Downside: Higher propane prices could hurt these names

Market Realist

What’s driving higher propane prices and how it could affect your portfolio (Part 3 of 4)

(Continued from Part 2)

More expensive propane costs could cause residential customers to buy less, hurting certain MLP names

All else equal, more expensive propane will likely result in lower propane sales volumes for distributors such as AmeriGas (APU), Ferrellgas (FGP), and Suburban Propane (SPH)—all of which are master limited partnerships and are found in MLP ETFs such as the Yorkville High Income MLP ETF (YMLP) and the Global X MLP ETF (MLPA). This is because propane distributors generally take a fixed margin from propane sales and pass on price increases to customers. So more expensive propane means a higher sales price for customers, which spurs customers to conserve the fuel and buy less. Most customers during the winter are residential and commercial customers who use the fuel for heating.

Propane distributors generally take a fixed margin on volumes, so lower volumes result in lower earnings

Because the margins on propane volumes are more or less fixed (on a per-unit basis), lower volumes mean lower earnings. Take a simplified theoretical example where the cost of propane to a distributor is $1.00 per gallon. If the distributor sells to end customers at cost plus a margin of $1.00 per gallon, the sales price to the customer is $2.00 per gallon. Let’s say the company’s customer demand at $2.00 per gallon is 1,000 gallons, so sales are $2,000 ($2.00 per gallon * 1,000 gallons) and gross profit is $1,000 ( [$2.00 – $1.00] per gallon * 1,000 gallons). If the price of propane rises to $1.50 per gallon, and the company sells propane at $2.50 per gallon, demand will likely drop below 1,000 gallons (let’s assume 900 gallons). At 900 gallons of sales, revenues are 900 * $2.50 per gallon or $2,250. However, gross profit falls to ($2.50 – $1.50) per gallon * 900 = $900.

Positive short term, but negative medium-term catalyst for propane distributors

Last week’s drop in propane prices was a short-term positive for names such as APU, SPH, and FGP, as lower prices may prompt customers to buy more. However, the increase in propane prices over the past few months, and propane’s higher prices compared to last winter, are negative factors for propane sales. Also note that names such as AmeriGas, Suburban Propane, and Ferrellgas make up a small proportion of some ETFs such as the Yorkville High Income MLP ETF (YMLP) and the Global X MLP ETF (MLPA).

For more analysis on propane, please see The 8 trends that could affect propane names this winter.

Continue to Part 4

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