Sunoco (SUN) Q1 2022 Earnings Call Transcript

Sunoco (SUN -0.16%)
Q1 2022 Earnings Call
May 04, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to Sunoco LP's first quarter 2022 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Scott Grischow, vice president of investor relations. Thank you, Scott.

You may begin.

Scott Grischow -- Vice President, Investor Relations

Thank you, and good morning, everyone. On the call with me this morning are Joe Kim, Sunoco LP's president and chief executive officer; Karl Fails, chief operations officer; Dylan Bramhall, chief financial officer; and other members of the management team. Today's call will contain forward-looking statements that are subject to various risks and uncertainties. These statements include expectations and assumptions regarding the partnership's future operations and financial performance, including expectations and assumptions related to the impact of the COVID-19 pandemic.

Actual results could differ materially, and the partnership undertakes no obligation to update these statements based on subsequent events. Please refer to our earnings release as well as our filings with the SEC for list of these factors. During today's call, we will also discussed our non-GAAP financial measures, including adjusted EBITDA and distributable cash flow as adjusted. Please refer to the Sunoco LP website for reconciliation of each financial measure.

I will now turn the call over to Dylan to discuss first quarter results, and our outlook for the remainder of 2022.

Dylan Bramhall -- Chief Financial Officer

Thanks, Scott. Before I walk through our first quarter results and accomplishments, I'd like to start by thanking our employees for their efforts in delivering excellent financial results this quarter against one of the most difficult macro backdrops in recent history. The team did an outstanding job of executing on our strategies in the face of a rapid increase in oil and gas prices, which resulted in the partnership reporting one of the strongest first quarters on record. Moving on to M&A.

We closed on our third acquisition in the past six months with the addition of the Gladieux Energy assets to the Sunoco portfolio on March 31, 2022. This acquisition demonstrates our continued commitment to expand our midstream asset base with low risk, solid return capital deployment. As a reminder, we expect a sub seven times EBITDA multiple on this investment, which combined with our ability to finance with a mix of low cost revolver borrowing and cash from operations, results in very strong accretion to our unit holders. Regarding guidance, the 2022 adjusted EBITDA of between $770 million and $810 million provided in early December excluded the impact of the Gladieux Energy acquisition, and we remain confident in that range for the legacy Sunoco business.

We are adding $25 million to this range to reflect the acquisition, which results in updated guidance of $795 million to $835 million. Now shifting over to our first quarter 2022 results. The partnership recorded net income of $216 million. Adjusted EBITDA was $191 million, compared to $157 million in the first quarter of 2021.

Volumes were approximately 1.8 billion gallons, an increase of 1% versus the first quarter of 2021. The margin was $12.4 per gallon versus $10.3 per gallon in the first quarter of 2021. Fuel margin results include the benefit of the 7-Eleven make up payment of $13 million. Total operating expenses in the first quarter were $124 million, up from $100 million in Q1 of last year, essentially flat to Q4.

This increase was primarily driven by the NuStar terminal acquisitions and some additional costs that we reinstituted over 2021 that had been temporarily cut during the onset of the COVID pandemic. First quarter distributable cash flow as adjusted was $142 million, yielding a current quarter coverage ratio of 1.63 times, and a trailing 12 months coverage ratio of 1.66 times. On April 26, we declared an $82.55 per unit distribution consistent with last quarter. We continue to maintain a stable and secure distribution for our unit holders, which remains the number one pillar behind our capital allocation strategy.

Leverage at the end of the quarter was 4.35 times, which includes a significant increase in working capital associated with higher commodity prices for our fuel inventory. We expect leverage to trend down toward our target throughout the year, and could see an acceleration of this deleveraging if commodity prices declined from current levels. In early April, we closed on an amended and restated $1.5 billion credit facility. The maturity date was extended out five years to April 2027, and substantially similar terms as the previous facility.

First quarter strong results, the recently closed acquisitions, and the successful extension of our revolving credit facility demonstrate our commitment to maintaining Sunoco's solid financial foundation and to increase value to our stakeholders through a strategy of disciplined capital investment, and balance sheet management. With that, I'll now turn the call over to Karl to walk through some additional thoughts on the first quarter performance and recent growth initiatives. Karl?

