On Propane and Pitfalls

By Jeffrey Simpson, Managing Director, Angus Finance

In recent years, the pace of long-established heating oil dealers jumping into the propane delivery business in an effort to diversify their offerings and seek new avenues for profitability has quickened.  Based upon the steady contraction in the retail heating oil market and the values assigned to propane distribution businesses in today’s merger and acquisition environment, this strategic move makes tremendous sense for many in our industry.

What often develops over time for owners expanding into the propane business, however, are numerous unanticipated headaches associated with growth.  While operational bumps are to be expected in any new endeavor, the potential financial pitfalls often are not fully understood.  A growing propane business requires cash—lots of it—and over time capital demands can begin to stress the entire organization if measured steps are not taken.  Cash reserves and bank lines of credit which were previously more than adequate to support the base operations of the company slowly but surely become insufficient.  As a result, banking and vendor relationships can become strained.   This is a story we have witnessed on many occasions as financial advisors to the industry.  In fact, it is a scenario that I have seen enough to dub it “hitting the propane wall.”

In a cruel irony, the greatest aspect of a propane distribution business—the dealer’s ownership of the customer tank, and the resulting lucrative “ownership” of the customer—can become a burden for the dealer.  In a sense, propane is more of a financial play for a fuel dealer than delivering heating oil.  Due to the consistent capital outlay what counts the most is return on capital, maintaining liquidity and structuring financing in anticipation of growth, not in reaction to growth.   It requires more complex planning than owners often think.   If you are serious about growing a profitable business, the cost of bobtails, customer tanks and, in some cases, bulk storage facilities will add up quickly.

As has been proven on many occasions, a propane growth strategy based solely on the use of cash generated from operations to fund propane expansion will often lead to problems for all but the most well capitalized fuel dealers.  Since few companies carry the financial strength to accomplish this, it is common for owners to cobble together a temporary solution in an attempt to keep pace with the mounting cash requirements.   Often, dealers utilize precious seasonal line of credit space to come up with the cash to fund the expansion.  This is a fundamental mismatch of long-term assets being purchased with the cash otherwise necessary to cover short-term liabilities.

To be sure, a company with tightened cash availability threatens not only the propane division but the company as a whole.  The weakened liquidity often manifests itself in one or more of the following ways:

• An Inability to clean up a line of credit in the summer
• Existing bank and supplier line(s) of credit are no longer adequate to support peak seasonal operations
• An over-advance on your borrowing base-driven line of credit in the spring and summer months
• Banks are slow to respond to requests for additional funding
• An inability to afford additional tanks to drive the growth required to become profitable

Whether such issues have emerged at your company or not, the best solution for successful growth is devising a comprehensive financing plan in the context of your organization’s overall needs.  This plan may further include revisiting margin and expense targets for one or more of your company’s divisions.  A key determination will be whether or not your company’s debt should be restructured to better match long-term assets with long-term loans and, if so, what level of profitability is required to support a healthy banking relationship.

We often find that a fuel dealer’s existing banking partner may not be comfortable with certain assets associated with the propane delivery business—namely, customer tanks.  Many banks are simply not fond of assets housed on customer sites over a wide geographic region.  However, we have found that some banks and specialized financing partners will work with you, particularly if you frame the request in a well thought out manner.  If you have been unable to locate such specific financing avenues, a deeper financial analysis with your accountant or advisor may be necessary to determine what capital structure will be appropriate to reach your goals.

If grown properly, your propane division may quickly prove to be the most valuable asset you own.  However, there is much for a dealer to consider as you expand.  Don’t allow poor planning to stunt the growth of your new endeavor, or worse, create financial difficulties for your entire organization. 

Angus Finance acts as an advisor on the subjects of budget preparation, capital structuring, the location of financing and banking negotiations.  Jeff Simpson can be reached at 860-299-3358 or jsimpson@angusenergy.com.