After the green shoots that emerged during 2021 for Martin Midstream Partners (Nasdaq: MMLP), early 2022 saw further improvements as my previous article outlined, which should see its distribution increase. While the third quarter was later affected by An unexpected headwind, fortunately there is nothing structurally wrong, and so investors can just heed this as a timely reminder that the market is both a giver and a taker, as discussed in this follow-up analysis.
Summary of coverage and ratings
As many readers will likely have a short time, the table below provides a brief summary and ratings of the primary criteria assessed. If you’re interested, this Google doc provides information regarding my rating system and more importantly, links to my library of equivalent analyzes that share a comparable approach to improving investment comparability.
Seeing strong cash flow performance during the first quarter of 2022 when doing my previous analysis, hopes were high heading into the second and third quarters. On the surface, it’s hard to tell if those hopes are lost with operating cash flow at negative $16.8 million through the first nine months, which at first seems terrible. Although the previous result was negative one year ago of $12.4 million during the first nine years of 2021, both of which stem from routine seasonal fluctuations in their financial performance, driven by routine working capital movements.
Viewing their operating cash flow on a quarterly basis, their results during the third quarter of 2022 hindered a larger-than-usual working capital build of $33 million. Combined with the working capital build during the second quarter, it comes to $58.1 million, which is a pretty big impact for this small partnership to only last two quarters. Looking back at the second and third quarters of 2021, those two quarters saw combined working capital of $33.3 million, which while still large, wasn’t as extreme as it was more recently during 2022.
If working capital movements are excluded, the second quarter of 2022 saw core operating cash flow at $25.1 million, which is a 100% increase year-over-year over the equivalent prior result of $9.8 million during the second quarter of 2021. Unfortunately , this did not carry over into the third quarter with its core result falling to negative $12.2 million, completely wiping out year-over-year versus the prior equivalent result of $9.8 million during the third quarter of 2021. While the third quarter is notoriously difficult Their seasonal financial performance, and unfortunately, has been particularly poor in 2022 due to various unforeseen market and economic headwinds affecting the Sulfur and NGL business segments, as per commentary from management below.
However, the sulfur and natural gas liquids sectors witnessed fluctuations during the third quarter. In the sulfur segment, both the fertilizer and sulfur groups faced price instability resulting in lower sales volumes of fertilizers. In addition, the pure sulfur business was impacted by unplanned maintenance expenses related to offshore assets deployed to support the business. Finally, within the NGL segment, the butane blending market was negatively impacted due to the sharp drop in prices in September, which led to a significant adjustment in the value of non-cash inventory.”
-Announcement of the third quarter results for Martin Medstree Partners for the year 2022.
This is a reminder that the market is both a giver and a taker, as commodity price movements, like many economic conditions, are beyond management’s control. Ideally, over time, these should be skillfully managed accordingly but realistically, no one is perfect, and as such, unit owners have to take the good with the bad. Following these unexpected headwinds, they have now revised their guidance for the fourth quarter of 2022 lower, along with their guidance for the full year, per comment from management below.
Despite the unpredictability of markets and the factors affecting them at this time, the partnership has been able to improve our financial results year after year. However, with commodity prices still moving erratically on the risk of a global recession and fears of weak oil demand, we are revising our revised EBITDA guidance for the fourth quarter to between $19 and $24 million, resulting in a range of $116 to $121 million in full 2022.”
-Announcement of the third quarter results for Martin Medstree Partners for the year 2022 (formerly linked).
While lower guidance isn’t a positive thing, the new range for 2022 is still higher than the previous result of $114.5 million through 2021. As such, in the grand scheme, these recent headwinds aren’t particularly big of a problem and don’t reflect structural problems. , in particular as the rest of their business segments performed strongly during the third quarter of 2022. Up to this point, Warehousing and Storage saw operating income increase year-over-year to $5.6 million from $4.3 million, while Transportation saw a larger increase. An increase to $12.1 million from $3.9 million across those two time points.
