2016 was supposed to be a great year for Sunoco LP (SUN 2.95%). The company completed a multi-billion dollar acquisition from its parent company and it also made some other acquisitions that were supposed to fuel growth. Despite these things, though, operational and earnings results didn't quite meet those expectations and, as a result, it is now looking to be in over its head with too much cash going out the door and too much debt weighing down the balance sheet.
On the company's most recent conference call, management acknowledged these issues and showed its path forward... sort of. Here's a selection of quotes from the company's most recent conference call that explain how management plans to dig itself out of this financial hole.
Poor payout coverage
This past quarter, Sunoco suffered some pretty bad results. On top of the huge swing into the loss column from a large goodwill impairment, the company's cash flow eroded significantly because of adjustments to inventory as well as a large increase in interest expenses. As a result, the company's ability to support its payout to shareholders with cash from operations completely disappeared. CEO Bob Owens tried to reassure investors that this is temporary and not the end of the world:
Our distribution for the fourth quarter remains unchanged from the third quarter at $0.8255 per unit. This distribution was a 3% increase from the fourth quarter of 2015 and resulted in a 0.61 times coverage ratio for the fourth quarter and a 0.98 times coverage ratio on a trailing 12-month basis. While sub 1 coverage is not something we want to manage to over the long term, we're comfortable keeping our coverage below 1 for short periods of time. The fourth and first quarters are seasonally our weakest quarters, during which we expect some downward pressure on the ratio. Further weak margins can effective this metric in any given quarter. We will manage to a 1 to a 1.1 times ratio over the long term.
Perhaps some of those things about seasonality are correct, but that doesn't change that the company is falling well short of its cash needs. Coming up that short on cash payouts can't last for long no matter how you slice it.
On top of not meeting payout expenses, CFO Tom Miller explained that the company is also seeing some of its key debt metrics erode even further:
For the fourth quarter we reported a leverage ratio of 6.5 times, up from the revised third quarter number of 6.18 times. The drivers were a fourth quarter increase in debt of approximately $40 million to fund growth capital and the Denny acquisition, partially offset by ATM proceeds and $35 million lower year-over-year EBITDA.
This has become such an issue that the company's creditors have stepped in and forced the company into a debt reduction program. By 2019, the company needs to have its leverage ratio down to below 5.5 times. That's a pretty generous target.
Fixing the problem
So a part of that debt reduction program is starting to take hold. Miller highlighted some of the steps the company will take in the coming months to improve its operational and financial results.
A Companywide focus on expense reduction, both G&A and operating expense. We have targeted $75 million in 2017. Continue to utilize our $400 million ATM program. Third, drive additional EBITDA from our 100-plus new to industry sites open since 2014 and our recent acquisitions. Fourth, use our real estate auction proceeds for debt repayment. Five, cut down -- cut 2017 growth capital growth expenditures by nearly half from where it has been in prior years. And six, reduce maintenance capital to a level lower than our current 2017 estimate of $90 million. These initiatives combined with the elimination of relocation expense will help reduce leverage and increase our coverage ratio. On a collective basis they still do not get us our long term goal.
So there is a two pronged approach to this. By improving operational performance, it can boost EBITDA to lower its leverage ratio. Or, it can pay down debt with that at-the-market (ATM) equity issuance program as well as selling off some locations, which should net them at least a couple hundred million.
But not ready to talk about it
Aside from those steps highlighted above, Miller was pretty clear that it is exploring other options. The kind of options you can't disclose on a conference call.
Let's be clear, leverage and coverage have management's full attention and focus. We will consider and evaluate all options, nothing is off the table. That said, we're not in a position to announce anything at this time, nor will we comment further during the Q&A. We hope to be able to come back to you with a path forward soon.
Comments like this are typically a pretty veiled way of saying that a payout cut is very much on the table. While management, shareholders, and Sunoco's parent company Energy Transfer Partners (NYSE: ETP) certainly don't want to have this happen, it really does look like an option that needs to be explored if Sunoco wants to get back on the right track.
A little help
For the most part, any questions about potential next steps were stonewalled by management during the Q&A section of the call, but the company did open up a bit when asked if parent Energy Transfer Partners could step in and provide some relief through things like foregoing incentive distortion rights for a few quarters to save cash. Based on what Miller said, it's a possibility, but we're still a ways away from that.
Our conversations with Energy Transfer continue to be positive and supportive. We're working our way through all the changes I described with -- in terms of Ben's question previously. We have lots of options on the table that we're looking at from a self-help standpoint and unfortunately we're not in a position to give any additional color on that. But I think that's what was referred to by [Energy Transfer Partners CEO] Kelcy [Warren]'s comment.
Just for perspective, here was the comment from the Energy Transfer Partners conference call regarding its support of Sunoco:
Sun's got to run its business first. I mean, we -- the businesses need to operate at the best they're capable of and the most efficient that they can be ran, and then, then you go and you look for [incentive distribution rights] really for support. I'm not convinced that I'm seeing that right now, so -- but that's not -- I'm not trying to be critical of a management team or staff, I'm just saying let's get them the fundamentals, let's run the business correctly, let's rationalize our cost and be -- compare well against our peers, so -- but we would look at either one of those things at the appropriate time.
That aren't exactly the most encouraging words you want to hear from the parent company, especially when Sunoco could use some help now with managing its cash inflows and outflows. It's also sounds rather damning to Sunoco's management. Perhaps all it takes is for Sunoco to get better about efficient operations to turn things around, but without help from the parent company it is going to take much longer to accomplish.