A lot of people -- and maybe you're one of them -- try to make a big change for the New Year. They vow to lose weight, or get more exercise, or eat healthy -- but by February, 80% of those resolutions fail.
Master limited partnership Sunoco LP (SUN +0.68%) has made some absolutely massive changes for 2018, but instead of fitness or dieting, the gasoline wholesaler has altered its entire business model. Will the change pay off for the company? Or will it end up like a broken New Year's resolution?
Sunoco has made big changes to its operations, selling locations in a bid for outperformance. Image source: Getty Images.
What's changing
In January, Sunoco closed the deal it had made with 7-Eleven in 2017 to sell the vast majority of Sunoco's retail fuel locations -- and their attached convenience stores -- to 7-Eleven in exchange for a 15-year "take or pay" deal for Sunoco to provide wholesale fuel to those locations.
In addition, Sunoco made a deal with a third-party commission agent to operate about 207 retail sites in West Texas, Oklahoma and New Mexico that were not included in the 7-Eleven transaction. That deal is also expected to close this quarter.
That leaves the company with just some "A-Plus" branded stores, which are operated by company franchisees, and 54 Aloha Petroleum-branded stores in Hawaii, which will continue to operate as a separate business unit within Sunoco.
Why it matters
Considering that nearly one-third of Sunoco's 2016 profits came from convenience-store sales, and another 28% from retail gasoline sales, that means the company is losing or changing the source of more than half its profits.
Of course, it's not as though Sunoco is just losing all of that income. Because of the long-term sales agreement with 7-Eleven, those retail sales will now be converted into wholesale sales. And Sunoco received $3.3 billion in cash for the convenience stores, plus a payment for inventory and gasoline. But the upshot is that the company is now practically a pure-play gasoline wholesaler.
That should play to the company's strengths and is likely to inject some stability into Sunoco's business model. In part because convenience-store sales are far more volatile than gasoline sales, and more susceptible to economic changes, Sunoco's income has been very volatile over the last year, far more so than wholesaler CrossAmerica Partners (CAPL 1.43%):
SUN Net Income (Quarterly) data by YCharts
On the whole, that's likely to benefit the company's shareholders.
How it could go wrong
Sunoco is sitting on a lot of debt. I mean, a lot of debt. As of the end of Q3 2017, the company had $4.2 billion of debt on its balance sheet, giving it a debt-to-equity ratio of 1.16. That's very high compared with other energy-related master limited partnerships, even those in the fuel distribution business. CrossAmerica's debt-to-equity ratio, for example, is just 0.49.
But remember, Sunoco just received a $3.3 billion windfall from 7-Eleven for the sale of its retail locations. It could use some or all of that money to get its debt under control. Of course, if it does, there are concerns about distribution coverage.
Currently sitting at about 11%, Sunoco's distribution yield -- technically, MLPs pay "distributions" as opposed to "dividends," but the effect is basically the same -- is among the highest in the industry, beating even CrossAmerica's 10.8%. But for much of the past year, the company has barely been able to cover that payout. in Q3 2017, Sunoco's cash coverage thankfully increased to 1.28, but that included convenience-store sales revenue, which is now gone.
Obviously, that $3.3 billion isn't going to last forever, regardless of whether the company spends it to reduce debt or cover its distributions. Now, it's possible that Sunoco could choose to pay down enough debt to reduce its annual debt payments substantially. If it could reduce those payments enough, it might be able to free up enough cash to make up for the lost convenience store revenue -- or at least enough of the lost revenue to be able to maintain its distribution yield.
For the first nine months of 2017, Sunoco's unitholder distributions totaled $312 million, and its long-term debt payments plus net revolving credit payments totaled $360 million, which means a scheme like that might work, which would indeed put 2018 on the path to being Sunoco's best year ever. But there's simply no way to know if the company can or will go that route.
What a year it may be
2018 is going to be a year of ifs for Sunoco. If the company can absorb the loss of its convenience-store income, and if it can use the 7-Eleven cash to manage its debt load, and if it can also maintain its distributions -- not to mention if the broader stock market and oil markets cooperate -- it could be a banner year for the beleaguered company.
But that's a lot of ifs to place a bet on, particularly considering we'll have to wait several months to get a sense of what the company's post-sale operations look like. For now, even though the yield may be tantalizing, investors interested in high-yielding MLPs are probably better off looking elsewhere.
