Higher steel prices impacting ROI

October 1, 2004 By    

During 2002, the rising world price of steel began to show up in the higher cost of new propane tanks. Domestic tanks are by far the largest asset class in our industry, representing the bulk of the capital expenditures necessary to build or grow a retail propane business. After being relatively flat for many years, domestic propane tank prices have risen 30 to 40 percent in just over two years.

 Carl Hughes
Carl Hughes

Aside from knowing that a new load of tanks will cost you more, have you evaluated the impact that higher capital outlay will have on your return on investment? Have you considered what impact the higher tank prices have on the value of your business?

Let’s look at some basic math to examine just what happens to your ROI when your capital requirement increases.

First, to keep our model simple we will examine the impact of a single 500-gallon above-ground tank. Let’s assume that the tank cost $650 in early 2002 and that today that same tank will cost $900. This $250 increase in capital outlay represents a 38 percent price increase.

Let’s look at comparison returns on these two investment dollars.

In the following chart we assumed that our gross margins, operating expenses, and earnings before interest, income taxes, depreciation or amortization are 60 cents, 35 cents and 25 cents, respectively. Our annual usage is 1,000 gallons. For the purposes of this column will use EBITDA and cash flow as the same thing.

Since both tanks generate the same $250 cash flow, simple math shows that the 38 percent return on the $650 investment in 2002 is a full 10 percent greater than the 28 percent return on the $900 investment in 2004.

If you wanted to keep the same return on investment, how much additional cash flow per gallon would you need?

Did you know that you must add 10 cents per gallon of additional cash flow over your 2002 per-gallon cash flow in order to maintain the same return on your investment? This means that if in 2002 you were generating 25 cents per gallon in cash flow, you must now generate 35 cents per gallon — a 40 percent increase.

Impact on company valuation

Can you assume that the additional capital that you invested in the higher tanks will automatically increase the value of your business?

The answer is no, if the cash flow generated from the investment is the same in 2004 as it was in 2002. Why? Because buyers of retail propane businesses are more interested in the cash flow that is generated off the asset than they are in the cost or the fair market value of the asset itself.

The simple fact remains that unless you increase your cash flow to correspond to the higher investment you need to make, the value of your business will not increase.

Carl Hughes is vice president of business development for Inergy LP. He can be reached at 816-842-8181 or by e-mail at Chughes@InergyServices.com

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