SPH - Suburban Propane Partners: Driving Growth Through Transition To RNG

2023-05-10 05:51:38 ET

Summary

• Suburban Propane posted disappointing earnings due to a warm winter but still had a promising future along with strong dividends.
• The company's acquisition of RNG platforms will hedge against regulatory risks and allow the company to capitalize on more rebates.
• Assuming my DCF figures, Suburban Propane stock is currently undervalued, resulting in a buy rating.

Suburban Propane Partners, L.P. ( SPH ) has displayed a recent pullback due to a weak quarter and cyclical downturns. I believe that the company is a buy due to their strong dividend, transition to RNG, and its relative undervaluation assuming my DCF figures

Business Overview

Suburban Propane Partners, L.P. and its subsidiaries have over 3200 employees which distribute propane, renewable propane, fuel oil, and refined fuels to residential, commercial, and industrial sectors through four segments: Propane, Fuel Oil and Refined Fuels, Natural Gas and Electricity, and All Other. The Propane segment supplies propane for heating, cooking, and fueling vehicles, including for agricultural and industrial purposes. The Fuel Oil and Refined Fuels segment delivers fuel oil, diesel, kerosene, and gasoline for heating homes and buildings. The Natural Gas and Electricity segment markets natural gas and electricity to customers in deregulated energy markets of New York and Pennsylvania.

With a market capitalization of $958.149 million, a ROIC of 8%, a 52-week high of $17.62, and a low of $14.40, a price of $15.09 for Suburban Propane displays a price that has fallen off their highs and is approaching value territory as displayed later in this article. Suburban Propane also pays a high dividend of 8.61% representing a payout ratio of 90.45% giving shareholders constant returns year after year.

Suburban Propane's March 2023 earnings were disappointing, and the company attributed the decline to warmer-than-expected weather during the first quarter of the year, resulting in decreased demand for heating products such as propane. In the second quarter of fiscal year 2023, Common Units' net income was $104.5 million, or $1.63 per unit, compared to the previous year's $175.1 million, or $2.77 per unit. Similarly, the Adjusted EBITDA for Q2 of fiscal year 2023 was $149.0 million, lower than the $172.5 million reported in the previous year. However, despite this downturn, Suburban Propane has consistently demonstrated growth over the years. This outcome was attributed to external factors rather than any management or product underperformance when compared to its competitors.

Suburban Propane Compared to the Broader Market

Over the past decade, Suburban Propane's performance, adjusted for dividends, has lagged behind the S&P 500, partly because of a significant correction in 2020. However, I believe that the company's capacity to pay out a robust dividend, continuous acquisitions expanding into renewable natural gas, and investment in its core business will enable the company to outperform the broader market in the future.

Acquisitions in RNG to Foster Growth

Suburban Propane has a history of using acquisitions to expand its services and improve its core business model, making it more scalable and better prepared for headwinds such as cyclical downturns and recessions. An example of this strategy is its recent purchase of RNG platforms from Equilibrium Capital Group for $190 million, including operational biogas facilities in Stanfield, Arizona, and Columbus, Ohio. This acquisition also established a long-term growth platform for identifying, developing, and operating additional RNG projects. The RNG platform is diversified across feedstocks, geographies, and revenue streams, complementing Suburban Renewables' construction, ownership, and operation of an RNG facility in Peru.

The acquisition and partnership will enhance Suburban Renewables' presence in RNG production and distribution, as well as provide growth and management in the waste-to-energy economy, which is rapidly expanding. RNG can be produced from various organic waste streams, including agricultural and food waste, reducing methane emissions while offering a low-carbon alternative to traditional natural gas. This move allows Suburban to expand its operations with a more long-term view in mind, improving brand recognition and diversifying its revenue streams to a safer, more renewable source.

Along with the acquisition's preventative measures, Suburban will also receive multiple rebates for switching to renewable sources, allowing for greater margins, reduced risk, and better utilization of their FCF. This will enable the company to predict and plan for growth more effectively, thereby facilitating faster growth rates.

Analyst Consensus

Analysts rate Suburban Propane as a "buy" which displays their confidence in the firm's ability to expand operations and deliver long-term value. With an average 1Y price of $17, analysts predict a 12.29% upside.

Valuation

To start my DCF analysis, I first determined the Cost of Equity and WACC for Suburban Propane by utilizing the Capital Asset Pricing Model. By factoring in a risk-free rate of 3.51%, I calculated that the Cost of Equity is 7.04%, as shown below.

Assuming this Cost of Equity value, I was able to calculate the WACC to be 5.43% as shown below, which is under the industry average of 5.90%.

Using the Firm Model DCF analysis with FCFF without CapEX, I have determined that Suburban Propane is undervalued by about 17% with a fair value of approximately $18.24. To arrive at this conclusion, I employed a discount rate of 7.16% over a 5-year period, which includes a 1.73% risk premium to factor in the impact of macroeconomic conditions and the risk of potential downturns. Additionally, I anticipated a low-single-digit growth rate for revenue beyond 2023 and accounted for the success of Suburban's acquisitions and the integration of RNG assets, which should result in increased margins due to rebates.

Risks

Weather Conditions: As a supplier of propane and other heating fuels, Suburban Propane is vulnerable to the unpredictable nature of weather patterns, particularly during winter. In the event of warmer than anticipated weather, there may be a decrease in demand for heating fuels, which could potentially result in an unfavorable financial outcome for the company such as limited FCF to expand and long-term slowdowns in sales.

Regulatory and Environmental Risks: The natural gas industry is closely monitored and regulated, with a particular emphasis on safety and environmental regulations. Any modifications to these rules or the company's inability to comply with them could lead to legal repercussions, such as fines and penalties, which could have a negative effect on the company's financial position.

Conclusion

To summarize, I believe that Suburban Propane is a buy due to its large dividend providing shareholders with consistent returns, its ability to transition to RNG and capitalize on long-term trends and rebates, and the company's undervaluation, assuming my DCF assumptions.

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