Karl Fails -- Chief Operations Officer

Thanks, Dylan. Good morning, everyone. We delivered another strong quarter supported by continued strength in margins and expense discipline. As Dylan mentioned, commodity prices in the first quarter were highly volatile.

In addition, the dramatic rise in prices created significant headwinds for the first quarter. Put it in perspective, both gasoline and diesel futures reached all time highs during the quarter, and hovered around prices not seen since 2008. From beginning to end, gasoline futures were up $0.96 a gallon and diesel futures were up $100.36 a gallon. Despite these challenging market conditions, the first quarter again showed the resiliency of our business model.

Volumes for the quarter were up about 1% versus first quarter of last year. As I mentioned in our last earnings call, there was some Omicron related weakness in January, with volumes returning in February. We saw some volume weakness in March, but are starting to see early signs of seasonal pickup in demand in April. Looking at margins.

In the first quarter, we delivered strong margins of $12.4 per gallon, even in the face of the record price increases across the quarter that I already shared. There are a few key contributing factors worth mentioning. The first is the 7-Eleven make up payment that occurs annually in the first quarter. Second, industry breakeven margins continue to stay elevated, especially in the face of rising inflation.

Finally, our gross profit optimization strategy continues to be part of our day to day business, which particularly helps us in volatile market conditions. A few years ago, we introduced the hypothesis that our business model exhibited asymmetric risk to market movements. While we are not immune to market dynamics, this quarter continues to show that our optimization strategies are able to counteract some of the effects of challenging market conditions like rising prices. And then when the market provides favorable conditions with falling prices, we are able to capitalize and deliver to the upside.

I also want to add a few thoughts on expenses. As we have discussed many times. Efficient operation and expense control is part of our DNA. This year we face headwinds on expenses, with the impact of higher fuel prices and overall inflation.

Much of this impact was contemplated in our guidance given in December, some was not. The most important thing to keep in mind is that higher costs are generally passed through and contribute to higher breakeven margins. As we use our size and scale to remain efficient, this can even be an advantage for us relative to other players in our space. Moving on to Brownsville.

We're excited to share that our terminals operational and commercial sales commenced in late March. There will be a natural ramp in operations over the next 24 months or so. We're excited to bring this organically developed asset into service with our strong domestic demand, as well as the export opportunities from this strategic location. We were also pleased with the closing of our Gladieux acquisition at the end of the quarter.

The integration is going well, and although we are early in the process, the business is performing as expected. This is another meaningful expansion to our midstream portfolio. As a reminder, the acquired assets consist primarily of the largest transmix processing facility in North America, located in Huntington, Indiana, as well as the associated refined product terminal. We also acquired a long-term operating lease in which we will operate Buckeye Partners' Indianola transmix facility outside of Pittsburgh.

As with all our midstream acquisitions, while we like the stand-alone business, we are most excited about the combination of these assets with our fuel distribution portfolio, and are looking forward to growing our presence in the Indiana market. Before turning over to Joe, I will reiterate the strength of our underlying business. We are off to a strong start to the year and we'll continue to focus on delivering results for our stakeholders' through our proven recipe of gross profit optimization, tight expense control, solid efficient operations, and growing our core business. Joe?

Joe Kim -- President and Chief Executive Officer

Thanks, Karl. Good morning, everyone. We delivered a strong first quarter. Dylan and Karl have walked you through the key details.

However, there are a few items I would like to further highlight. On the volume side, every quarter presents a unique set of challenges, but this quarter had more than most. The volume recovery that we saw last year subsided at the beginning of the quarter due to a massive increase in COVID cases. As cases start to go down and volume started to recover, a rapid and material increase in fuel prices became evident at every street corner.

The short and long-term impact of higher prices is still to be determined. The pace of continued volume recovery will center around a few key questions; First, how long were higher prices remain?; Second, how is the overall economy performing?; And finally, how many more workers will return to a more traditional pre-COVID commuter schedule? Even with all these questions, we do expect fuel volume to increase as the year progresses as a result, the typical seasonality, and we expect margins to remain healthy given higher industry breakevens. The key to Sunoco's earning power has been our ability to optimize fuel gross profit and control costs. This has allowed us to minimize the downside, and also allow us to capture the upside when the commodity market supports it.

