Sprague Resources LP (NYSE:SRLP ) Q1 2022 Earnings Conference Call May 5, 2022 1:00 PM ET

David Glendon - Chief Executive Officer

David Long - Chief Financial Officer

Paul Scoff - Vice President and General Counsel

Ladies and gentlemen, thank you for standing by and welcome to the Sprague Resources First Quarter 2022 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to hand the conference over to your speaker today, Mr. David Glendon, CEO. Please go ahead, sir.

Thank you, Ren. Good afternoon, everyone and welcome to Sprague Resources first quarter 2022 conference call. Joining me today are David Long, our Chief Financial Officer and Paul Scoff, our Vice President and General Counsel.

I’d 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 couldn’t be any prouder of the way our team executed in the first quarter of 2022. Market volatility, episodic bouts of cold weather, significant call on oil-fired generation due to natural gas constraints and overall tight supply-demand balances in both refined products and natural gas, meant that our team’s considerable logistics expertise was regularly put to the test, and they delivered with the outstanding results released today.

While David will review the details in a few minutes, the overall theme is one I’ve discussed several times on recent calls, our business’ ability to deliver a solid baseline, while periodically benefiting from our proprietary asset base, customer franchise and logistical capabilities. The upside can be driven by weather, market structure and distillates or volatility in natural gas.

In the first quarter of 2022, the global tightness in natural gas increased dramatically, as the Russian invasion of Ukraine forced the recognition that Europe was entirely too dependent on Russian gas and oil. The attendant price escalation, as countries competed for LNG cargoes, affected Northeast gas markets since LNG traditionally served as the marginal supply source in winter months. The increased volatility led to optimization opportunities that our team was able to capture in generating the record results. We anticipate that this structural tightness will persist as European countries move aggressively to develop alternative sources of supply in limiting their reliance on Russia.

Our Refined Products team also exhibited strong performance under very challenging market conditions, keeping our customers supplied and meeting incremental demand for oil-fired power generation despite the structural disincentives for holding inventory. As listeners know, our policy of maintaining a fully hedged inventory position means that rolling these hedges, in a severely backwardated environment, as existed in Q1, translates into significant associated costs.

While we strive to limit our inventory position in this environment, our proven ability to keep customers wet is a big part of our value proposition and source of competitive advantage, and our team struck a terrific balance in managing supply against this backdrop. Unfortunately, the remainder of the year doesn’t look to get any easier as the projected supply-demand imbalance, implied by the forward curve, suggests the persistence of severe backwardation. While I’m confident in our team’s continued ability to navigate these dynamics, it’s fair to acknowledge the structural headwind over the remainder of 2022.

Looking forward, we are excited to see increased interest in renewable liquid fuels across our customer base and reduced carbon intensity of transportation and heating fuels. Use of higher bio-fuel blends or renewable diesel contributes 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 incentives, mandates and voluntary adoption of higher renewable fuel blends.

We are encouraged by the recent moves in Northeastern states towards low-carbon fuel standards and we are finally seeing signs of federal support for low-carbon liquid fuels alongside electrification efforts. We believe that our extensive asset profile is well suited to meet the needs for both traditional energy sources as well as increased renewable content in fuels.

We are investing in the flexibility of our terminal assets to support higher blends and also supporting the development of new forms of carbon-free fuels. While these development efforts in renewables present exciting growth opportunities to leverage Sprague’s inherent advantages, we shouldn’t lose sight of the continued prospects and long tail of our existing core businesses, with added benefits from Hartree’s support, expertise and extensive network.

In April, the Board of our general partner declared a distribution of $0.4338 per unit for the first quarter of 2022, flat to the previous quarter. Regarding the Hartree Partners LP January 11 proposal to acquire all of our outstanding publicly held units, the Conflicts Committee, along with its legal and financial advisers, continues to review the offer. Either the partnership or the Conflicts Committee will communicate when appropriate through public announcements. Accordingly, we will not be taking any questions on this topic during our call today.

Now I’d like to turn the call over to Dave Long for a detailed review of our first quarter results. Dave?