After initially seeing their net debt decrease in the first quarter of 2022 to $483.1 million from $499.1 million at the end of 2021, building working capital during the second and third quarters has now seen it rise at $543.2 million. Although this is not necessarily ideal, if not for this routine seasonal event their net debt would otherwise have been broadly constant and therefore should not be seen as a cause for concern as such accumulations should be reflected in future drawdowns.
Moving on to leverage, it’s not surprising that net debt to EBITDA and net debt to operating cash flow rose after the second and third quarters of 2022 on the back of their higher net debt. These two indicators now sit at 5.24 and 10.61 respectively, up from previous results of 3.02 and 4.75 after the first quarter. Although this change seems extreme and now sees both above the 5.01 threshold for very high territory, given its seasonal financial performance, it would be wise to wait until Q4 results before making any assurances.
More importantly, they continue to make progress in reducing the adjusted leverage ratio that is set by their credit facilities and driving working capital movements within their seasonal financial performance. Under the terms of their credit facility, it contains a covenant whereby they cannot declare quarterly dividends above the current paltry rate of $0.005 per unit, unless the adjusted leverage ratio is less than 3.75, as discussed in detail in my previous analysis. It’s very interesting that their most recent score of 3.63 is now below that limit already, albeit by a small margin, according to comment from management below.
Our adjusted bankable leverage ratio at the end of the third quarter was 3.63x, which includes a supplemental debt withholding for working capital in connection with the build of our seasonal NGL inventory. The actual increase in debt attributable to NGL inventory was approximately $95 million, while the maximum debt allowable during the quarter was $50 million.”
Martin Midstream Partners Conference Call for the Third Quarter of 2022.
While management has clearly not yet increased its dividend nor discussed the process publicly, it should only be a matter of time now, thus putting it on the radar in 2023. My guess is that they will wait until the adjusted leverage ratio drops, probably around 3.25 to provide a margin of safety. In the event that market events outside their control affect their financial performance again. Especially since they also face a major debt refinancing on the horizon in 2023 which is a top priority, as discussed later.
Aside from creating room for distribution growth, driving the adjusted leverage ratio lower also helps boost debt serviceability, which is becoming an increasingly important consideration with rapidly rising interest rates. This is especially useful because as things stand right now, their interest coverage is risky at just 0.89 when compared to EBIT on an accrual basis, while negative operating cash flow makes any cash-based comparison pointless. Their credit facility, which comprises about a third of their total debt, sees the interest rate vary not only on the SOFR level but also on the adjusted leverage ratio.
The lower the adjusted leverage ratio, the lower the fixed component of the interest rate on credit facility debt. While this alone doesn’t necessarily make or break their partnership, it nonetheless creates another impetus to push the adjusted leverage ratio lower, thus helping to quickly combat the effects of tightening monetary policy.
After the second and third quarters of 2022, liquidity witnessed a decrease in its current ratio to 0.75 after ending the first quarter at 1.68. While still appropriate, this change stems from their existing liabilities now including $200.7 million in debt maturities related to their credit facilities, which fortunately they have already begun the process of refinancing, per comment from management below.
“The credit facility loans are shown as current on our balance sheet on September 30 since the facility matures on August 31, 2023. We are in the process of amending and extending the credit facility and believe we will be successful in this endeavour.”
Martin Midstream Partners Conference Call for the Third Quarter of 2022 (formerly linked).
Since they have until August 2023 to process that debt maturity, they should have plenty of time, but even so, that’s still another hurdle preventing management from pushing its dividend higher for the time being, despite advances in the adjusted leverage ratio. Once completed, they don’t see at least a relatively minor maturity of $53.8 million through February 2024, making it an easy year before having to deal with their much larger debt maturity of $292 million in February 2025.
I suspect that refinancing their credit facility will be catalyst to see distribution growth or if not, at least see Discussion come back on a broad schedule because their adjusted leverage ratio now is below the covenant limit imposed by said credit facility. While the market has created headwinds recently, there is nothing structurally wrong with their partnership and investors should remember that the market is both a giver and a taker, and as a result, I think maintaining my Strong Buy rating is appropriate.
Notes: Unless otherwise stated, all figures in this article have been taken from Martin Midstream Partners’ SEC filingsAll figures calculated were performed by the author.