Business Context and Reporting Period
Star Group, L.P. is a Northeast, Central and Southeast U.S. distributor of home heating oil, propane, diesel, gasoline and related installation, maintenance, plumbing and service offerings. The company served approximately 458,000 heating-oil and propane customers, plus approximately 80,000 delivery-only customers, at December 31, 2018. This unaudited Form 10-Q covers the three months ended December 31, 2018, the first quarter of fiscal 2019. Results are highly seasonal, with winter quarters typically generating most annual sales and working-capital needs.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Total sales | $535.0 million | $436.8 million | Up 22.5% |
| Operating income | $6.1 million | $31.1 million | Down $25.0 million |
| Net income | $2.3 million | $30.2 million | Down 92.3% |
| Limited-partner earnings per unit | $0.04 | $0.45 | Down $0.41 |
| Adjusted EBITDA | $44.8 million | $27.4 million | Up 63.6% |
| Cash used in operating activities | $62.9 million | $63.2 million | Improved $0.3 million |
| Capital expenditures | $4.0 million | $3.6 million | Up $0.4 million |
Product sales increased to $458.7 million from $366.7 million. Product gross profit was $152.5 million, compared with $123.9 million. Home heating oil and propane volume increased 9.6% to 113.3 million gallons, while the related realized gross margin increased to $1.2515 per gallon from $1.1193. Installations and services revenue increased 8.9% to $76.3 million; the combined installation and service gross profit was $2.0 million versus $0.5 million.
The reported operating margin was approximately 1.1%, compared with 7.1% in the prior-year quarter. The principal driver was a $31.0 million charge from the decrease in fair value of commodity derivatives, versus an $11.4 million gain in the prior-year period. The company reports commodity derivatives as economic hedges, causing significant non-cash earnings volatility.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $23.8 million at December 31, 2018, compared with $14.5 million at September 30, 2018; cash, cash equivalents and restricted cash totaled $24.0 million.
- Total debt was $191.8 million, consisting of $92.5 million drawn on the revolving facility and approximately $99.3 million of carrying value on the senior secured term loan.
- The revolving facility permits borrowings of up to $300 million, or $450 million during the December-April heating season, subject to borrowing-base limitations. Availability was $180.3 million.
- The credit facilities mature July 2, 2023. The effective rates at quarter-end were approximately 5.1% on revolver borrowings and 5.8% on the term loan.
- The company was in compliance with its fixed-charge coverage and senior secured leverage covenants. It had $7.1 million of outstanding letters of credit.
- Operating cash use reflected seasonal working-capital investment, including a $95.7 million increase in receivables and a $20.2 million increase in inventories. Financing activities provided $80.3 million, principally from revolver borrowings.
- The company paid $6.4 million in distributions and repurchased 0.6 million common units for $5.7 million during the quarter.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher wholesale product costs, 15.8% higher total volume, acquisitions and improved home heating oil and propane per-gallon margins.
- Heating oil and propane volume benefited from temperatures 5.3% colder than the prior-year quarter, although weather was 0.9% warmer than normal. Net customer gains declined to 800, or 0.2% of the customer base, from 4,800, or 1.1%; management attributed higher losses to pricing, credit issues and service disruptions.
- Delivery and branch expenses increased 12.6% to $102.7 million, driven by acquisitions, higher delivery, labor, customer-service, bad-debt, vehicle and concierge-service costs.
- Average borrowings increased by $40.1 million to $141.6 million, and the weighted average interest rate increased to 5.6% from 4.4%, contributing to higher net interest expense.
- The company adopted ASC 606 effective October 1, 2018. Adoption increased first-quarter net income by approximately $0.4 million compared with amounts that would have been reported without adoption and increased opening partners’ capital by $9.2 million.
- Prior-year net income benefited from an $11.5 million discrete tax benefit related to the Tax Cuts and Jobs Act. The current-quarter effective tax rate was 29.6%, compared with negative 5.3% as reported in the prior-year quarter.
Outlook, Commentary, Risks and Unusual Items
No formal earnings guidance was provided. Management expects the remainder of fiscal 2019 maintenance capital expenditures of approximately $6.5 million to $7.5 million, plus $1.5 million to $2.5 million for propane operations. At the then-current quarterly distribution rate of $0.1175 per unit, management estimated remaining fiscal 2019 distributions of approximately $18.4 million to common unitholders, $0.6 million to general-partner holders and $0.5 million to management.
- Weather, fuel-price volatility, customer consumption, customer attrition, natural-gas conversions and the ability to pass higher product costs to customers materially affect results.
- Higher or sharply lower wholesale prices can increase working-capital, hedging, collateral, interest, bad-debt and credit-card processing requirements.
- For fiscal 2019-2021, weather hedges can provide up to $12.5 million annually but may require payments of up to $5.0 million annually. The company recorded a $2.0 million weather-hedge charge for the quarter.
- The company entered into interest-rate swaps covering $50.0 million, or 50%, of long-term debt. A 100-basis-point increase in applicable interest rates would reduce annual after-tax cash flow by an estimated $1.4 million.
- An unresolved customer litigation matter seeks unspecified compensatory, punitive and other damages and potential class certification. The company cannot assess its potential outcome or materiality.
- Operating leases had undiscounted future minimum payments of approximately $131.3 million through 2033. The company expects adoption of the lease standard in fiscal 2020 to materially change the balance sheet, but had not yet estimated the discounted assets and liabilities.
- In January 2019, the company declared a $0.1175-per-unit quarterly distribution, repurchased and retired approximately 0.5 million units, and acquired a New York metropolitan-area subcontractor’s assets for approximately $13.2 million.
Investor Verification Priorities
- Reconcile Adjusted EBITDA growth with the substantially lower GAAP operating income and net income, particularly the $31.0 million derivative fair-value charge.
- Assess seasonal liquidity requirements, revolver utilization, borrowing-base availability and compliance with debt covenants during the remainder of the heating season.
- Evaluate whether the higher $1.2515-per-gallon heating-oil and propane margin is sustainable; management expressly cautions that it may not be.
- Monitor customer attrition, natural-gas conversions, service disruptions and credit losses.
- Review the effect of ASC 606 and the forthcoming lease standard on reported revenue, margins, assets, liabilities and partners’ capital.
- Track the customer litigation, weather-hedge settlements, commodity derivative positions and interest-rate exposure.