PPGPL / TTNGL UPDATE: WHAT DIFFERENCE DOES A YEAR MAKE?

11 August 2015


Last June, based on publicly available information, we conducted a basic analysis and valuation of Phoenix Park Gas Processors Limited (“PPGPL”), which was slated to offer shares to the public later in the year. Over a year later, the initial public offering is officially underway as of 11:00 a.m. today, August 10th, 2015.

Now that we have a prospectus and financials in hand, we can conduct a quick but informed valuation of Trinidad and Tobago NGL Ltd (“TTNGL”), the vehicle which is being listed on the TTSE.

The phrase “What a difference a year makes” has never been more appropriate. In the interceding period, West Texas Intermediate crude oil prices have collapsed from over USD 100 per barrel, to USD 43.75 per barrel (as of August 7th, 2015). The same has largely held true for propane, butane and natural gasoline, which are the three commodities that PPGPL produces using natural gas as its feedstock. But what impact has it had on PPGPL? How much does it actually decrease the attractiveness or increase the risk of the investment in TTNGL? In short, what difference does a year make?

TTNGL is a much less attractive prospect today than it was last year. However, we maintain that TTNGL is still an attractive proposition for investors who want to take on additional moderate risk in their portfolios. The company is fairly stable and has substantial pricing and earning power, but is also exposed to commodity price cycles and as such may experience volatility in its earnings and cash flow. There are substantial additional risks regarding other more technical aspects of the business. We will discuss PPGPL’s profitability and financial health, delve into the various technical and economic risks involved in the business, and also examine hypothetical downside scenarios—a critical part of any analysis, given the substantial commodity price risk involved in TTNGL / PPGPL.

But first let’s revisit our primer on valuation from last year, to frame the conversation.

A BRIEF PRIMER ON VALUATION

Benjamin Graham explained it best when said, “Price is what you pay, value is what you get.” Graham was Warren Buffet’s professor at Columbia Business School and became his mentor, helping shape the investment strategy of arguably the world’s most successful equities investor.

Let’s say had to choose between two hypothetical investment opportunities—two different stores, for example. Would you rather pay 100 dollars for a store that makes 10 dollars a year, or pay 105 dollars for a store that makes 15 dollars a year?

If you are focused on valuation and on maximizing your potential profits, you would choose the 105 dollar business, which you would be buying for 7 times its profits (105 divided by 15), as opposed to the 100 dollar business, which you would have bought for 10 times its profits of 10 dollars.

This is a very, VERY simplified example, and there are many other variables to consider before making an investment. However, the principle behind valuation remains: what are you getting for the price you are paying?

PHOENIX PARK AND TTNGL BY THE NUMBERS

 

phoenixpark

 

 

 

 

 

 

As you may have already heard, PPGPL is in the business of processing natural gas for the downstream industry in T&T, as well as for the production and export of LPG and gasoline. In fact, PPGPL is the only company that processes natural gas for T&T’s vast downstream industry—without PPGPL to remove liquids from the natural gas, there is no effective downstream natural gas industry, and no petrochemicals industry.

PPGPL has been consistently profitable from inception, and has paid dividends every year in the last 23 years. However, profitability trends have been on the decline for two main reasons. Natural gas supply was curtailed between 2010 and 2013 due to maintenance on offshore platforms and pipelines. Decreased feedstock supply inevitably leads to decreased production and capacity utilization, and lower profits.

This issue was compounded in 2014, when prices of LPG and natural gasoline took a substantial hit. Based on data from the Wall Street Journal, benchmark prices for butane declined by 60% while benchmark prices for propane fell by 65%, between June 30th, 2014 and August 7th, 2015.

 

150810 ppgpl profitability

 

 

 

 

 

 

While margins have remained healthy and remarkably consistent on both Operating Profit / EBITDA (earnings/profit before interest, taxes, depreciation and amortization) and Profit After Tax, the actual dollar amounts have declined. Profits have declined by about 48% since 2011 due to the factors outlined above. Year over year, profits declined by 17.7% from USD 202.6 million to USD 166.6 million. These numbers do not incorporate the impairment losses, which are non-cash items.

