Description

Note: UGI has a September 30 fiscal year end. All references to years are FY.

UGI Corporation is a holding company with four owned subsidiaries, each operating in a different industry and having its own capital structure. The first two subsidiaries, AmeriGas and UGI International, operate in the propane distribution market in the US and Western Europe, respectively. The last two subsidiaries, Midstream & Marketing and Utilities, operate in the natural gas industry. Midstream & Marketing focuses on midstream natural gas pipelines in Pennsylvania, Ohio, and West Virginia (84% fee for service / volume commitments model), and runs a natural gas marketing business that retails natural gas to industrial customers at fixed prices. Utilities is a 100% regulated local utility in parts of Pennsylvania and West Virginia, primarily distributing natural gas to local customers, but also producing electricity in a small part of their service area.

Historically, the holding company had no debt, with its only purpose being to collect dividends from subsidiaries and pay out a common stock dividend. However, between 2019 and 2021, UGI's management made several acquisitions, including buying out minority MLP unit owners in AmeriGas Partners (APU), acquiring several Midstream assets (Columbia and Pennant), and purchasing a West Virginia utility (Mountaineer). These acquisitions were funded by a mix of debt at the operating subsidiaries and $1 billion of new Holdco debt, plus $220 million of Holdco Preferred Stock. In hindsight, the decision to use debt/preferred over equity was a poor one.

During this time, a combination of warmer weather, a failed commodity price hedge on a new energy marketing venture in Europe, and what appears to be over-aggressive cost-cutting in AmeriGas led to significant deterioration in cash flow generation and ultimately dividends to the holding company. This has resulted in near-term Holdco debt maturities of $250 million in 2024 and $377 million in 2025, along with a high dividend obligation of $1.50 per share or $315 million per year. Furthermore, the company has committed $500 million of cumulative equity investments in 10 renewable natural gas (RNG) projects over the next several years, which will be funded on an ad hoc basis by the operating subsidiaries due to tight liquidity at the holding company level.

UGI's current cash position is $321 million, but the holding company's cash is just $58 million as of March 31. The company's investor relations deck now features a slide on liquidity, showing that the company has access to $1.6 billion of undrawn liquidity. However, this figure is misleading, as the 10-Q shows that $0.6 billion of the liquidity is in the AmeriGas subsidiary, which is in covenant breach and cannot make restricted payments to the holding company. Another table in the March 10-Q shows average and peak borrowings on R/Cs. While end of quarter balance drawn was $640M, average balances were $923M and peak balances in the last 90 days were $1,357M, meaning the company paid down facilities on the last day of the quarter to dress up the books. Also notable that peak draw on the holding company’s R/C was $292M (out of $300M) meaning that at one point in the last quarter they were down to wire on cash.

Due to the breach of covenants at the AmeriGas subsidiary, the holding company has irrevocably committed to fund contributions up to any amount necessary to equity cure future covenant breaches. It injected $31 million in the March 31 quarter to cure a covenant breach and help refinance a 2024 Notes maturity. Additionally, there has been significant management turnover, with the CFO departing in March and the General Counsel leaving in June.

Since becoming CEO, Roger Perreault has conducted an aggressive cost-saving plan at AmeriGas that seems to have backfired, leading to numerous complaints of consumers not getting their propane tanks refilled on a timely basis and even an investigation by the Colorado Attorney General into billing practices. The business is suffering from an accelerated decline in customer count due to poor service levels. Despite cutting costs, AmeriGas Adjusted EBITDA declined from $558 million to $430 million.

The crown jewel of the business, Utilities, does not distribute any cash flow to the parent company. After several large explosions related to old gas pipes, regulators in Pennsylvania and West Virginia mandated that all cast iron and bare metal gas pipes need to be replaced. The approximately $300 million per year system capital investment gets repaid over time by rate payers with a 10% return on equity (ROE), which has been the primary reason why the utility's net income has been steadily growing. However, the utility generated $517 million of EBITDA but had $529 million of Capex in FY2022, and it still has $75 million of interest expense on top of that. In FY2022, the Holdco contributed $35M into the PA Utility and $30M into the WV Utility to fund cash needs.

Due to AmeriGas being in breach of covenants and Utilities being a cash-negative business, all of the holding company's liquidity comes from UGI International and the Midstream & Marketing segments. These two segments generated combined net income of $363 million and last year distributed $285 million of cash to the parent. However, as laid out above, this cash generation is not sufficient to fund the holding company's interest/principal repayments, stock dividend, RNG investments, AmeriGas covenant equity cures, and utility cash shortfalls. It is incredible that the management team has let the cash situation become this acute.

The company is currently paying a 5% dividend yield, which is unsustainable. It is believed that the elimination of the dividend, along with the suspension of RNG investments, will make this stock unattractive to both dividend-seeking retail investors and ESG-focused long-only investors, causing a decline in the stock price. Risks to the short thesis include a potential liquidity squeeze being resolved by discontinuing the dividend, selling a business, or an equity raise. Other risks include a cold winter, credible board members and (some) management, and potential M&A activity or activist attention.

Catalyst

• Discontinuation of dividend
• Cancelation of RNG investment strategy
• Dilutive equity raise (or incremental preferred stock issuance)
• Near term maturities in 2024/2025 at the HoldCo
• Continued covenant breaches and EBITDA declines at AmeriGas
• Ratings downgrades at subsidiary and holding company level (Utility was already downgraded due to Holdco debt issues)