Sprague Resources LP

Thank you, Angela. Good afternoon, everyone, and welcome to Sprague Resources’ third quarter 2020 conference call.

Joining me today are David Long, our Chief Financial Officer; and Paul Scoff, our Vice President and General Counsel. I would like to remind listeners that some of today’s call will include forward-looking statements.

These statements are based on our current expectations, which we believe to be reasonable as of today’s date, and Sprague does not undertake any obligation to update any forward-looking statements to reflect new information or future events. Actual results may differ significantly because of risks and uncertainties that are difficult to predict.

Please refer to our 10-K for a list of risk factors, which could cause our actual results to differ from anticipated results and review our 10-K, 10-Q, current reports and other filings with the SEC. We also describe our business using certain non-GAAP financial measures.

Reconciliations of these measures to comparable GAAP measures are available in our non-GAAP quarterly supplement and our earnings press release, both of which can be found in the Investor Relations section of our website. I would like to start today’s call by recognizing the outstanding efforts of my coworkers throughout the company at maintaining a safe and healthy environment, while providing essential fuel and services to our customers.

As we navigate the COVID-19 pandemic, we continue to adapt our offices and terminals to stringent health and safety protocols, which are tracked and managed along with our traditional roster of HS&E metrics. As we enter our high demand period, I’m confident that our commitment to one another’s well-being will enable us to maintain our impressive safety track record, while capitalizing on the market opportunities in front of us.

On our last call, I discussed the primary opportunity associated with our extensive storage assets in the contango market structure, and we’ve continued to see that materialize in the third quarter. Our hedged inventory appreciates as we roll the hedges month-to-month, capturing the benefits of the structure without exposing us to additional commodity price risk.

The incentive to store barrels has enabled us to lease incremental tanks to third-parties at attractive economics in several of our locations. We then have the opportunity to purchase in-tank inventory from these counterparties, lowering our working capital and transportation costs to land the product in our terminals.

Entering the demand season with higher storage levels has allowed us to reduce the fixed costs of our seasonal time charter barge commitment as we’re now pressured by just-in-time inventory management requirements. While demand for transportation fuels remains lower than normal by about 10%, we anticipate that heating oil sales will not be reduced by COVID and may, in fact, increase, with a larger number of consumers continuing to work from home.

In any case, weather will continue to be the biggest driver of demand for that core product. Looking forward, we’re excited to see increased interest in renewable liquid fuels across our customer base, in the inexorable transition to lower carbon fuels.

As many listeners know, Sprague has a long history of leading the market on the adoption of cleaner fuels, from the initial introduction of ultra-low sulfur diesel, to being the first certified BQ-9000 marketer of biodiesel, to the first East Coast trial of renewable diesel with New York City last year. Use of higher biofuel blends contribute an immediate reduction in greenhouse gases without any capital cost for customers,, as would be incurred in a transition to equipment like electric heat pumps.

And we expect to see both further mandates involuntary adoption of higher renewable fuel blends. We remain committed to serve this need and expect to continue to enjoy a leadership position in this arena.

Finally, this quarter, the Board of our general partner declared a distribution of $0.6675 per unit, which is equal to distributions in the third quarter of 2019. Now I’d like to turn the call over to Dave Long for a detailed review of our third quarter results.

Dave?

Thank you, Dave, and good afternoon, everyone. Sprague’s quarterly adjusted gross margin increased by 9% from $4.8 million to $56.6 million as compared to the third quarter of 2019.

This increase was attributable to gains in our Refined Products and Material Handling businesses, which were partially offset by the declines in the natural gas business. I’ll provide more detail of the underlying results of each business shortly.

Sprague’s third quarter adjusted EBITDA of $20.2 million increased by $6.3 million or 45% as compared to the prior year. Operating expenses decreased by 10% or $2.0 million in the third quarter, primarily due to decreases in employee-related expenses, repairs and maintenance and utilities.

SG&A expenses increased by $0.5 million or 3%, primarily as a result of an increase in incentive compensation, insurance and audit-related expenses, which were partially offset by a decrease in travel and promotional activities associated with the COVID-19 restrictions. Below the EBITDA line, third quarter cash interest of $8.1 million decreased by $0.4 million or 5% below the prior year, which was primarily due to lower borrowing rates.

Sprague recorded $1.6 million for cash taxes in the third quarter, which was down modestly year-over-year. Quarterly maintenance CapEx decreased by $1.4 million to $2.1 million.

Maintenance CapEx was lower principally due to the timing of several IT and terminal-related projects. Given the increase in adjusted EBITDA and lower cash interest and maintenance CapEx, Sprague’s distributable cash flow for the third quarter increased by $9.4 million year-over-year to $9.0 million, generating a quarterly distribution coverage ratio of 0.5x.

At the end of the third quarter, Sprague’s permanent leverage was 3.4x, while our borrowing capacity under our working capital and acquisition lines was $142 million at quarter end. In terms of forward guidance, Sprague’s full year adjusted EBITDA target remains unchanged to $105 million to $120 million.