PPGPL in the first quarter to March 2015 fell to $116 million vs $200mill in 2014, Gross Profit fell to $39 million from $74 mill and Profit after tax fell to $15 million from $43 million. Of note was $10 million in finance costs up from $2 million in 2014.

PPGPL has some buffering due to its long term contracts with companies such as Petrotrin, Atlantic LNG and NGC. Margins have also remained consistent due to the very low feedstock costs and indexed pricing, which make PPGPL one of the most competitive NGL fractionation facilities in the Western Hemisphere. However, the company is not impervious to the fluctuations of commodity prices, and this represents its primary source of risk going forward in a scenario of falling prices. Its gas feedstock uses a formula on Mont Belvieu pricing just as its products are at a premium or discount to Mont Belvieu thereby mitigating the negative impact on net earnings.

TTNGL IPO VALUATION ANALYSIS

TTNGL owns 39% of Phoenix Park Gas Processors, and is selling 49% of itself to investors through the IPO. TTNGL does not carry any debt of its own and its only real assets are its shares in PPGPL. TTNGL also does not participate in the operational and financial decision making processes for PPGPL. It is essentially a holding company. As such, it is entitled to a share of 39% of the profits from PPGPL.

According to the prospectus, 75.85 million Class B shares are being offered at TTD 20.00 each. The offering is equivalent to around 65% of Class B shares, and 49% of the total amount of shares in TTNGL. This would indicate that there are 154.8 million shares total in TTNGL.

150810 valuation metrics

 

 

 

 

 

 

 

 

Based on 154.8 million shares, we were able to calculate two key valuation metrics: the Price to Earnings Ratio (“P/E”), and the Price to Book Value Ratio (“P/BV”). The P/E ratio is the Price per Share divided by the amount of Earnings or Profit per share. It is the metric we used in our valuation primer example to discuss which investment had the better valuation. The P/BV is the Price per Share divided by the value of the equity of the company as presented on the balance sheet, calculated on a per share basis.

TTNGL has been priced relatively conservatively, with an attractive P/E of 8.97 and a P/BV of 1.06. Relative to other companies in the local and international markets, these ratios are very attractive—most blue-chip companies in T&T trade at a P/E between 10 and 16. National Enterprises Limited (NEL) is the closest comparable company to TTNGL that is listed on the TTSE, and trades for more than 20 times its profit.

Based on a range of percentages of profits paid out as distributions, we were also able to calculate indicative dividend yields. The prospectus indicates that up to 99% of profits can be distributed as dividends, and that the policy will be to distribute all profits remaining after any administrative and financing costs. These costs are not likely to be substantial given the holding company nature of TTNGL.

With a conservative estimate of 60% of profits attributable to TTNGL paid out as dividends, investors who are able to get shares at the IPO price of TTD 20 per share will enjoy a dividend yield of 6.69%. The dividend yield could be higher than 8.9% if 80% or more of profits are distributed as dividends. The yields are at a substantial premium to other available options on the TTSE, which tend to provide dividends of 3-4% at best in most cases.

UPSIDE SCENARIOS

150810 ttngl return scenarios

 

 

 

 

 

Based on the relatively low valuation, high levels of liquidity, and intense appetite for new issues by recognized names in T&T, there is room for reasonable upside in a relatively short time frame.

A highly defensible scenario would see the valuation of the firm increase to a P/E multiple of 10, from its current level of 8.97. This would translate into a price of TTD 22.31 per share, or an 11.53% return. Factoring in the potential dividend of TTD 1.34 would lead to a total return (appreciation plus dividend yield) of 18.22%. Dividends are calculated based on the assumption that 60% of profits attributable to TTNGL would be distributed.

An increase in valuation from a P/E of 8.97 to 12 is also plausible. If this were to happen, returns from price appreciation would clock in at 33.83%, with a lagniappe from dividends leading to a total return of 40.52%.