Quarter after quarter, we have proven the durability of our business and looking forward, we expect 2022 to be another strong year. Moving on to growth. We continue to strengthen our business by growing our midstream assets. With the addition of Gladieux and the start-up of the Brownsville terminal, we continue to vertically integrate and provide a more enhanced platform for fuel distribution growth.

We'll continue to look for attractively valued midstream assets with material synergy opportunities. On the field distribution side, we'll continue to grow organically and also look for attractively valued acquisition opportunities. Let me close by stating that our current and future growth plans will build on our history of maintaining financial discipline, which means, protecting the security of our distribution while also protecting our balance sheet. Operator, that concludes our prepared remarks.

You may open the line for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Theresa Chen with Barclays. Please proceed with your question.

Theresa Chen -- Barclays Capital -- Analyst

Good morning, and thank you for taking my questions. I first want to ask about the near-term margin outlook. Understandably, you had very strong results in the first quarter, despite the unrelenting upward move in wholesale gasoline prices for most of the quarter. Now that we move into second quarter and that pattern seems to -- the pattern seems to be more normalized with volatility from increases and decreases depending on the day.

Would you expect the margin to be better than first quarter? Or how should we think about that?

Karl Fails -- Chief Operations Officer

Hi, Theresa. Good morning. This is Karl. I mentioned in my prepared remarks a few different factors that really contributed to our first quarter margin.

And -- so first is the 7-Eleven makeup payment. Second is really the our base gross profit optimization strategy that's really across the whole fuel supply chain. And really, as we've talked about before volatility, really, our size and scale help us take advantage of that volatility, and that's generally constructive. And then, the third is the the higher breakeven margins.

As we look forward into the year, I think some of those pieces are still relevant and some of them maybe not so much. We're not going to have a benefit of a makeup payment from 7-Eleven in the second or third quarter. I think the trend on the breakeven margin is going to continue with inflation and other factors. And then the gross profit optimization and volatility is, as you've said, I mean, it's going to be hard to mimic the volatility that we saw in March.

But April was had its own volatility, and we're starting May with some movements. So, my crystal ball isn't perfect in terms of what the market conditions are going to be. But I think our system and our ability to take advantage of that is going to going to remain. So, which of those outweighs the other in terms of where the margin is, I'm not sure.

But those factors in our ability to take advantage of them is it's how we look at it through the year. And as we've talked before, margins are these things that we have guided to on an annual basis. They'll be some quarters that are stronger than others. But we think overall, strength of our business will -- weigh out.

Theresa Chen -- Barclays Capital -- Analyst

Got it. And I'm sorry if I missed this, but what would the cent per gallon have been without the 7-Eleven payment in first quarter?

Karl Fails -- Chief Operations Officer

I don't have the math. I don't know, Scott, if you have it. I think it's probably around 70 points --?

Theresa Chen -- Barclays Capital -- Analyst

Got it. Thank you. And just looking at the volume side of things. Clearly, the demand picture has remained resilient absence the impact of COVID per Joe's prepared comments.

But going forward, as we're seeing the escalation in gasoline prices, are you seeing any softening as far as a demand response to higher prices? And when do you think we'll reach that inflection point of demand elasticity? And then similarly, are you seeing any substitution among the octane curve [Inaudible] results?

Joe Kim -- President and Chief Executive Officer

Hi, Theresa. This is Joe. As far as -- let me answer the second question first. It's only been roughly about probably about 30 days or so.

So it's still a pretty short period of time whenever since -- when March prices started hitting record gasoline prices. So I'll probably try to give you some insight by looking backwards and then put in a crystal ball. Probably look back at history and see if that's applicable on a going forward basis. So if you think back to 2008, gas prices were roughly sitting somewhere between $3.50 and $4.

And when that happened, we saw demand destruction happen whenever prices hit that $4 mark back in -- 2008. And during that time period, what we did see, we saw some volume go down and we saw people trading down from premium down to -- down to a regular unleaded. So I think if you use that as a kind of a point in time, I think it has some potential applicability going forward. One of the things to keep in mind about the 2008 prices sitting somewhere around $4 and above.

