Propane distributors grow though acquisitions
Part of the business model of propane distributors such as Suburban Propane (SPH), Ferrellgas Partners (FGP), and AmeriGas (APU) is to expand through acquisitions. Currently, the top three propane retailers serve ~30% of the market, with the rest of the market fragmented into 5,000+ independent retailers. One of the growth strategies of the big three is to acquire these smaller retailers, and these companies are constantly on the lookout for potential acquisition opportunities.
For example, APU noted in its most recent earnings call that now that it has sufficiently integrated its Heritage acquisition, it’s again on the lookout for smaller tuck-in buys.
Note: AmeriGas’s acquisition of the Heritage propane business was a very large, company-transforming transaction that made $1.46 billion in cash, $1.32 in common units, and the assumption of debt. The types of acquisitions that propane distributors use on an ongoing basis are usually smaller tuck-in acquisitions.
Higher funding costs make acquisitions less attractive
Propane companies make acquisitions because they contribute to growth and gradually support earnings. However, if funding costs increase enough, they could make acquisitions less attractive, which could slow the growth of propane companies. To provide a simplified example, assume an acquisition target generates $10 million of yearly EBITDA (earnings before interest, taxes, depreciation, and amortization) and is selling for $60 million. Let’s also assume that the acquisition is funded with half debt and half equity, so $30 million is funded with debt. If the cost of debt (interest rate) is 5%, the incremental interest associated with the acquisition is $30 million * 5% or $1.5 million. Assuming no cash taxes (MLPs don’t pay corporate-level tax), the after-interest earnings from the acquisition are $28.5 million ($30 million EBITDA – $1.5 million interest).
However, if the cost of debt increases to 7%, the incremental interest associated with the acquisition is $2.1 million, the after-interest earnings from the acquisition is $27.9 million.
Higher interest essentially reduces the distributable cash flow from an acquisition, and if interest costs are high enough, companies may be dissuaded from making purchases.