Around this time last year, Sunoco LP (NYSE:SUN) announced a transformative divestment. The sale of its extensive retail filling station network to convenience store specialist 7-Eleven was going to give management the cash it needed to clean up its balance sheet and provide it with a much more stable revenue source. One would have assumed that when the company made this transaction, Wall Street would reward the stock with a higher valuation. That hasn't been the case, though, as Sunoco's stock is still languishing with a sky-high distribution yield north of 12%.
One has to wonder if this is a case of Wall Street not recognizing a transformed business, or if all those changes made aren't necessarily going to lead Sunoco to a brighter future. Let's take a look at what happened this past quarter to see if there are any clues about what we can expect from the new and (possibly) improved Sunoco.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$3.75 billion||$2.96 billion||$2.81 billion|
|EBITDA||($26 million)||$158 million||$135 million|
|Distributable cash flow||$84 million||$89 million||$77 million|
|Distribution coverage ratio||1.00||1.03||0.74|
Whenever a company makes a transformative sale or purchase in a quarter, there are likely going to be some significant charges that distort earnings. In this case, the company took two significant charges in the quarter as part of closing the $3.2 billion sale of its retail fuel network to 7-Eleven back in January as well as a charge related to the early termination of debt. While some of those are cash charges, they are likely one-time in nature and shouldn't be an issue further down the road.
On top of the debt reduction efforts, the company also made the following transactions
- Refinanced $2.2 billion in debt at significantly lower interest rates that were available thanks to the company's improved financial standing
- Redeemed $300 million in preferred shares held by Energy Transfer Equity
- Repurchased 17.3 million common shares from Energy Transfer Partners
These deals are important to Sunoco because the company's cash commitments for interest and distributions was simply too much for the business to handle. There is also the fact that selling all of its retail business will likely reduce cash flows, so by reducing the amount of cash going out the door each quarter, it can finally improve its distribution coverage ratio and hopefully bring it back up to sustainable levels, which the company struggled with for several quarters in a row.
This past quarter, it also found a long-term solution for the remaining retail sites it held after the 7-Eleven transaction. Almost all of these retail sites will now operate under a commission agent structure where Sunoco will get a small cut of the retail fuel sold at those stations and will receive rent from the agent that operates the retail station. Aside from a small handful of sites in Hawaii and on the New Jersey Turnpike, all of Sunoco's retail sites are now operating under this commission agent model.
What management had to say
After making all of these divestment efforts in the quarter, Sunoco then immediately went back on the offensive by acquiring a smaller wholesale fuel distributor. According to CEO Joe Kim, the company's new structure will allow it to make several of these kinds of acquisitions over time to grow the business.
Last year we outlined a plan and during the first quarter, we executed on this plan. First, we completed the 7-Eleven transaction. Second, we converted or West Texas sites to the commission agent model. Third, we fixed our balance sheet and finally, we transformed Sunoco LP into a cost-efficient organization. We now have the foundation in place to materially grow. In April, we closed on the Superior Plus acquisition. This acquisition serves as a blueprint for small bolt-on deals. The highlights include a 200 million gallon a year wholesale business. Three terminals that provide fee-based cash flow, material commercial and G&A synergies with the ability to add additional customers. And finally an attractive post-synergy multiple between 5x and 6x and its accretive in year one.
This acquisition is one example to type of opportunities we continue to pursue in a fragmented marketplace. We have developed a robust pipeline of potential M&A opportunities, we'll be deliberate to only pursue the most attractive opportunities that meet or exceed our financial targets.
After a corporate reset, more of the same?
It's certainly helpful that management was able to find a way to correct its balance sheet issues by selling assets while at the same time finding a way to generate revenue from those assets over the long term. Sunoco's long-term wholesale fuel contracts with 7-Eleven for the retail sites it sold was one of the best moves that its management team has made. From a numbers perspective, Sunoco looks to be in much better shape than it has in years. It's generating enough cash to cover its distribution, and its debt to Adjusted EBITDA ratio of 3.82 puts it well within the guidelines of its debt covenants.
At the same time, though, management needed to make all of these moves because of poor capital allocation in the past. It aggressively pursued growth to the point that its debt levels became untenable. Now, management is talking about a growth strategy that centers around acquisitions. Without any internally retained cash flow, it is going to have to rely on debt to pay for it because it's simply too costly to issue equity today. Considering that acquiring assets and taking on debt to pay for them is what got it in trouble before, it's not exactly reassuring that it wants to head down this path again.