If you inflation adjust that, that's more like a 525 price in today's environment. And the one other factor you got to, I think about is, if you think about inflation, and you also think about the efficiency of cars have improved since 2008. If you look at it kind of a 20-year average of dollars per miles driven for an average American, we're sitting somewhere in the midpoint of that average. The other big factor and I alluded to it in my prepared remarks, is the economy matters.

In 2008, we saw high prices coupled with the recession. And the recession and combination of $4 plus gasoline and recession is what really had really had volume going down. So as I said in my prepared remarks, it's early. So the effects of high prices, the economy and I think the commuter schedule is also an important element.

All those are playing out. But with all that said, I do believe that our volume is going to increase throughout the year. If you look at our most recent numbers, somewhere around mid-April through today, we have seen a volume increase that started happening around this time. So those are some encouraging signs.

Theresa Chen -- Barclays Capital -- Analyst

Thank you for the thorough answer.

Operator

Thank you. Our next question comes from Spiro Dounis with Credit Suisse. Please proceed with your question.

Spiro Dounis -- Credit Suisse -- Analyst

Thanks, operator. Morning, guys. First question is on M&A, actually. Just thinking about funding future deals for the rest of the year.

If we look at your liquidity, I think you guys are fine, there no issues. But leverage has been ticking up after these last few deals. And Dylan, I know you mentioned sort of a natural path to delevering as the year goes on. But just curious, is your expectation that you would prefer to delever first before getting more active again? Or is that not necessarily a gating item yet?

Dylan Bramhall -- Chief Financial Officer

Yeah. I think it's more the latter at this point. I'll never take anything off the table. I would say, you're absolutely right.

In prepared remarks, I mentioned that we expect some deleveraging through the year. I think, if you look at our -- look at the guidance and then, with depending on what happens with commodity prices, that could be a bit of a tailwind as well. And then, we expect to probably lower inventory levels a little bit from where they are today. So, all that going to lead to lower leverage.

I will say that right now, when we look out at M&A, we're probably going to be a little bit more critical in our analysis and a little more selective there. But for the right deal, I don't think where we're at -- from a leverage standpoint or liquidity standpoint would keep us out of the market.

Spiro Dounis -- Credit Suisse -- Analyst

Got it. OK. That's [Inaudible], Dylan. Second question, just looking for an update on J.C.

Nolan and how that's running. Sounds like demands has been moving higher in that basin, but we're also seeing more competition to move fuel there as well. So just curious how you're thinking about the performance of that pipeline and the competitive dynamics going forward?

Dylan Bramhall -- Chief Financial Officer

Yes, Spiro. I've talked about before how our West Texas business and our diesel demand has lagged the recovery in the rest of the country. And I'd say, in the last 3 to 4 months, there's been some catching up out there, as you'd expect, with these higher oil prices, activity in drilling and fracking has increased, and we've seen that in the pipeline volumes. So I wouldn't say we're quite back to where the pipeline was in the first.

If you remember, that pipeline started up at the end of 2019, and it was just ramping up in the first quarter and kind of in full operation the first quarter 2020, and then the COVID demand impact occurred. We're not quite back to those volumes, but we've had a few days and weeks back to those volumes. So it's been promising.

Spiro Dounis -- Credit Suisse -- Analyst

Helpful colors, always. Thanks for the time, guys.

Operator

Thank you. Our next question comes from Gabe Moreen with Mizuho. Please proceed with your question.

Gabe Moreen -- Mizuho Securities --Analyst

Hey, good morning, everyone. I know this didn't really have much of a bottom line impact, but just curious what sort of the income tax stuff flowing through the DCF line was? Seems like it was related to a prior transaction?

Dylan Bramhall -- Chief Financial Officer

Yeah. This is Dylan. Absolutely, it's related to the 2018 return that included the divestiture of the retail assets to 7-Eleven. So in the first quarter, we filed an amended federal and state income tax returns related to that 2018.

