SPH - Suburban Propane Partners: Steady Q1 Further Expansion Into RNG

Summary

• SPH delivered a strong start to fiscal 2023 with Q1/23 revenues of $397.5 million and $0.71 in EPS.
• Suburban also expanded in the RNG market by purchasing 2 existing plants for $190 million. Without associated financials, it is hard to judge the quality of the transaction.
• SPH maintained its quarterly distribution of $0.325.

Overall, Suburban Propane Partners L.P. ( SPH ) continues to be a beacon of stability in a volatile macro environment. The underlying business continues to perform well, with 3.3% volume growth in Q1/2023 and $0.71 / share in EPS.

Looking forward, the large price tags placed on RNG transactions gives me some pause, is management overpaying? Without any financial statements to analyze, it is hard to gauge the economics and valuations of SPH's RNG transactions. For now, I will give management the benefit of the doubt.

Strong Start To Fiscal 2023

On February 3rd, Suburban announced its results for the 1st quarter of fiscal 2023, ended December 24, 2022. SPH's quarterly results were solid, with the company reporting revenues of $397.5 million, a 5.9% YoY increase from Q1/2022. Operating income was also strong, increasing 67.0% YoY to $62.3 million, and EPS was $0.71, a 108.8% YoY increase from $0.34.

Customer base growth and cooler than average temperatures in December (which improved heating demand) were the primary drivers of the strong operating results, as retail propane volumes increased 3.3% YoY.

SPH's bounce back in quarterly profits also helped assuage some investor concerns that were raised in the fourth quarter, when SPH reported a loss of $0.86 / share on the back of MTM losses on derivatives. As I wrote in my prior note, " The key is to track the unrealized MTM gains and losses over time and make sure they even out." It was comforting to see SPH report Q1 COGS of 46.0%, a 6.3% YoY improvement from 52.3% in Q1/2022, showing no residual effects from Q4's MTM hedging losses (Figure 2).

SPH's Q1/2023 gross margin of 54.0% is also consistent with the company's long-term gross margins of ~50% (Figure 3).

Operating Expenses Continue To Creep Higher

One area that deserves monitoring is SPH's operating expenses line, which increased 9.4% YoY due to labour and vehicle fuel increases (Figure 4). As a percentage of revenues, operating expenses rose to 29.1% from 28.2% in Q1/2022, indicating the business had gotten less efficient.

Further Expansion Into RNG

A few months ago, I highlighted SPH's entry into the renewable natural gas ("RNG") market an agreement with Adirondack Farms to build and operate a biodigester to produce RNG. SPH followed up with an announcement on December 28, 2022 that the company was acquiring a platform of two producing RNG assets from Equilibrium Capital Group for $190 million.

The purchase of $190 million includes a large-scale RNG production facility in Stanfield, Arizona, that is currently operating with manure rights from ~55,000 dairy cattle and an interconnect to an interstate pipeline. It also includes an operating facility in Columbus, Ohio, that is currently receiving a tipping fee from several large food and beverage companies for processing food wastes into fertilizer and biogas. in addition, the deal includes the right of first offer for a third RNG facility that is currently being developed by Equilibrium and a joint venture (70% SPH / 30% Equilibrium) to invest in future RNG projects.

The large $190 million price tag was a bit of a surprise to me and shows SPH is committed to developing its RNG business. SPH is funding the transaction with $120 million in revolving credit and the assumption of $80 million in outstanding green bonds.

RNG Refresher

Renewable Natural Gas ("RNG"), for those not familiar, is pipeline quality natural gas that is made from the decomposition of bio materials such as landfills, livestock, and waste treatment plants.

While there is certainly an element of hype surrounding RNG, its promise of greenhouse gas reduction with an ability to plug into existing natural gas infrastructure is alluring. Based on a 2018 presentation by SoCal Gas, the U.S. has enough biomass to produce ~1Tcf of RNG (Figure 5). So the potential is enormous.

But Is SPH Overpaying?

However, the key question to me is whether SPH is overpaying to enter the market. $190 million for 2 operating plants sounds like a steep price. Unfortunately, the announcement was not accompanied by any financials, so it is impossible to assess what kind of revenue or profit multiples were paid. Investors need to keep an eye on future quarterly reports from SPH to assess the economics of SPH's nascent RNG business.

Hopefully, SPH will split out the RNG operating results into its own business segment so it will be easier for analysts to track and monitor. But if not, I expect revenues and expenses will flow through the 'Natural gas and electricity segment' .

Distribution Maintained

SPH also maintained its quarterly distribution rate of $0.325 / unit, or an 8.3% current yield. With LTM diluted net income of $2.55 / unit and operating cash flows of $240.2 million or $3.74 / unit, the distribution appears to be well covered.

Conclusion

Overall, Suburban Propane continues to be a beacon of stability in a volatile macro environment. The underlying business continues to perform well, with 3.3% volume growth in Q1/2023 and LTM diluted EPS of $2.55. Looking forward, I am slightly concerned at the large price tags placed on expansions into the RNG market. Without any financial statements to analyze, it is hard for me to assess the economics of SPH's RNG opportunities. For now, I will give management the benefit of the doubt.

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