RISKS AND DOWNSIDE SCENARIOS

There are a number of risks which need to be carefully considered before making an investment in TTNGL.

These risks include, but are not limited to:

  • Commodity Price Risk: commodity and energy prices have declined substantially over the last 18 months, driven by a number of factors including oversupply, the rapid appreciation of the US Dollar, and perceived dissipation of geopolitical risks. Industry observers believe that prices will remain low for at least the next three years, barring any major geopolitical events or supply disruptions. This risk is somewhat mitigated by the very low feedstock costs PPGPL enjoys, but this advantage will not inoculate the company from price swings or declines.
  • Product Risk: increasing amounts of contaminants have been found in PPGPL’s feedstock, including Sulphur and benzene, which are highly hazardous. Health, Safety, and Environmental regulations and demand for cleaner products are driving demand away from LPG and natural gasoline with relatively higher levels of contaminants. This may affect both pricing and volumes sold for PPGPL going forward unless the issue is addressed. The prospectus makes no mention of methods to address this issue, which is concerning.

150810 downside dividend scenarios

 

 

 

 

 

 

 

 

 

From a dividend perspective, decreases in commodity prices would still allow for TTNGL to pay out superior dividends assuming a conservative distribution of 60% of profit; if prices fall by 40% from current levels, TTNGL would still be able to comfortably pay a 4.62% dividend yield. Industry consensus is that a decline of that magnitude from current levels is highly unlikely.

150810 downside impairment scenarios

 

 

 

 

 

 

The far more concerning risk is the possibility of further impairments and write downs in the value of the assets. Energy and commodity companies globally have had to write down hundreds of billions of dollars in investments over the last year, as commodity prices have fallen precipitously. PPGPL is no exception, having been acquired by TTNGL and other government or NGC-affiliated entities in the last two years.

So far, TTNGL incurred an impairment loss of TTD 1,097.9 million during fiscal year 2014 due to the decline in commodity prices. This loss was not a cash loss but nevertheless lead to a paper loss of TTD 4.87 per share (and accounting for the new price of TTD 20 per share versus last year’s offer of TTD 25 per share). The loss also impacted profitability adversely, leading to a loss of TTD 804.2 million.

According to page 103 of the prospectus, for every 1% decline in key commodity prices, the impairment loss will increase by TTD 37.4 million. The table above delineates pricing scenarios where key commodity prices decline between 20% and 50%, and the potential impairment losses that would be incurred. Most analysts believe that energy prices would have a price floor 25% lower than where they are today before the market would steady itself and recover.

A 20% to 30% decline in key commodity prices would lead to impairments of between TTD 748 and 1,122 million, or TTD 4.83 to 7.25 per share. These would affect the valuation of the shares between -24% and -36%, respectively.

Special attention must be paid to this risk, because there is a reasonable probability of further impairments. As such, investors should only invest some of their capital from within the portfolio allocation they may have set aside for moderate risk—the risk in TTNGL is higher than many other blue-chip firms in T&T, despite the fact that it is state owned, enjoys very low leverage, and consistent profits and profit margins due to pricing advantages. It is important to keep in mind that the impairment losses are accounting, and not cash losses, but nevertheless impact upon profitability, which would then translate into the share price.

SUMMARY: PROS AND CONS

The offering in TTNGL is still attractive despite much higher risk relative to last year.

Among the positives are:

  • Reasonable and attractive valuation metrics, both on a standalone basis as well as compared to international and domestic equity alternatives;
  • Potential for very high dividend yields, even with higher commodity price risks;
  • Strong pricing power and competitiveness, with world-renowned management and safety records.

However, the negatives must also be addressed candidly:

  • Potential for additional elevated impairment losses, which could adversely and severely affect profitability and book value;
  • Elevated commodity price risk, leading to lower profits and more constrained cash flow.

Other factors that may contribute to the success of the offering and price appreciation are:

  • High levels of liquidity in the T&T financial system, as well as at the institutional level across the region (and where most regional institutions are amenable to buying equities in T&T);
  • Persistently low yields, especially from recognizable names, across both debt and equity.

