Propane industry consolidators face unique challenges

Consolidation is a healthy natural evolution of any industry’s life cycle due to the economies of scale that are created.

Consolidation establishes the industry’s flagship companies whose larger market share creates a widely recognized brand, improved technology-enabled customer service and the resources needed to develop new markets.

How has consolidation been working for the propane industry? Has the propane market been consolidating into its largest marketers since 2000? As indicated in the report “Consolidation Carousel in the U.S. Propane Industry: A Historical Perspective & Outlook,” the answer is no as measured by the percentage of the industry’s gallons held by the top 10 propane marketers.

Why isn’t the propane industry consolidating after the billions invested? It’s anyone’s research-based conclusion.

However, what is known is any consolidator must overcome the integration challenges below if the benefits of size are to be leveraged into competitive advantage while not losing its acquired customer base:

• Higher cost basis: The acquirer’s cost of tanks, bulk plants, etc., plus the customer list, which are valued at current acquisition prices, must compete against the local competitor’s lower asset costs, which are often at fully depreciated values.
• Employee transition: The employees of the acquired company, an often-overlooked human capital, must adapt from its more local ways of running a business to a more corporate culture with standardized operating practices and more oversight.
• Diverse propane market dynamics: Each geographic propane market is different. Florida, Maine and Illinois, as examples, have different customer demands for propane and service. Competition within and outside the propane industry are different. The consolidating company must market and operate with the flexibility to compete in these different markets rather than fitting them into a one-size-fits-all operating model.
• Shareholder expectations: The owners of consolidators generally have stricter rate-of-return expectations. If it’s a publicly traded company, those expectations for short-term financial results lead to higher margins or expense cuts to meet this year’s earnings guidance. Conversely, family-owned independent companies have more flexible financial return expectations.
• Local management: The consolidator must retain with its new front-line management that sense of ownership and local relationship enjoyed by the owner of the acquired business.

If the acquiring company does not overcome these challenges, customer loss will result. The company must now generate more profit per gallon from the remaining customers through either higher margins or lower expenses to service its debt, pay shareholder dividends, satisfy investor return expectations and invest in capital expenses that grow and maintain the business.

The industry must have consolidators capable of creating the economies of scale benefits for the consolidating company and the industry. Otherwise, customers may switch to the smaller, local independent or to electricity.

Will the propane industry witness vibrant mergers and acquisitions activity in the next 10 years? Absolutely. The U.S. propane industry has attracted some of the best international propane companies that are committed to their “growth through acquisition” strategies. The regional consolidators and private equity firms are investing today with confidence. The financial community will continue to lend and invest in propane’s attractive utility-like, recession-proof risk profile. There will be plenty of family-owned businesses without a succession plan to be consolidated. As history has taught us, many of yesterday’s consolidators, such as Heritage Propane and Inergy, merged into another propane company.

Will the propane industry consolidate over the next 10 years with its top 10 marketers holding a higher percent of the industry’s gallons? This remains to be seen. As the past 20 years has taught us, the national consolidator’s challenge to convert its size into competitive advantage while retaining acquired gallons is not an easy task. The full-service regional propane marketer that is well capitalized, with a culture of customer service and operational excellence, should be well positioned for regional consolidation.

Regardless, we are in for an exciting decade of consolidation in the propane industry.

Randy Doyle is a 40-year industry veteran who serves on the NPGA board of directors and is active in the Virginia Propane Gas Association. He is a past PERC councilor. He consults with Holtzman Propane in Mt. Jackson, Virginia.