SPRAGUE RESOURCES LP SRLP
March 16, 2016 - 3:38pm EST by
lindsay790
2016 2017
Price: 18.50 EPS 3.71 0
Shares Out. (in M): 11 P/E 5.0 0
Market Cap (in $M): 400 P/FCF 4.8 0
Net Debt (in $M): 275 EBIT 110 0
TEV ($): 675 TEV/EBIT 7.1 0

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Description

Long SRLP. Sprague Resources (“SRLP”) is one of the largest independent wholesale distributors of refined products
in the Northeast United States with a network of 19 terminals aggregating over 14 million barrels of
capacity. SRLP also purchases, sells and distributes natural gas and has a materials handling business.
Structured as an MLP whose GP is the private Swedish industrial concern Axel Johnson, Sprague has
been in business since 1870.The Company became part of Axel Johnson in the 1970s. The MLP went
public in 2013 at $18 per share. The minimum quarterly distribution at the time of the IPO was $0.4125
per unit. The most recent quarterly distribution was $0.5175 and distributions are expected to grow at a
12% growth rate. Currently, the units are trading around $18.50 with a yield of over 11%. Given
expected double digit distribution growth and a 2x coverage ratio this is cheap. When compared to
peers, we think SRLP should trade at a yield of 8% or around $29 per unit in a year or so. Add in
anticipated distributions of $2.22 and returns would be in excess of 60%.
 
The Opportunity
 
SRLP has been caught up in the turmoil inflicted on the MLP market given the fall in commodity prices.
However, lower commodity prices are not necessarily bad for SRLP. In fact, lower commodity prices
arguably are better for SRLP as they encourage higher volume purchases by SRLP’s customers.
The mild weather in the Northeast has, on the other hand, impacted SRLP’s business in a negative way
with heating degree days this year so far over 10% lower in 2016 as compared to 2015. Even so, SRLP’s
2015 results were good given the mild fourth quarter and profitability has not deteriorated this year to
such an extent that distributions are (even close to) threatened: coverage ratios are strong at over 2x
and the long term outlook for distribution growth is healthy. I’m not a meteorologist, but I believe that
in the long term, hot and cold seasons should even out over time. Be that as it may, recently provided
adjusted EBITDA guidance for 2016 of $105 to $120 million may be disappointing to some given 2015
results came in at $110 million. This guidance assumes a warm (and presumably weak) first quarter.
 
The Business
 
Refined Products 62% of adjusted gross margin (adjusted gross margin is a cash margin that removes
the impact of unrealized commodity hedges)
 
Sales in the Refined Products segment consist of distillates (72% of volumes), gasoline (13%), and
residual fuel oil and asphalt (15%). Distillates consist of heating oil, diesel, kerosene and jet fuel. Sales of
refined products are to wholesalers, retailers, resellers, commercial and industrial accounts including
federal and state agencies, municipalities, transit authorities and corporations. Sales are made under
rack agreements and contracts with index-based pricing terms and are typically made from a terminal or
other storage locations owned by SRLP. SRLP uses derivatives and forward contracts to maintain a
position that is substantially balanced between purchases and product sales.
 
The Refined Products segment has over 1,100 customers and sold 1.7 billion gallons of product in 2015.
 
Natural Gas 18% of adjusted gross margin
 
SRLP delivers natural gas to customers through utility interconnections of pipelines and manages
interactions with utilities pursuant to fixed price, floating price and other structured contracts.
Derivatives are used to manage natural gas commodity price risk. In order to manage supply
commitments and provide operational flexibility and arbitrage opportunities, SRLP has supply contracts,
leases for pipeline transportation capacity, leases for storage space and other physical delivery services.
Customers in the Natural Gas segment are commercial and industrial concerns such as hospitals,
universities, apartment buildings, manufacturers, pharmaceutical companies, and chemical and
processing companies.
 
The Natural Gas segment had over 14,000 customers and sold almost 57 Bcf of gas in 2015.
 
Materials Handling 17% of adjusted gross margin
 
The Materials Handling segment moves raw materials and finished goods through waterfront terminals
that SRLP owns. The terminal network is used to offload, store and prepare for delivery a large number
of liquid products, bulk and break bulk materials, and provide other handling services to many of the
same customers that acquire refined products from SRLP.
 
Services include ship handling, crane operations, pile building, warehouse operations, scaling and
transportation to the final customer. SRLP plays the role of a distribution agent and, because the
products handled are generally owned by customers, SRLP has virtually no working capital
requirements, commercial risk or inventory risk. In addition, materials handling contracts are typically
long-term and fee-based.
 
