In and of itself, 2017 wasn't the worst year ever for Ferrellgas Partners, L.P. (NYSE: FGP). But it still wasn't a good year for the propane delivery specialist. Here's a quick review of the damage that took place in 2016, and why 2017 did nothing to help the partnership recover from the hit.
A bad capital allocation call
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The troubles that Ferrellgas Partners had to deal with in 2017 really started way back in 2014 with the acquisition of Sable Environmental. That was when previous CEO Steve Wambold started to build an oil and natural gas midstream business at the partnership that, prior to that, had focused exclusively on delivering propane. Delivering propane is actually a fairly stable business, in which small bolt-on acquisitions over time offset the slow and steady attrition of customers switching to other heating options, like electricity.
The midstream business was seen as a way to diversify Ferrellgas' operations into a faster-growing industry. That said, it's worth noting that competitors AmeriGas Partners, L.P. (NYSE: APU) and Suburban Propane Partners LP (NYSE: SPH) remained focused on the propane space while Ferrellgas was attempting to shift toward a new approach. Yes, both AmeriGas and Suburban continued to use acquisitions to grow, but they stuck to their knitting.
Through additional acquisitions, Ferrellgas' midstream business grew to the point where it accounted for 30% of the company's revenue in fiscal 2016. But the loss of an important customer at the end of that fiscal year turned this diversification effort into a major headache and financial drain. For example, revenue in that division declined 44% year over year in the fiscal first quarter of 2017, with net operating margin falling into the red. A business that was profitable just months earlier was now bleeding cash.
Ongoing trouble on the balance sheet
Here we start to see the real lingering problem of 2017. At the end of 2016, Ferrellgas fired its CEO, bringing back its namesake founder. It slashed the distribution by a painful 80%. It wrote down the value of its midstream business by $650 million. And it announced plans to focus on trimming its debt load. These were all of the right moves, though they were painful ones -- particularly for income investors who had been relying on the distribution.
Debt, however, is the real disaster left behind from the midstream push. At the start of fiscal 2014, Ferrellgas' long-term debt stood at roughly $1.1 billion. It used leverage to build up the midstream business, increasing long-term debt to $1.9 billion by the time the business started to crumble in 2016. That's a 75% increase in long-term debt in just three years, and the business that was supposed to help pay for that debt was hitting the skids.
The distribution cut was meant to free up cash to pay down debt, but debt has actually been going in the wrong direction. Ferrellgas' long-term debt levels rose 1.5% in fiscal 2017. I'll admit that's a pretty small increase, but this partnership can't really afford to see its debt levels keep rising. At over 10, the debt-to-EBITDA ratio is higher than it's ever been at the partnership. And the company has now received two waivers from its lenders to loosen debt covenants. (For reference, debt-to-EBITDA ratios at peers AmeriGas and Suburban are around 5.)
The balance sheet, then, is where the things went really wrong for Ferrellgas in 2017. Of course, that's compounded by the troubles on the income statement because of a faltering midstream business, but it's the debt that's the deeper problem.
Hoping for a better 2018
At this point, Ferrellgas has merely limped through 2017. It didn't help that a warm winter heating season was a headwind on the propane side of things, either. Although there's probably material upside potential here, most investors should avoid Ferrellgas at this point unless they have a strong stomach and a penchant for turnaround investments. The partnership has to figure out what to do with the faltering midstream operation, and it has to trim its debt -- two very big tasks. Until it achieves material success in either of these efforts, the tough times are likely to continue.
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