Thank you, Dave, and good afternoon, everyone. As Dave mentioned, we had a strong start to the year, given outstanding execution by our teams in a highly volatile market environment, supported by episodes of colder-than-average weather, incremental demand from oil-fired power generators and global supply-demand tightness given the Russian-Ukraine conflict. There is plenty of work ahead, particularly given the backwardation in the forward curve. We remain confident in our team’s ability to deliver exceptional service to our valued customers and capture optimization opportunities provided by the markets.

And now a review of our financial results in the first quarter. Sprague’s quarterly adjusted gross margin increased by 33% by $35.3 million to $141.5 million as compared to the first quarter of 2021 and first quarter adjusted EBITDA of $89.6 million increased by $27.8 million or 45% as compared to the prior year.

Operating expenses increased by 21% or $4 million in the first quarter, primarily due to increases in insurance, utilities, boiler fuel, stockpiling and employee-related expenses. SG&A expenses increased by $3.5 million or 14%, primarily as a result of an increase in insurance, legal, sales commissions and incentive compensation expenses.

Below the EBITDA line, first quarter cash interest expense of $9.2 million increased by $1.9 million or 25% above the prior year, which was primarily due to higher net borrowing rates. Sprague recorded $5.9 million for cash tax benefits in the first quarter, which was higher by $6.9 million or 702% year-over-year. Quarterly maintenance CapEx was higher by $0.7 million to $2.7 million, which was higher principally due to incremental investments in tank repairs of several Sprague terminals.

Given the increase in adjusted EBITDA and tax benefits, which were partially offset by an increase in cash interest expenses and maintenance CapEx, Sprague’s distributable cash flow for the first quarter increased by $29.8 million year-over-year to $83.6 million, generating a quarterly distribution coverage ratio of 7.3x. Trailing 12-month distribution coverage at the end of the first quarter was 1.6x.

Turning to our balance sheet, Sprague’s permanent leverage was 2.9x at the end of the first quarter. We continue to have ample excess capacity in our credit facility. As of March 31, 2022, our borrowing capacity, under our working capital and acquisition lines, was $299 million.

So subsequent to the first quarter close, we are pleased to share that we successfully increased our working capital borrowing capacity from $750 million to $887.5 million in our credit facility. Given the rise in commodity prices, we believe this increase in capacity provides sufficient additional liquidity to support the company’s near-term working capital needs. Please note the details of this amendment in our SEC filing on April 13, 2022. We continue to appreciate the long-term support from our valued lenders and are pleased to welcome several new banks into Sprague’s credit facility. In terms of forward guidance, Sprague’s full year adjusted EBITDA target is $105 million to $125 million.

And now a discussion of our business segments, in Refined Products, sales volumes increased by 10% for the quarter as demand, particularly in distillates, increased due to colder weather; demand from oil fire power generators, given the higher relative cost of natural gas; and strength in transportation fuels, given improved economic conditions. Adjusted gross margin increased by $3.1 million or 6% to $54.1 million, entirely driven by higher volumes, with the unit margins lower by 4%, given less attractive conditions to purchase, store and hedge oil.

In Natural Gas, sales volumes for the quarter decreased by 6% year-over-year, with a rising commodity price environment being a contributing factor. Adjusted gross margin was $71.4 million, which was an increase of $30.3 million compared to the same period a year ago. The increase in adjusted gross margin was in part due to the market volatility, given episodes of colder weather and geopolitical tensions following the invasion of Ukraine by Russia. This volatility gave rise to supply optimization opportunities in both the prompt and forward books. In addition, we recorded a gain associated with the assessment of fair value of Sprague’s forward assets and liabilities under ASC 820 accounting guidelines, which contributed to the gross margin variance to the prior year.

In Materials Handling, first quarter adjusted gross margin was $13.1 million, 9%, or $1.1 million higher than the same period a year ago. The increase was principally due to higher tank rental demand from third parties at Sprague’s Canadian operation and modestly higher salt, pulp and vessel handling services in the U.S., which were partially offset by lower asphalt throughput revenue, given the sale of the Oswego, New York terminal in late April 2021 and the termination of the asphalt contract at the Everett, Massachusetts terminal at the end of 2021.

At this point, I’d like to open the call for questions.

Thanks everyone for joining our call today. We appreciate your continued interest in Sprague and look forward to updating you on future calls.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day. You may all disconnect.