Earnings Call Transcript - SPH Q2 2022

Operator, Operator

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

Davin D'Ambrosio, Vice President & Treasurer

Good morning, everyone. Let me start with the safe harbor language. 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 a cautionary statement in this earnings press release, which can be viewed on the company's website. Also, written and oral forward-looking statements attributable to the partnership or persons acting on behalf are expressly qualified in their entirety by such cautionary statements. Joining me this morning is Michael Stivala, our President and Chief Executive Officer, Michael Kuglin, Chief Financial Officer and Chief Accounting Officer, and Steve Boyd, our Chief Operating Officer. This morning we will review our second quarter financial results along with our current outlook for the business. Once we concluded our prepared remarks, we will open the session to questions. Our annual report on Form 10-K for the fiscal year ended September 25th, 2021, and Form 10-Q for the period ended March 26, 2022, which will be filed by the end of business today, contain additional disclosure regarding forward-looking statements and risk factors. Copies may be obtained by contacting the partnership or the SEC. For non-GAAP measures that will be discussed on this call, we have provided a description of those measures, as well as the 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 suburbanpropane.com. At this point, I will turn the call over to Mike Stivala for some opening remarks. Mike?

Michael Stivala, President & Chief Executive Officer

Great. Thanks, Davin. Good morning. Thank you all for joining us today. The second fiscal quarter was another outstanding quarter for Suburban Propane on a number of fronts. We delivered solid operating results. We made further progress on the execution of our long-term strategic initiatives toward the build-out of a renewable energy platform. And we continue to drive improvements in our key financial metrics. Despite a challenging operating environment resulting from an erratic weather pattern, historically high commodity prices, and inflationary factors impacting expenses, we were able to expand our customer base and effectively manage margins and expenses to deliver an improvement in adjusted EBITDA compared to the prior year second quarter. When you combine that with the improvement from our first quarter, we have now reported a $7 million or nearly 3% increase in adjusted EBITDA through the first six months of the fiscal year. On the strategic front, we made a number of moves during the quarter. First, in March, we acquired a 25% equity stake in Independence Hydrogen, which is a better and owned and operated start-up company focused on developing a hydrogen ecosystem from production to distribution, which will deliver locally sourced, clean hydrogen to local markets with initial focus on material handling and backup power applications. This is a real strategic investment for us. We believe in the role that hydrogen will play in the coming years as society moves toward decarbonization across many sectors of the economy that may prove difficult to address with alternative renewable energy sources. Second, we committed additional capital to support our investment in Oberon Fuels as we collectively get closer to commercialization of our new product offering called Propane Plus rDME. This blended product combines the versatile, clean, and portable benefits of propane with the low carbon attributes of renewable dimethyl ether to reduce the carbon intensity of propane in order to create a pathway for meeting aggressive carbon reduction standards. We also deployed capital to complete the construction of the world's first commercial Propane Plus rDME blending facility in our Placentia, California location. Just last week, we celebrated the first commercial launch of Propane Plus rDME with a ribbon-cutting ceremony at that location. We are now selling this lower-carbon alternative to our customers in Southern California. Third, we formed a new subsidiary branded Suburban Renewals, which will serve as the platform for these and other investments in renewable energy businesses and assets. You can learn more about these investments by visiting our website. We funded these investments with excess cash flow from operations while also allocating approximately $42 million to reduce debt during the quarter. It's a very balanced approach to making strategic investments and continuing to pay down debt to strengthen our balance sheet, which are all very long-term focused and in line with our stated strategic goals. In a moment, I'll come back for some closing remarks and provide added core on our strategic initiatives. However, at this point, let me turn it over to Mike Kuglin to discuss the second quarter results in more detail. Mike?

