In recent years, long-established heating oil dealers have been jumping into the propane delivery business at a quickening pace, in an effort to diversify their offerings and seek new avenues for profitability. This strategic move makes tremendous sense for many in our industry, 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.
Business owners expanding into the propane business often face 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. Slowly but surely, cash reserves and bank lines of credit that were previously more than adequate to support the base operations of the company become insufficient. This puts a strain on banking and vendor relationships, a situation 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.”
The greatest aspect of a propane distribution business, which is the dealer’s ownership of the customer tank and the resulting lucrative “ownership” of the customer, can become a burden for the dealer. Propane is more of a financial play for a fuel dealer than delivering heating oil. Because of the consistent capital outlay, what’s important is return on capital, maintaining liquidity and structuring financing in anticipation of growth, and not in reaction to growth. This can require more complex planning than owners expect. 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.
Only the most well-capitalized fuel dealers can develop a propane growth strategy based solely on using cash generated from operations to fund their propane expansion without running into problems. This has been proven on many occasions. Few companies carry the financial strength to accomplish this kind of strategy, and 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. Using cash otherwise necessary to cover short-term liabilities to purchase long-term assets is a fundamental mismatch.
A company with tightened cash availability threatens not only the propane division, but the company as a whole as well. 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
- Peak seasonal operations are no longer supported by existing bank and supplier line(s) of credit, which have become inadequate
- 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
The best solution for successful growth is devising a comprehensive financing plan in the context of your organization’s overall needs, even if these issues have not yet emerged at your company. This plan may further include revisiting margin expense targets for one or more of your company’s divisions. Key determinations include whether 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.
Many banks are simply not fond of assets housed on customer sites over a wide geographic region, and thus may not be comfortable with certain assets associated with the propane delivery business — namely, customer tanks. 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, your accountant or advisor may need to provide a deeper financial analysis to determine what capital structure will be appropriate to reach your goals.
A propane division can quickly prove to be the most valuable asset you own, if grown properly. There is much to be considered 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.
About the Author
Jeffrey Simpson is Managing Director of Angus Energy’s Advisory & Finance team and has worked in the fuel distribution industry for seventeen years in operational, banking and financial advisory roles.Angus Advisory & Finance provides advisory services for evaluating strengths and weaknesses, improving financial management practices, supporting banking relationships and also designs/implements growth, risk management and acquisition strategies. The group also provides funded capital solutions through the investment fund, Angus Fund, L.P. Jeff can be reached at 860-299-3358 or firstname.lastname@example.org.