Now that economic conditions have recovered from the severe recession of 2020, the very high payout yield of 10.27% still offered by Sprague Resources (SRLP) looks very attractive on the surface, although unfortunately, digging deeper, they ended 2021 facing an impending liquidity crisis, as my previous article discussed. Given this critical situation, this article provides a follow-up analysis that reviews their recently released fourth quarter 2021 results as well as the outlook to 2022, which unfortunately sees their liquidity crisis escalate with a terrible first quarter coming in, making it time to sell.
Executive summary and ratings
Since many readers are likely short on time, the table below provides a very brief summary and ratings for the main criteria assessed. This Google document provides a list of all my equivalent ratings as well as more information about my rating system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial position.
After seeing operating cash flow of $246.8 million in the first nine months of 2021, it suddenly ended the year negative $56.8 million, which means the fourth quarter has saw negative operating cash flow of $303.6 million as their very large temporary working capital drawdown reversed. during the fourth quarter, which was reported in my previous analysis. If the remaining working capital movements are removed from their annual results for 2021, that leaves their underlying operating cash flow at negative $42.5 million, which means that regardless of how the year is considered, they have always seen a consumption of cash simply by managing their operations. Admittedly, this is a slight improvement from their equivalent result of negative $96.2 million in the first nine months of 2021, meaning their underlying operating cash flow was positive of $53.7 million during the fourth quarter. This reprieve stems primarily from the refined products market moving away from a forward structure to a more favorable contango structure, per the management commentary included below.
“In addition to base margin, we often capture a significant increase in margin when environmental or market factors take advantage of our advantaged assets and logistics capabilities. In refined products, this materializes when the stress of the Cold weather demand results in higher margin realization or a contango market structure allows us to capture value from our vast storage resources.”
– Sprague Resources Q4 2021 conference call.
Almost ironically, the now allayed fears surrounding the Omicron Covid-19 strain in December 2021, which caused oil and refined product prices to plummet against demand fears, actually helped their cash performance, but being given the pain earlier in the year, it was tantamount to simply using a garden hose on a house fire. Looking ahead, however, this remains only temporary, with the market returning to a deep backwardation structure until 2022, as shown in the chart below.
It can be seen that the April 2022 RBOB gasoline futures spot price is currently $3.7791 per gallon at the time of writing, while the longer term September futures price 2022 is only $3.2675 per gallon. Since the longer-term price is significantly lower than the shorter-term price, this means that the market is currently in a deep backwardation pattern compared to a contango structure in which the shorter-term prices are significantly lower. lower than longer-term prices. A backward market structure occurs when the market is currently undersupplied and vice versa for a contango structure.
Unlike a contango market structure that creates an opportunity to capture a significant increase in margins because it is profitable to stock refined products, this current deep offset market structure creates the opposite nightmare, in which their financial performance suffers greatly. This raises the prospect of seeing significant liquidity consumption again in the first quarter of 2022, especially with the Russian-Ukrainian war now pushing shorter-term prices higher as the market fears the possibility of further disruption. impending supply.
Looking away, their adjusted EBITDA forecast of $112.5 million at the midpoint represents a slight year-over-year increase from their earnings of $110.7 million, according to the announcement. Q4 2021 results. While that doesn’t sound too bad, it’s worth remembering that these 2022 forecasts were made before the Russian-Ukrainian war sent prices skyrocketing in the nearer term. Additionally, their Adjusted EBITDA is a non-GAAP accrual estimate, which at $110.7 million in 2021 clearly did not match their negative operating cash flow in 2021 and, considering given their struggling financial situation discussed later, their cash flow performance remains paramount.
After seeing their working capital decline in the first nine months of 2021 reverse in the fourth quarter, their net debt understandably increased significantly to end the year at a record $874.3 million. In addition to representing a significant increase of 18.58% year over year from their net debt of $737.3 million at the end of 2020, which is far more concerning, it also represents a massive increase of 58.13% since only the end of the third quarter of 2021. when their net debt was $552.9 million. This imposed a heavy draw of $321.4 million on their working capital credit facility, further depleting their liquidity discussed later.
While this increase in net debt obviously also pushed their already very high leverage even higher with their debt ratio now well over 100% given their negative equity of $65.6 million, the aspect far more important right now is their liquidity. Although leverage is often the biggest problem in the medium to long term when dealing with distressed organizations, they normally face persistent problems when their liquidity weakens to the point that they do not cannot meet short-term liabilities. Moreover, as their operating cash flow and their result are both negative, it would be quite futile to evaluate in detail their leverage since their ratios would produce logically invalid negative results. If any new readers are interested in more details regarding their very high leverage earlier in 2021 before they hit that distressed state, please refer to my other article.
Although their current ratio improved to 0.90 at the end of the fourth quarter of 2021 against its previous result of 0.83 at the end of the third quarter, their already very weak liquidity has not fundamentally improved. Due to their cash burn, the issue was and still is the remaining available balance of their working capital credit facility, which was only $326 million when the previous analysis was conducted that followed. the third quarter of 2021 and therefore barely above the previously discussed increase of $321.4 million. their net indebtedness lasted through the fourth quarter.
To my surprise, their lenders increased their borrowing base from $548.7 million at the end of Q3 2021 to $750 million after Q4, injecting more cash and saving the day. Despite being positive unfortunately this only kicks the proverbial can down the road as even now their remaining available balance is only $171.8 million and so given their performance highly volatile cash flow and deep offset market structure, this could easily be exhausted throughout the first quarter of 2022 or if not, during the second quarter.
It remains to be seen whether their lenders will be kind enough to increase their borrowing base again, as their working capital credit facility has terms that allow for a maximum borrowing base of $1.2 billion. While this would potentially unlock $450 million in additional liquidity, it remains “subject to certain conditions, including the receipt of additional commitments from lenders…,” according to their 2021 10-K SEC filing. Although these conditions are not detailed, suffice to say that it would not be surprising if they included the suspension of their distributions in the future which, even after being reduced in 2021, still cost 11.3 million dollars each quarter.
The prospect of seeing the market in a deep reverse structure makes immense cash burn very likely at the start of 2022, which is particularly scary given their very high leverage and very low liquidity which could eventually escalate. deplete this quarter, thus seeing their liquidity the crisis continues. Whether their lenders will provide additional borrowing capacity remains to be seen, but relying on that is about as risky as it gets when it comes to income investing and therefore still wise. for their unitholders to prepare for their distributions to be suspended or even worse, they face very real risks to their ability to remain a going concern. I suspect their unit price would have plunged had it not been for the prospects of a takeover providing an anchor and so since this may not continue, I now believe the downgrade to a sell rating is appropriate.
Notes: Unless otherwise stated, all figures in this article are taken from Sprague Resources’ SEC Filingsall calculated figures were performed by the author.