Other 3% of adjusted gross margin
 
Other operations include the marketing and distribution of coal (Sprague’s origins lie in this business),
some commercial trucking activity, and a small heating equipment service business.
To a certain extend SRLP is a roll-up story and the company tries to acquire terminal or marketing
businesses that are synergistic with its existing operations. Since going public, SRLP has acquired five
similar businesses including one “drop down” from Axel Johnson.
 
2015 Financial Data ($ in Millions)
 
Revenues 3,481.9
EBITDA 127.4
Adjusted EBITDA 110.4
Net Income 78.0
Distributable Cash Flow 89.7
Maintenance Capital Expenditures 8.9
Total Capital Expenditures 14.9
Equity Market Capitalization 400.0
Permanent Debt 275.0
Total Enterprise Value 675.0
 
Commentary on Financials
 
SRLP’s GAAP financial performance appears somewhat volatile given that the Company includes gains
and losses on hedges in cost of sales. SRLP allows for this by removing the unrealized portion of hedges
from its financial performance when reporting Adjusted EBITDA. This makes sense as long as the
Company is running a matched, not speculative, hedge portfolio. SRLP uses Adjusted EBITDA for the
purposes of calculating distributable cash flow too. Net income is not presented on an adjusted basis so
PE multiples are not always that meaningful (although for 2015 net income per limited partner unit
came in at $3.71 which would make SRLP screen cheap at a PE of 5x). Capital expenditures for the
business as a whole in 2015 came in at around $15 million of which about $9 million was designated
“maintenance”. Distributable cash flow in 2015 was almost $90 million. This amount compares to 2015
distributions of about $40 million. True free cash flow (using all capital expenditures as opposed to just
maintenance capital) is about $84 million which also provides for additional coverage security (and a
cash flow multiple on the equity of 4.8x). The bottom line is that SRLP has a strong free cash flow
business, even fully loaded for capital expenditures, that provides a significant buffer to cover the
existing distribution and grow it in the future.
 
So what is that growth? The board has committed to growing the dividend at $0.015 per quarter for
now. That would get SRLP to a $0.5775 quarterly dividend in a years’ time, a future annualized dividend
of $2.31 per unit, a 12% annual growth rate, and a forward yield of over 12%. Now, if only the Board
could be persuaded to pay out a little more of the cash….
 
Owing to the seasonality of its business, SRLP has some pretty meaningful working capital requirements
and swings. On the recent earnings call, management stated that permanent leverage was 2.5x adjusted
EBITDA or about $275 million. With an equity market capitalization of about $400 million, SRLP’s total
market capitalization works out to be about $675 million. Using EBITDA of $110 million, SRLP trades at
6.1x. Adjust for $15 million of capital expenditures then the unlevered free cash flow multiple is 7.1x.
Now, if only the weather got a bit colder….
 
Also on the recent earnings call, management stated that the Company had paid down $93 million of
permanent debt in 14 months, essentially covering the purchase price of the third party acquisitions
made since the IPO.
 
Comparables
 
A peer group for SRLP is listed below. None of them is a particularly close comparable.
 
Company    Yield       LTM Coverage     LTM EBITDA Multiple     Yield Growth
 
APU             8.8%       1.0x                    9.1x                            4%
ARCX         17.1%       1.2x                    9.3x                            NA
BKEP          12.0%       1.3x                    9.2x                            0%
FGP            13.2%       1.0x                  11.4x                            0%
GLP            13.6%       2.0x                    7.3x                            NA
SGU             4.8%       3.6x                    4.1x                            8%
SPH            12.1%       0.8x                    9.9x                            1%
SRLP          11.0%      2.3x                   7.1x                           12%
TLP              7.3%       1.4x                   10.5x                            1%
WPT             8.5%       1.3x                    8.5x                             0%
 
Some notes: ARCX is involved in litigation relating to a material amount of its cash flow. To allow for
acquisitions, ARCX’s multiple is based on 2016 projections. GLP recently cut its distribution. SGU pays
corporate taxes. SRLP’s reported EBITDA multiple on Bloomberg is 7.3x. TLP’s GP was recently acquired
by ArcLight, a private equity firm, which is anticipated to improve growth potential. Data sourced from
Bloomberg.
 
So where should SRLP trade?
 
With a free cash flow yield (to the equity) of some 20% and some growth anticipated, one could argue
that SRLP should be a double without accounting for distributions. If it were to trade for an 8% yield in a
year’s time a target price would be around $29. An 8% yield is at the lower end of comparables that
have higher multiples, lower distribution growth, and lower coverage. Add distributions of $2.22 and the
total return on an investment at $19 is 64%. All things considered, a trading price today in the mid $20s
is completely reasonable. At $25 SRLP’s yield would be 8.3%.
 
What could go wrong?
 
A rogue trade in the hedge book.
Irrational pricing by competitors.
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

MLP market becomes more rational.

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