Sunoco LP's (NYSE:SUN) stock is yielding around 10%. That's an enticing figure for income investors. However, there are a lot of moving parts at this gasoline-focused limited partnership today. Before you buy high-yielding Sunoco LP, you need to understand just how different a partnership it will be in a few months.
Now and later
Today Sunoco's business is split between two main operations. On the wholesale side, it delivers gasoline to nearly 8,000 gas stations across 30 or so states. This business is largely built on long-term supply agreements, though it does make spot sales as well. The other side of the partnership owns and operates gas stations and their associated convenience stores. Wholesale made up around 28% of 2016 profits, retail gas sales 28%, convenience store sales 32%, and "other" the rest.
That's set to change very soon, because Sunoco has agreed to sell most of its retail locations to 7-Eleven. The deal is expected to close by the end of 2017. Sunoco will keep around 200 locations in the Texas area that are earmarked for future sale and 54 locations in Hawaii that it plans to keep for now. Sunoco will receive $3.3 billion in cash, plus a payment for inventory and gasoline at the stores, from 7-Eleven and a long-term supply agreement. Once this deal is done, Sunoco will have largely transformed itself into a pure gasoline distributor.
The supply agreement Sunoco is getting from 7-Eleven means it isn't losing the 28% of profits from retail motor fuel sales at the stations being sold, because they will now be wholesale gallons. Jettisoning the convenience stores, meanwhile, should make Sunoco's business more predictable over time, since retail sales are inherently volatile. You may need to keep buying gas in an economic downturn, but you certainly don't need to keep buying overpriced sodas and hot dogs.
The problem in all of this is that convenience-store sales made up roughly a third of the partnership's profits last year, and that's a big hole to fill. The current plan is to use a portion of the $3.3 billion sales price to pay down debt. The partnership's debt-to-EBITDA ratio has been hovering around 6 for the past year or so, a high number for a partnership, and the goal is to get that metric down to around 4.5, a far more reasonable number. Sunoco is also expecting to reduce its operating costs, since it will no longer be running those gas stations.
Lower interest expense and reduced costs should help make up for the loss of the convenience-store profits, but I'm not convinced it will be enough to fill the entire hole. Based on the partnership's 10%-plus yield, it looks as if most investors are concerned as well. Note, too, that Sunoco intends to keep expanding its business through acquisition. So it will have to balance debt reduction against its long-term growth goals, and continue to support its distribution. That's a lot of moving parts, and the partnership only covered its distribution by 1.03 times over the 12 months through June. That doesn't leave much breathing room.
And there are far safer options in the partnership space, including Enterprise Products Partners LP (NYSE:EPD) and Magellan Midstream Partners, L.P. (NYSE:MMP). Both of these partnerships have debt-to-EBITDA ratios that are below Sunoco's target range and coverage ratios that are in the area of 1.2, providing a margin of safety that Sunoco's distribution lacks. The yields are lower, at 6.7% for Enterprise and 5.3% for Magellan, but investors can be far more certain of getting paid. That security is probably worth the lower yields.
Better off waiting
Although a 10% yield is enticing, most investors are better off waiting for the dust to settle here before jumping aboard, or simply looking for safer options. The first year after the deal is likely to be hit by one-time items related to the sale, which will make its financials hard to read. And at this point, there's no way to tell if the partnership will be able to maintain the distribution at its current levels. Only aggressive types with a penchant for special situations should be venturing into Sunoco at this point.