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Summary Star Gas Partners is the largest distributor of home heating oil in the United States, serving residential and commercial customers in fourteen states throughout the Northeastern U.S. and Mid‐Atlantic. At the current valuation the Company is selling at an 18% cash flow yield based on our expectations for $68 million in distributable cash flow in 2015. When valuing SGU at close to a 30% discount to its peer EV/ EBITDA multiples the stock is worth over 90% more than the current share price. Star Gas Partners (NYSE: SGU ) is the largest distributor of home heating oil in the United States, serving residential and commercial customers in fourteen states throughout the Northeastern U.S. and Mid‐Atlantic. The Company has a market value of just $375 million, yet in 2014 generated $1.96 billion in revenues and $103 million in EBITDA. SGU’s revenues are highly recurring, with 97% of customers on automatic delivery schedules. The market for home heating oil is mature but extremely fragmented; Although, SGU has a market share that is likely under 5% it is still 200x larger than its average competitor. The heating oil industry also features attractive financial characteristics, with recurring cash flows and contractually determined gross profit per gallon. Star Gas’s gross profit is largely fixed at $1.00/gallon and the Company constantly hedges its exposure. Considering Star Gas has net debt of approx. $75 million (net debt is adjusted after making changes to working capital to reflect receivable collections) the market is drastically undervaluing the Company. At the current share price of $6.55 the Company is selling at an 18% cash flow yield based on our expectations for $68 million in distributable cash flow in 2015. Essentially, if one were to buy the Company outright at the current price they would net an 18% annual cash return before Capex (Capex is running at approx. $10 million per year). The question one might ask is how can such a high return investment be available in the current low return environment we are in? The answer lies in the following non-fundamental issues that have caused investors to bypass making an investment In SGU: SGU has an inefficient corporate structure- Star Gas was formed as an MLP, yet should ideally be structured as a corporation. Star Gas acts as a partnership, which owns Petro Holdings, which acts as the heating oil corporation. Although Petro Holdings is taxed at the corporate level, any cash moved out of the holdings and into the partnership for either dividends or share repurchases may also be taxable to unit holders as dividends. Therefore, shareholders may be obligated to pay a dividend tax without ever receiving a dividend if funds were used to repurchase shares. Although, the current structure is by no means efficient it is not material enough to justify the current discount of the Company’s shares. Low dividend yield- Although Star Gas generates over $60 million in distributable cash flow it pays out less than $20 million in dividends, which implies a 5% yield. MLP peers typically payout over 80% of their cash flow and at higher yields. Highly seasonal business leads earnings to appear volatile- Because Star Gas makes money in the winter season the Company generates all of its earnings during half the year and loses money during the other half. This presents an appearance of inconsistent earnings from quarter to quarter. Declining business due to competition- The main competition for heating oil distributors is customer conversion to natural gas, which is generally significantly cheaper than heating oil. However, for many heating oil users, the local utility has no gas main capable of reaching their homes. For others, however, once their oil burner requires replacement (estimated cost: $2,000‐$3,000) the economics can be compelling. Conversion costs average $10,000, so the incremental costs of converting can be $7,000 to $8,000. Yet, over the past five years, the loss to natural gas conversion has ranged from 1.5%‐2.0% and the Company’s overall net attrition stood at just 0.9% in 2014. All the above issues have existed now for some time, yet Star Gas continues to increase both profits and shareholder value. Since 2010 the Company has increased annual EBITDA by 44% and reduced shares outstanding by 23% from 75 million shares to 57.2 million shares. Thus, on a per share basis the Company has increased EBITDA from $1.02 to $1.79 or by 75% over the last 4 years. The market also fails to realize that Star Gas is a beneficiary of low oil prices. As heating oil prices have gone down Star Gas’s business has received a major tailwind. The company is now able to buy the same quantity of heating oil while using significantly less working capital therefore minimizing borrowing costs and working capital needs. Furthermore, as a result of lower heating bills the Company’s customers are now less likely to switch to natural gas as conversion economics have come down substantially. This tailwind was evident in their most recent Q1 2015 earnings as the company increased EBITDA by 25% to $45 million. Assuming YOY growth remains flat for the remainder of the year, Star Gas should be able to generate $70 million in cash flow and $60 million in Free Cash Flow for 2015. This should allow the company to either significantly increase its dividend or buyback program. To put things in perspective, Star Gas has a distribution coverage ratio of over 3x their current dividend. If their distribution coverage was similar to that of their MLP peers (1.1x to 1.2x) the company would have a current dividend yield of well over 10%. When we compare Star Gas to larger propane and fuel delivery MLPs the investment looks even more compelling. Company Mkt Cap (In millions) P/E Ratio EV/EBITDA P/CF Dvd Yld Average $ 3,163 20.3x 11.17x 9.87x 7.68% SUBURBAN PROPANE PARTNERS LP (NYSE: SPH ) $ 2,721 20.3x 11.1x 9.6x 7.8% FERRELLGAS PARTNERS-LP (NYSE: FGP ) $ 1,937 23.2x 11.8x 10.2x 8.6% AMERIGAS PARTNERS-LP (NYSE: APU ) $ 4,831 17.4x 10.7x 9.8x 6.7% STAR GAS PARTNERS L.P. $375 11.5x 4.8x 6.3x 5.35% As the larger comps clearly have more diversified stable businesses we do not believe Star Gas should trade at a similar multiple. However, we firmly believe the company should trade at a multiple between 6x to 8x EBITDA. Using that range, Star Gas shares would be worth anywhere from $9.15 to $12.50 per share. This implies potential upside of 40% on the low end to over 90% on the high end. Disclosure: The author is long SGU. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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