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Rates are up and more likely to make moves higher rather than lower
Broadly speaking, interest rates have been rising through 2013. The rate on the BofAML High Yield Index (an index that represents a composite of high yield bonds) is currently ~6.50%, compared to ~5.25% as recently as May 2013. All three propane distributors are high yield, and have bonds that are components of the high yield index.
Interest rates for specific propane distributors have also increased throughout 2013. Currently, the yield on Amerigas’ (APU) 7% Senior Note due 2022 is ~6%, compared to under 5% in May and June of this year. The yield on Ferrellgas’ (FGP) 6.5% Senior Note due 2021 is ~6.5%, compared to ~5.5% in April of this year. The yield on Suburban Propane’s (SPH) 7.375% Senior Note due 2021 is currently ~6%, compared to ~4.75% in April of this year.
This means that if these companies needed to issue bonds in the market right now, the rates they could obtain would be more expensive than if they had issued bonds earlier in the year.
Note that none of the companies has any immediate need to issue debt. However, many market participants see a significant risk of interest rate volatility. Please see Why domestic tensions threaten the market in September and Why the bond and loan markets have remained jumpy in recent weeks for more information.
Refinancing more costly, or not economically rational
Though none of the propane companies needs to issue debt immediately, higher interest rates could affect refinancing decisions and economics. For instance, Ferrellgas Partners (FGP) has $300 million of bonds outstanding (9.125% Senior Notes due 2017) that are currently callable at 104.563 (note that call prices of high yield notes generally step down over time until maturity). This means that the company could retire the debt at a cost of $300 million * 1.04563 = $314 million. Retiring the debt saves the company $300 million * 9.125% of interest = $27.4 million every year.
Let’s assume FGP wants to roll over the entire cost of ~$315 million into new debt. If the new interest cost is more than $27.4 million a year (or 8.70% on $315 million), refinancing at this point may not make sense, as the company has a few years until the bond matures and can wait it out either until maturity or until the call price decreases enough to make refinancing economical. Until then, FGP can continue paying 9.125% interest on its notes.
However, let’s say FGP can issue $315 million of new notes at 7%. The new interest cost at 7% is $315 million * 7% = ~$22 million. Without taking into account fees, FGP could save about $5 million in interest cost per year by refinancing.
If interest rates moved up, and FGP could no longer issue new notes at 7%, but rather at a rate of 8%, the savings on interest would be reduced. It might still be economically rational for FGP to refinance, but refinancing at a higher interest rate means higher interest expense and reduced earnings and distributable cash flow.
© 2013 Market Realist, Inc.