And with this updated returns, we've had some increase in tax basis that resulted in about a $40 million refund. And so, what you're looking at there on the distribution -- on the DCF reconciliation is that, that refund, that cash tax refund. But since that related to the M&A transaction, that's where you see that line item that you don't normally see where it backs -- that back out. So we're not taking credit for that in DCF.

The only other place we see that showing up is on the balance sheet, that's part of the increase there in the current asset line as well, as we have a -- we have a receivable on that. We'll expect to receive that cash in later this year.

Gabe Moreen -- Mizuho Securities --Analyst

Got it. Thank you. And then maybe if I could just ask one broader question on industry breakevens, and also just related to that. Karl mentioned their costs -- are increasing throughout some you anticipated, some of you didn't.

Can you talk about what you did and didn't anticipate and we're seeing? Some unexpected pressure, whether it's pass through or not? And then I assume, look, relative to smaller wholesalers. Sunoco clearly has cheaper cost of capital. But I'm just wondering if you're seeing you think there's pressure on others with these high commodity prices and if that -- there's a potential to raise industry breakevens as a result if gasoline stays where its currently are?

Karl Fails -- Chief Operations Officer

Yeah, Gabe. I'll give you an example of some of the cost pressures that we anticipated, things like wage increases and or increase in some of our service partners. I mean, we'd baked that into our assumptions, and we haven't seen anything there. That's -- that we did not anticipate.

An area of cost that we didn't necessarily have baked into our original guidance would be credit card fees. So obviously, we pay for credit cards to be processed. Some of that is passed through with our customers, our wholesale customers. But we pay that for the 70 to 80 sites that we company operate, right, on the New Jersey Turnpike and in Hawaii, we pay those fees.

Now, those are generally going to be covered in margins, but those are often based on the absolute price of the fuel since it's a percentage fee. And so we didn't necessarily anticipate that we were going to have the retail prices that we have this year. All things being equal, we prefer that prices be lower than they currently are. So that's an example of an expense that we didn't anticipate in our guidance.

but that will be pass through and that impacts higher break even margins. And then building on to your second question, yes, we think our size and this is another example of our size and scale that where it benefits us is, we are able to with -- withstand inflationary pressures or periods like this where capital gets tight, the working capital requirements based on the higher prices are higher, and we're able to withstand that, where maybe some smaller competitors in the marketplace struggle with that, and that will put upward pressure on the break even margins.

Gabe Moreen -- Mizuho Securities --Analyst

Thanks, Karl.

Operator

[Operator instructions] Our next question comes from John Royall with J.P. Morgan. Please proceed with your question.

John Royall -- J.P. Morgan -- Analyst

Hey. Good morning, guys. Thanks for taking my question. So just back on the opex, just looking at your guidance.

Once you will think about a quarter of the high end of the guidance range, and I know there's a variable component with volumes moving up throughout the year. And then, you've also got this acquisition that you bumped up EBITDA guidance that you didn't move the opex, and as well as the pressures you're talking about. So am I interpreting this correctly that maybe that opex guidance is biased upwards, but it could be offset elsewhere with the margin? Is that what the message is? Because, I know you didn't move the guidance number for anything but EBITDA, just want to make sure I understood that?

Dylan Bramhall -- Chief Financial Officer

Yeah. So -- you're right. We do -- we did not move any -- we did not, we only updated the EBITDA guidance. And so, the opex guidance is now stale.

That said, I think as we look at it, obviously there's going to be some opex related to Gladieux. I think, pointed to some of the seasonality I think, some of the seasonality that we see in opex, we've taken out of the business a little bit. We've done some things to just smooth out some things with some changes in how we accrue for items so that we don't get some of the lumpiness there. And then the last one I touch on really is what you hit there.

You noted is that, some of it's more of a pass through to margin and things like credit card, which Karl talked about there. And so from -- we -- put that all together and like we're not updating guidance. But I think that should -- that hopefully gives you a little bit of clarity and how we're looking at opex going forward.

John Royall -- J.P. Morgan -- Analyst

Yep. Yep. Understood. Thank you.