Despite the increased risk level, we expect the offering to be oversubscribed due to demand. Firstline Securities would be happy to work with you to determine what your adequate allocation to the offering should be, depending on your risk profile and appetite.

If you have not read the prospectus, please click on this link! http://www.ngl.co.tt/images/docs/NGL-Prospectus-2015-web.pdf

8 Responses to “PPGPL / TTNGL UPDATE: WHAT DIFFERENCE DOES A YEAR MAKE?”

  1. Neil Singh says:

    Why are you using the 2014 financial and not projecting using 2015 Q1?

    Take a look at the MBV price and you will see the valuation using the 2014 financials is not a good indicator for 2015.

    Based 2015 Q1 financials, the P/E is around 20 and dividend yield around 4.8% for 2015.

    http://www.indexmundi.com/commodities/?commodity=propane&months=12

  2. FSL says:

    Hi Neil, thanks for your comment.

    The convention in the industry is to use the last 12 months, and since the 9 preceding months or three preceding quarters are not broken down, we can’t incorporate the last quarters numbers. We therefore have to use FY2014 numbers.

    Q1 numbers are only using figures from one quarter of the whole year. That means it would be one quarter or less of what the entire years numbers will look like and would therefore distort the numbers. We can’t make forward looking projections because we do not know what the volumes actually sold look like, which may be higher or lower.

    • Investor says:

      Thank you FSL firstly for putting out an early opinion.

      I am inclined to agree with Neil. While it is true what you said regarding the 12 month standard and the quarters not being broken down, this can work in a situation where we do not have Q1 2015 results for the company, in which case we would not have official results to act as a guidance for 2015.

      However we do have the benefit of the Q1 2015 results, to provide some guidance. In addition and most importantly the results are “materially” lower than 2014 (a more than 60% decline in revenue) it is for this primary reason why valuing using 2014 figures without regard for the 2015 figures even if they are for one quarter, can in fact be misleading and overly optimistic.

      As for the volumes case, gas supply disruptions have already occurred in Q12015 (a spill over from 2014) and are expected to continue into 2H 2015 when BPTT is expected to take down its Immortelle platform next month for 22 days (according to CBTT). At best volumes are expected to stabilize over the 2014 volumes.

      Even if their was an increase in volumes, it would be marginal and would be substantially offset by the more than 60% fall in NGL prices since August last year and over 25% YTD.

      Having said this, it would in fact be more realistic to value on 2014 figures but with annualized figures for 2015, which project a very different scenario from 2014 with a projected full year P/E of 21.05, based on a full year 2015 EPS of $0.96, which is on the higher end relative to the market and a less attractive 4.75% Dividend Yield, based on a best case payout of 99%.

      This would certainly in my humble opinion present a more balanced position regarding returns (yield/capital appreciation).

      I would also like to thank you for your blog space and allowing us to weigh in from time to time, do keep up the good work.

  3. Richard says:

    You’re doing your readers a disservice by using 2014 results to calculate PE and dividends. Extrapolating 2015 q1 results would be a more realistic scenario. YOu should have at least have a separate chart showing tthose calculations.

    You admit energy prices are substantially lower than a year ago, yet use prices from a year ago to calculate forward PE and dividends?? Am I missing somethign here?

    Your paint a very rosy picture – but you must know that its unrealistic.

    The article is VERY misleading. Lets hope small investors are properly guided elswhere

    • FSL says:

      Hi Richard,

      We would not want to simply multiply the first quarter results from the year. There are seasonality and production volume considerations not to mention pricing to consider, all of which require more time than the few hours we had to put out our initial analysis. For example, oil prices recovered briefly this year before coming back down and that would affect revenue for Q2 and Q3 and require consideration from us in a write-up.

