(By Mani) PetroLogistics LP (NYSE:PDH) is another way that investors can invest according to their fundamental views on the North American shale gas phenomenon.
The supply of propylene, the company's only product, is limited do the industry's switch to light feedstock for ethylene cracking and away from heavy, crude-oil based feeds.
For many years, propylene sold at a 15-20 percent discount to ethylene, but now sells at a premium to ethylene due to its relative shortage of supply. About 60 percent of propylene is made into polypropylene that until recently had been growing at 5-6 percent per year.
"With prices for PDH's only product, propylene ultimately linked to oil, the continuing strong oil-to-gas price environment in the near-term is supportive of the company's margins," UBS analyst Gregg Goodnight wrote in a note to clients.
Petrologistics' production capacity of 1.45 billion pounds accounts for 5 percent of the US domestic supply of 30.6 billion pounds of chemical grade and polymer grade in 2011. At a theoretical capacity of 44 billion pounds per year, the industry ran significantly under capacity due to lack of coproduct propylene production.
PetroLogistics has the only first-intent, propane dehydrogenation, propylene production unit in North America. The start timing of this unit in late 2010 was coincident with the US shale gas surge that has resulted in oversupply and cheap prices for its raw material, propane. At the same time, propylene prices have been strong and are ultimately tied to crude oil prices through the use of propylene to make gasoline blendstock.
The unfolding North American shale gas story has resulted in exceptionally cheap natural gas prices and a significant pick-up in natural gas liquids production. This has increased inventories and depressed prices for propane, the only significant feedstock for PetroLogistics.
Meanwhile, global oil prices have recently softened $20 per barrel due to macroeconomic concerns and easing geopolitical tensions but are still very strong in a historic context.
"Based on anticipated propylene-to-propane spreads, we believe that PetroLogistics will generate NTM EBITDA of $322 million and provides a distributable cash flow of $236 million, with an anticipated dividend of $1.70," Goodnight noted.
Due to its variable master limited partnership (MLP) structure, PetroLogistics will dividend 100 percent of its distributable cash. The anticipated dividend is expected to generate a yield of 11.6 percent at yesterday's price of $14.61.
"For investors that understand the long-term fundamentals, we believe that there will be favorable entry points for the stock within the context of a strong strategic story," Goodnight added.
Since the IPO on May 12, the stock has been under pressure with falling global oil prices and a temporary inventory correction resulting in contract propylene prices. A dip in propylene prices and stock weakness gives a good buying opportunity.
"However, we believe that longer term, high oil prices and the North American shale gas story supports the company's performance," the analyst added.
The company expects earnings for the full-year ending June 2013 to be $1.99 a share, above UBS forecast of $1.87 a share. For the same 12 month period, the company's EBITDA estimate is $346 million compared to UBS estimate of $322 million.
With one product, one raw material, and one manufacturing facility, the company's offers excellent earnings transparency and investors will be able to take positions that fit their long and short-term views on oil and natural gas prices.