Michael Kuglin, Chief Financial Officer & Chief Accounting Officer

Thanks, Mike. And good morning, everyone. To be consistent with previous reporting as I discuss our second quarter results and excluding the impact of unrealized mark-to-market adjustments on our commodity hedges, which resulted in an unrealized gain of $33 million for the second quarter compared to an unrealized gain of $1.6 million in the prior year. The large unrealized gain on our commodity hedges reflects the fair value of open positions as of the end of the second quarter, partially offset by the reversal of unrealized net gains at the end of the first quarter as a portion of those unrealized net gains were realized during Q2. The contracts associated with the open commodity hedges at the end of the second quarter are expected to mature over the course of the next nine months. And the evaluation of the hedges is subject to change as commodity prices fluctuate. Excluding these items, as well as the non-cash equity earnings of Oberon Fuels, which is an unconsolidated subsidiary accounted for under the equity method, and a non-cash pension settlement charge in the prior year, net income for the second quarter was $142.8 million or $2.26 per common unit, compared to net income of $126.3 million or $2.10 per common unit in the prior year. Adjusted EBITDA of $172.5 million for the second quarter improved by $0.5 million compared to the prior year. As Mike mentioned, the earnings for the quarter were driven by several factors, but most significantly from solid margin management, the sustainable impact of our commodity hedging, and a risk management strategy in a period of dramatically rising commodity prices, as well as the benefits from continued positive trends in customer base growth. These factors more than offset the impact of soft volumes resulting from customer conservation, lower heat-related demand from warmer weather, and inflationary pressures on our expenses. Retail propane gallons sold in the second quarter were 159.2 million gallons, which was 5.8% lower than the prior year. Volumes sold were negatively impacted by elevated customer tank levels coming into the quarter due to the impact of near record warm temperatures during the month of December, and from warm and inconsistent temperatures throughout the second quarter. In addition to a less favorable weather pattern during the most critical months of the heating season, which was from December through February, volumes were also adversely impacted by a considerable level of customer conservation, resulting from the historically high commodity price environment. With respect to the weather, the second quarter got off to a warm start, but equivalent trend in late January into early February provided a short-lived boost in demand. Warmer weather then returned in mid-February and tempered heat-related momentum. Overall, average temperatures for the second quarter were 7% warmer than normal and similar to the prior second quarter. For the critical heating months of December 2021 to February 2022, average temperatures were 8% warmer than normal and 1% warmer than the prior year. By commodity perspective, wholesale propane prices were elevated coming into the second quarter and continued to rise throughout Q2 in line with increases in crude oil prices and as a result of persistently low inventory levels relative to historical averages for this time of the year. Within the quarter, wholesale prices, basis Mont Belvieu, moved from a low of $1.10 in early January to $1.63 in early March, which is the highest price for propane in 13 years. Overall, average wholesale prices for the second quarter were $1.31 per gallon, which is 45% higher than the prior second quarter and 5% higher than the first quarter of fiscal 2022. Excluding the impact of the mark-to-market adjustments on our commodity hedges that I mentioned earlier, total gross margin of $316.1 million for the second quarter increased $12 million or 4% compared to the prior year. Improvement in gross margin was driven by effective selling price management during a rising 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 second quarter were principally comprised of net long positions that were favorably impacted from the significant rise in commodity prices. Regarding expenses, combined operating and G&A expenses of $143 million for the second quarter increased $12.4 million or 9.5% compared to the prior year, primarily due to higher payroll and benefit-related expenses, higher vehicle lease and fuel costs, higher provisions for doubtful accounts, and other inflationary pressures across many areas of the business. Interest expense of $15.3 million for the second quarter was $2.8 million or 15.7% lower than the prior year due to refinancing of two tranches of senior notes at lower rates in the third quarter of fiscal 2021, as well as a lower average level of outstanding debt. Total capital spending for the quarter of $11.6 million was $3.2 million higher than the prior year, primarily due to the acquisition of several properties in growth markets that were previously leased, and from the impact of higher steel prices in our purchases of tanks and cylinders to support customer growth. Turning to our balance sheet, during the second quarter, we repaid $41.9 million of borrowings under the revolver. We funded the debt repayment loan with our seasonal working capital needs, capital expenditures, additional investments in Oberon Fuels, and our $30 million equity investment in Independence Hydrogen, using cash flows from operating activities. With the debt repayment, our total debt outstanding as of March 2022 was $46.7 million lower than March of last year. The combination of the increase in earnings and debt repayments during the second quarter resulted in our consolidated leverage ratio for the trailing 12-month period ended March 2022 improving to 3.87 times. We have now moved through our historically high period of seasonal working capital needs and remain focused on utilizing excess cash flows to further strengthen the balance sheet and, if opportunities arise, to fund strategic growth initiatives. Back to you, Mike.