      For us to comfortably project fourth quarter revenue from Q1 data is asking us to predict oil prices going into the end of the year. If we could realistically do that we would be lounging in a hot tub in our private jet while our analyst Michael’s algorithm did all the work 🙂

      But we hear you sir. And we hear Neil. And we hear InvestorTT.

      That said, we did not paint a rosy picture and we encourage investors – both large and small to read our whole analysis inclusive of the table showing serious downside risk of up to 60% based on impairments.

      As we mentioned yesterday: look out for our updated analysis soon.

  4. FSL says:

    Hi Investor,

    Thank you for your detailed comment.

    You can look out for further detailed analysis from us either today or tomorrow.

    Firstline Team

  5. Anthony Wilson says:

    Hi Firstline,

    Someone associated with the offer sent me a link to this analysis today, the day on which my own first past at the TTNGL IPO was published in the August 13 edition of the Business Guardian.
    I must say that in the column I used Neil’s back-of-the envelope approach, extrapolating from the first quarter results, to conclude that an estimated PE of 20 might be more appropriate.
    An estimated PE of 20 would mean that TTNGL is tremendously overpriced and would present little short to medium term value for potential investors.
    In other words, at an estimated PE of 20, TTNGL is not likely to be oversubscribed and unlikely to provide investors with the type of bounce that FCB did.
    What’s more is that while NEL, UTC and NIB were in the market to buy FCB shares, those institutions already have stakes in Phoenix Park, by virtue of their acquisition of the 10 per cent of PPGPL held by Pan West in November last year.
    While there is merit in using the complete 2014 results, by NGC’s own admission, product prices in 2015 are likely to be “at least” 45 per cent less than 2014.
    That admission, in my view, means that using the 2014 results may present a misleading estimate of TTNGL’s value.
    Of course, if NGC were to publish PPGPL and TTNGL’s second quarter results (for the period ending June 30, 2015) potential investors would have a better sense of whether using the 2014 results to come up with a PE estimate is even advisable.
    By the way, listed companies are required to publish their quarterly results within 45 days of the end of the quarter.
    Looking forward to the more thorough analysis promised.
    As the first past raised some issues I had not contemplated, I am wondering whether Mr King would give me permission to publish this one in the Business Guardian.

  6. Senyela says:

    Anthony, Investor, Neil,

    While I understand your concerns, Firstline presents a measured view, addressing various factors other than the focus of your comments.

    In all fairness to Firstline, the Issuer has been deficient in its presentation of the numbers within the Prospectus. We all know that both Trailing and Forward P/Es are best calculated utilising quarterly data. Whilst the prospectus contains data for Q1 2015 it has not allowed for the calculation of a trailing P/E and leaves much to the imagination with respect to the forward P/Es.

    I would have thought that given the details regarding the Forward looking Information in Appendix 11, that at the very least, we the Investors would have been provided with financial forecasts to year end 2015.

    The charts clearly paint a picture of decline in 2015 as it relates to MBV prices, but there are also statements to the effect that PPGPL has been able to renew term contracts at higher prices to MBV. What is not known however is the extent of the premium and the length of the term.

    So does erring on the side of caution mean using actual experience or does it mean speculation on unknowns. Certainly Q1 results in a market as volatile as this is, introduces a level of subjectivism that can extend and prolong this debate even further.

    If we really want to analyze TTNGL’s potential for capital appreciation and dividend yields, shouldn’t we also be looking at areas such as the high leverage of the company, the fact that it recently refinanced its debt without a clear indication of the impact of the refinancing in the disclosure notes, that TTNGL has pledged its shares in PPGPL as additional collateral security for the obligations of PPGPL, the fact that its free cash flows have been on the decline, among other things.

    Clearly in this transaction, the devil is in the details or should I state, the lack thereof? At the end of the day however, investors should have a clear idea of of their risk appetite, their investment strategy, whether they are in for the long haul or short term and that equity investments unlike fixed income instruments offer no guarantees of yield and the timing of same. Page 32 of the Prospectus is clear. I urge all Investors to take time to really understand all the issues surrounding this transaction. Numbers count but must be used in conjunction with the narrative.