And now a discussion of our business segments, in Refined Products, sales volumes decreased by 6% for the quarter, primarily in diesel fuel sales, as transportation requirements in Sprague’s commercial on-road and marine bunkering businesses declined due to the COVID-19 pandemic. Adjusted gross margin increased by $7.0 million or 21% to $40.4 million, primarily due to inventory basis appreciation and unrealized mark-to-market gains on poor Sprague’s positions.

In natural gas, sales volumes for the quarter decreased 15% year-over-year, while adjusted gross margin decreased by $3.1 million or 84% to $0.6 million compared to the same period a year ago. The decline reflect several market dynamics, in particular, the continuing impact of COVID-19 economic slowdown to lower demand and limited supply optimization opportunities.

In materials handling, the third quarter adjusted gross margin was $13.8 million, 5% or $0.7 million higher than the same period a year ago. The increase was principally due to higher tank rental income for Refined Products at Kildair and additional revenue from windmill component handling activities in Maine.

At this point, I’d like to turn the call over to Angela to take any questions.

Hi. What was your inventory at the end of Q3 in dollars?

Just one second, I will get that answer for you. $240 million in inventories at the end of September 2020.

Yes, my question relates to – so at the end of Q2, you had about $192 million of petroleum products inventory. And given the prices of your products, at the close of that quarter, I assume volumetrically, your inventories were considerably higher than recent history.

Is that an accurate statement?

Inventories have been higher at the end of Q2 and Q3 than they were in previous years given the contango structure in the market. So yes, they have been higher sequentially in both second and third quarters to take advantage of the industry structure.

So, I am wondering why you have not raised or at least narrowed the range of your EBITDA guidance for the year?

Yes, fair question. I would say, clearly, if you look at the trajectory through the year, we are trending towards the higher end of our guidance range.

But we believe, just given the continued uncertainty in the market about potential lockdowns and demand uncertainty, that it was prudent to just maintain the existing guidance.

Okay. And the guidance assumes, I believe, I don’t have the statement in front of me.

It assumes typically normal weather conditions and normal market structure. I realized that what is a normal market structure, a fairly flat curve?

Fairly flat distillate curve is what we would consider typical. Obviously, we have seen a range – over the last few years, we have seen backward dated conditions and, as we are now, contango conditions.

But yes, we assume a pretty flat curve as normal.

And just one last question, so when you – if sitting right here, if I look at the contango, am I looking for safe – for heating oil traded on NYMEX? Am I looking at contract four or less spot or the front month or four or less the front month or is that how you would sort of generally communicate?

Yes. I mean, we tend to look at the winter strip at this point in time, which is where we hold the inventory for sales.

So you look at no March strip. And again, what we look at is the month – we don’t typically say it’s a one to six month or so, we say what each month look like in the forward strip.

So – but we’d be looking, in particular, through the winter months.

Okay. And just one last question, if I may, if you could just walk me through a typical – so you are taking physical delivery, you mentioned that your costs are down because you’re not renting barge capacity.

So would you historically take physical delivery, say in New York, and put the barrels, let’s assume it’s heating oil, in your storage? And you would hedge that out, sell that forward months or whatever?

And would you have to also to execute that contract, deliver that – those barrels physically back to New York Harbor in 4 months?

No. So we physically sell them to our customers at the end of that period of time.

So we have the natural shore with our marketing business to sell those barrels out to our customers, either on a contracted basis or on a spot basis. So it would be exceptionally rare for us to load a barge back and sell it back into New York Harbor.

It’s, again, extinguished through the rack. And in response to your first question, yes, we are taking delivery of those.

And when I mentioned the transportation decrement, we do take on some dedicated barges throughout the winter period,, just given it’s our high demand period. In this winter, we have less dedicated barge capacity than we would typically take, given that we’re coming into the winter with much more full storage tanks than it has been the case over the last few years.

Some of which is leased out to third-parties, as you mentioned in the prior statement?

Yes. So, there has been a couple of tanks that we brought back into service this year, because, again, lease rates were exceptionally high when we had the tightness in storage.

So there are a few tanks throughout our system that are leased to third-parties, which, again, expect to sell those barrels in place to us over the course of the coming winter.

Okay, great. Thanks for answering my questions.

You are welcome.

Yes good afternoon. I am interested, as a stockholder and what determines your stock price?

Boy, your guess is as good as mine on that dimension. Typically, MLPs have been valued on a yield basis.

That’s obviously not been the case over the last 12 months or so – or gosh, longer. But it’s based on the distributions, and I think future expectations of distributions would be the appropriate theoretical answer to that.

We have obviously maintained a healthy distribution payment and intend to continue doing that based on the current dynamics. So I am not sure if that answers your question?

Or if there’s something else you were seeking in that response?

Well, a couple of things. Because I know there’s obviously a directive and a high level of interest to go to these renewable energy sources.

And you folks are mostly in fossil fuels, and things like that, so that’s necessarily going to have some sort of a psychological impact on your business, I would think, over the long term. Because I did buy this stock several years ago at a much higher price, and it doesn’t seem to be moving off the teens, the area of the teens.

