U.S. Treasury rates have moved significantly higher, and may continue to do so
Rates on U.S. Treasuries have moved significantly higher throughout 2013. Previously, quantitative easing from the Federal Reserve had helped to keep rates at historical lows. However, as the domestic economy improves, the Fed has hinted that it would begin to stop such measures, resulting in higher rates. In response, Treasuries sold off and may continue to move higher. For more on this, see Must-know: Why the rise in Treasury yields will affect MLPs.
Propane investors hold for yield, not growth
The propane distribution industry doesn’t have fantastic growth prospects. As Ferrellgas (FGP) noted in its 10-K (earnings report), “The propane distribution industry is a mature one. We foresee only limited growth in total national demand for propane in the near future. Year-to-year industry volumes are primarily impacted by fluctuations in temperatures and economic conditions. Our ability to grow our sales volumes within the propane distribution industry is primarily dependent upon our ability to acquire other propane distributors, to integrate those acquisitions into our operations, and upon the success of our marketing efforts to acquire new customers.”
So investors in propane names are holding for their relatively juicy distribution yields. As of September 9, Ferrellgas (FGP) was yielding ~9%, AmeriGas (APU) was yielding ~8%, and Suburban Propane was yielding ~7.5%—some of the highest distribution yields across the MLP space. However, if Treasury yields increase (as they have been through much of 2013) the rate that investors may require of these propane names should theoretically also increase.
Let’s take a simplified example of the ten-year Treasury increasing by ~100 bps (basis points). Assuming an investor demands ~100 bps more yield from FGP, its distribution yield should theoretically be ~10%. FGP currently has a distribution of $0.50 per quarter ($2.00 per year) and a stock price of ~$22. If FGP maintains its current distribution of $0.50 per quarter, its stock should theoretically decrease to ~$20 for investors to receive a ~10% yield.
To reiterate, because of propane’s attractiveness in its yield, a move higher in rates could negatively affect the valuation of FGP, SPH, and APU.