Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.