Michael Stivala, President & Chief Executive Officer

Thanks, Mike. As announced on April 21st, our Board of Supervisors declared our quarterly distribution of $0.325 per common unit in respect to our second quarter of fiscal 2022, that equates to an annualized rate of $1.30 per common unit. The quarterly distribution will be paid on May 10th to our unit holders of record as of May 3rd. Looking back on the most recent heating season, we are extremely proud of how our operations personnel have continued to stay focused on delivering outstanding service to our customers, adhering to the highest standards for safety, and executing on our customer base growth and retention initiatives to help drive net customer base growth, all in the face of the significant challenges that continue to play the economy. Namely, historically high commodity prices, inflationary factors creeping into so many aspects of our business and expenses, shifting work behaviors, and hiring challenges in a post-COVID phase, as well as customer conservation efforts resulting from the challenges consumers face in managing their own spending budgets in this inflationary environment. Our supply and risk management team continues to do an outstanding job managing propane supplies, as well as the volatility in commodity prices. With the improvement in adjusted earnings EBITDA, coupled with prudent management of capital expenditures and the benefits of nearly $10 million in interest savings in the trailing 12-month period, our distribution coverage remains strong at 2.56 times. Our leverage is trending lower at 3.87x compared to 3.95 at the end of March 2021. We're continuing to position the business both operationally and financially for long-term growth and sustainability. Leveraging our strengths as an organization, we will continue to look for opportunities to make strategic investments in the build-out of our renewable energy platform and support the country's ongoing energy transition toward a lower carbon future while also fostering the growth of our core propane business, both through acquisitions and strategic market expansions, and bringing down leverage toward our mid-3x target range. For all of the reasons discussed today, we feel that we offer a very compelling story of a business that has a more than 90-year tradition of safely meeting the energy needs of its customers and local communities around the country, with a best-in-class operating model that is leveraging its expertise to help support the country's ongoing energy transition to a low carbon economy, and is positioned to competitively grow the business for the next 90-plus years. Finally, despite these challenging times, the foundation of our ongoing success continues to be rooted in our more than 3,100 employees at Suburban Propane and their hard work and unwavering focus on the safety and comfort of our customers and the communities we serve. I'm extremely proud of all of their efforts. As always, we appreciate your support and attention today, and would now like to open the call for questions. Rocco, could you help us with that?

Operator, Operator

Yes, sir. If you were using a speakerphone, we ask that you please pick up your handset before pressing the keys. We'll pause momentarily to assemble our roster. And today's first question comes from Ned Baramov with Wells Fargo. Please go ahead.

Ned Baramov, Analyst

Hi. Good morning. Thanks for taking the questions. Could you talk a little bit more about margin management specifically? Could you provide additional details on your selling price management initiatives and maybe any thoughts on the gross margin trajectory going forward? Much appreciated.

Michael Stivala, President & Chief Executive Officer

Sure, Ned. Thanks again for your interest. Obviously, in a commodity environment like we're experiencing right now, it's a real challenge out there. Not only for our customers that have to contend with higher energy bills, but also, we operate in a very competitive market. So, managing prices in this environment is no easy task. However, I believe what we've experienced over the many years that we've been running the business is that we do an excellent job managing selling prices through any commodity cycle. That's what you're seeing in our field operations. Our ability to manage increasing prices is essential. On top of that, you have to understand that when people talk about the ability to expand margins, inflation creeping into so many aspects of our expense base, like fuel costs and maintenance costs, means we are investing heavily in our people, so payroll costs are up. Margin has to expand to keep up with the rising expense base. Lastly, I want to comment on overall margins. We have a strong risk management strategy that insulates the business from the volatility we're experiencing in the market. So, we have a combination of solid margin management at the field level, good risk management of a very volatile commodity price environment to deliver strong overall margins. But it’s no easy task for sure when commodity prices are at a level we haven't experienced in a very long time.