And I’m just wondering what kind of an impact is the new President is going to have? And moving away from fossil fuels, how is that going to impact your business?

Yes. Look, I would say there is a lot embedded in that question.

I would say a couple of things. One is, as I mentioned on the call, look, we believe there will be a transition to increasingly lower carbon fuels.

And I think Sprague continues to be well positioned to capitalize on that transition with both our assets and our customer franchise. And I think regardless of who ultimately wins this election, that transition is and will take place over a long period of time.

And again, we will position ourselves to succeed in that environment through that transition. So you are absolutely right that all energy properties have been not strong performers in the market, including most MLPs during that period of time.

We have actually held up much better than the market as a whole. But share your frustration at the valuation that’s realized now.

But again, fossil fuels are going to be around for a long period of time, but we need to be transitioning to lower carbon fuels, and we think we’re leading that transition, and we’ll continue to do so.

Do most MLPs, do they have to pay – do they pay their earnings out and distributions?

Yes. That’s most – a lot of them have cut their distributions recently, but most MLPs pay a healthy percentage of their distributable cash flow out as distributions.

And do you folks retain much in the way of returned earnings for working capital investment purposes and things like that?

It wouldn’t be for working capital. Working capital is financed through our credit facility.

But this year, as David mentioned, our coverage ratio through 12 months is we’re paying out most of our distributable cash flow, almost all of it, in the form of distributions to our unitholders.

Okay. Yes, it’s pretty healthy – it’s a pretty healthy dividend, so that’s encouraging.

It’s sure is a nice yield. Yes.

It is. Unfortunately, it’s not going to cover for the stock loss.

That’s the problem with that issue. It’s going to take a long time to recover from any stock loss on that.

So I just was wondering, yes, if you see any potential, I know all the challenges ahead and what you’re saying, but do you think the stock will recover at some point in time down the road?

I’d like to believe the market will fairly value us at some point in time. But again, I think the energy sector, as a whole, has been pretty beaten down recently.

And unfortunately, we’re tied to that sector. So we tend to trade along with the sector to some extent, despite our continued strong results and very healthy yield, obviously, on the units today.

And does Axel Johnson own – they own 49% of the business?

No, they own 56% of the common and all of the general partnership as well.

Okay, 56% of the common and all the general partnership. Okay.

And do they always take your distribution or they have decided not to – is there have been times that they haven’t taken the distribution at times?

Yes, the third quarter of last year, they chose not to take the distribution, or defer until future conditions warrant it. But yes, they deferred on the distribution in the third quarter last year.

Does that mean when they finally do take your distribution, they’re going to get that third quarter if they did not take it at that time or they are just being...

No, only under certain conditions where there is excess distributable cash flow would that be the case.

Okay, okay. Alright.

So there is no threat. Obviously, there is always – I heard your limitations and challenges, but there is always an issue with cash flow as well with this type of business, correct?

This business certainly has some underlying volatility to it. And there is certainly – as you’ve seen, there’s clearly seasonal dynamics to this business, where the first and fourth quarters are traditionally far stronger than the second and third quarters.

Yes. Does OPEC have any – I mean, you are pretty small-scaled compared to what OPEC does.

But does that have any impact on your prices at all?

The crude dynamics have limited influence on our business. Obviously, we’re a refined products business.

But certainly, earlier in the year, I would argue that the OPEC or the OPEC+ dynamics contributed to the disconnect between supply and demand, together with COVID. They did create some of the nice opportunities we saw in the contango structure that moved from the crude markets to the refined products markets.

And I guess my last question, you – as far as you know, you are going to continue to pay the 15% dividend. I know you can’t say for how long, but – and well into the future, I guess, is that an accurate statement?

Well, the current plan is to maintain the distribution as it is now. I wouldn’t say it’s $0.6675 per unit quarterly, which I hope, over time, will translate to a – as I think you do as well, a lower yield as the unit price increase.

Right.

But yes, the current – we’ve maintained a flat distribution for 1.5 years now or so and have no plans to change that distribution, although it is a quarterly decision with the Board.

Okay. Well thank you very much sir.

Appreciate it. Thank you.

You are welcome.

Just had a question on the natural gas transportation contact – contracts, I think you had unrealized mark-to-market losses in the queue. Were they – should I be thinking of those as basis differentials Pennsylvania versus your end customers in the Northeast?

Is that where they arrived?

Well we have long-term transportation contracts on all the major Northeast pipelines. To be 100% honest with you, I need to go back and look at the unrealized gains quarter-to-quarter and how those have manifested themselves.

So we do see some quarterly noise there on an unrealized basis that tends to, on an annual basis, kind of even itself out. So I wouldn’t attribute too much meaning to a quarterly mark-to-market difference on those long-term contracts.

I know that is not a very helpful answer to the question, but I need to go back and look at that in more detail. But again, these contracts have value that accrues over the term of the contract.

But there is some quarterly noise in how those are marked, again, on an unrealized basis.

Okay, thanks.

You are welcome.

Thanks, Angela. We appreciate everybody’s interest today and look forward to continuing to update you on future calls.