And then just one on the 7-Eleven make up payment of -- your payment this year, I think was smaller than last year. So volumes, we've got volumes headed in the right direction. And I think we all hope that continues that way. So I guess the question is, and I know you won't get too granular here because it has to do with the contract, but just try to think through how much growth we would need to see from here for that contract to not be under water anymore and not be thinking about these these payments anymore.

Are we sort of getting close there? Or are we still have a little bit to dig out?

Karl Fails -- Chief Operations Officer

Yeah. Here's how I think about it. And you already touched on it. I probably -- I'm not going to give you a clear answer, and here's why.

It's really at 7-Eleven discretion and choice on how they manage that over our relationship with 7-Eleven remains as good as it's ever been, and that they're a great partner and we really like the contract. But one of the things we got out of that contract is a guaranteed gross profit on an annual basis. And one of the things they got out of the contract is some flexibility to manage that volume the way that it makes sense for them and their business. And so, some of that makeup payment is really driven by the choices that they're making.

I wouldn't necessarily give it as a read through on industrywide volumes. So, I would expect we're going to be in a similar to slightly smaller range. But again, I don't want to take any of the flexibility or give too much guidance on what 7-Eleven plans are.

John Royall -- J.P. Morgan -- Analyst

Understood. If you don't mind if I could just sneak a third one in there. You guys are just such a huge player in gasoline. I just wanted to get your view on the waiver of the E15 summertime ban.

Do you expect that to be have any real impact on your business? Or is that just maybe not as impactful as politicians may want to think it is?

Karl Fails -- Chief Operations Officer

Yeah. E15 is a product that is going to continue to grow in demand, but it's starting from a really low base. If you dissect the 1 pound waiver, it's really only available in conventional gasoline market. So that already says that, that limits it to a certain geography.

And then I think there have been some retailers and wholesalers that have offered E15 with some success and there are others who have have offer it and it hasn't really taken off as much. And then the other thing with today's prices, one of the things that E15 that makes it interesting is that, even when you adjust for the lower BTU content, it's still a cheaper fuel, which in today's market is -- makes it more attractive. But we still haven't seen a huge demand pickup for that. And then from our perspective, it's not clear whether the margins on that are going to be any better or maybe even worse than the E10.

So that's how we're looking at it from our view is, is even though it's a pretty small base, we're looking at ways that we can sell and offer more E15 for our customers. And as that demand picks up, that'll become a bigger part of what we sell. It's just not material right now.

John Royall -- J.P. Morgan -- Analyst

Thank you, guys.

Operator

Thank you. Our next question comes from Ned Baramov with Wells Fargo. Please proceed with your question.

Ned Baramov -- Wells Fargo Securities -- Analyst

Hi. Good morning. Thanks for taking the question. You reaffirmed growth capex guidance for 2022, and this is after a fairly light Q1 spending budget.

So maybe, -- if you could just talk about the cadence of capex for the remainder of the year and over some of the larger items that could bring capex above the $150 million threshold. Thanks.

Karl Fails -- Chief Operations Officer

Yeah, Ned, I'd say, I wouldn't read through anything in particular. Q1 is traditionally been a lighter capital quarter for us for a multitude of reasons. And we still are comfortable with the $50 million maintenance than $150 million of growth capital. If you look at the larger projects, I mean, we're finishing up the back half of the Brownsville project is a component of that growth capex.

And then the vast majority of the rest of the growth is on assigning a new fuel distribution customers.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Scott Grischow for any closing comments.

Scott Grischow -- Vice President, Investor Relations

Well, thanks, everyone for joining us on the call this morning. As always, feel free to reach out to me with a follow up question. We'll see everyone soon.

Operator

[Operator signoff]

Duration: 37 minutes

Call participants:

Scott Grischow -- Vice President, Investor Relations

Dylan Bramhall -- Chief Financial Officer

Karl Fails -- Chief Operations Officer

Joe Kim -- President and Chief Executive Officer

Theresa Chen -- Barclays Capital -- Analyst

Spiro Dounis -- Credit Suisse -- Analyst

Gabe Moreen -- Mizuho Securities --Analyst

John Royall -- J.P. Morgan -- Analyst

Ned Baramov -- Wells Fargo Securities -- Analyst

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