Ned Baramov, Analyst

That's helpful. And maybe on that last point, I guess, lighter volumes in the quarter were largely due to weather, but in the press release, you also pointed out to customer conservation given that high commodity price. So, maybe if you could expand a little bit on this point and quantify the impact from customer conservation in the quarter and also if you could talk about the price of propane on a wholesale basis that triggers conservation patterns among your customer base.

Michael Stivala, President & Chief Executive Officer

Yeah, I'll take the second point first, which is we've historically seen that when prices at Belvieu start to get above $1.25 or close to $1.50, you really start to see a different behavior in the customer base. Right now, or at least yesterday, Belvieu closed at about $1.28. We're stuck in that range, and we've been above $1.25 for quite some time. When it gets up to $1.63 or $1.50, we definitely see a level of conservation that you don't otherwise see when prices are, say, in the $1.85 range. Belvieu has been as low as $0.25 since I’ve been with the company for the last 20 years, but certainly the level we are now is where we typically see the impact of conservation. As for quantifying it, it's tough to put an exact impact on volumes. Overall volumes were down 6% year-over-year in the quarter, and I would say a couple of percentage points of that is due to conservation. It’s not an exact science, but you can definitely tell there is a behavioral shift in usage per customer trying to manage their spending in this inflationary environment.

Ned Baramov, Analyst

Understood. Thank you.

Operator, Operator

Gentlemen. As a reminder, we'll pause momentarily to assemble our roster. And it looks like we have a follow-up from Ned Baramov with Wells Fargo. Please go ahead.

Ned Baramov, Analyst

Thanks again, just one more. So, we've seen the fiscal second quarter distribution complete a full-year of higher distributions after the 8.3% step-up in the last year. Could you maybe talk about the board's most recent view on distribution increases going forward?

Michael Stivala, President & Chief Executive Officer

Yeah, Ned. I think what we've said all along is we obviously take a very hard look every quarter as to how to allocate capital. What we're excited about right now is the opportunities we see in front of us with respect to deploying capital towards the build-out of our renewable platform. We have a number of exciting things that we're continuing to look at and support that effort and as well as propane opportunities. As we come out of the heating season, many more businesses come to market, and we're starting to see that activity pick up again as normal. It's a balance. We are fortunate that we have the excess cash flow generating capacity that this business is generating. If you look at our trailing 12 months, we're generating over $100 million of excess cash flow, and as we've demonstrated in the second quarter, we really take a balanced approach towards deploying capital, investing in growth, but also getting to a point where we achieve our target level of leverage, which is in the mid three-time. We still have work to do on debt reduction and opportunities ahead for the build-out of our renewable platform, as well as propane opportunities. There is a period of time here that offers great opportunities for capital deployment, with long-term strategic and growth implications. As those materialize, not only do we ensure the long-term sustainability of this business for the next 90 years, but we also create growth opportunities for our unit holders willing to stay with us through this transition from a long-term propane distributor to a diversified propane and renewable energy distributor. To sum it up, we feel very optimistic about the great opportunities ahead of us, and we must be disciplined in our approach to capital deployment and long-term vision.

Ned Baramov, Analyst

Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's question-and-answer session. I'd like to turn the conference back over to Mike Stivala for the closing remarks.

Michael Stivala, President & Chief Executive Officer

Great. Thanks for your help today, and thank you all for joining us and for your interest. We look forward to talking to you again in relation to our third-quarter earnings in August. In the meantime, I wish you all a very happy start to the summer season and stay healthy and safe. Thank you.

Operator, Operator

Thank you, sir. 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.