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Is Sunoco LP a Buy?

By Maxx Chatsko - Sep 19, 2018 at 6:05AM

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A distribution yield hovering near 12% looks pretty attractive, but the fuel distributor severely lags the S&P 500 on one key metric.

It's one of the best-known brands in America, the official fuel of NASCAR and INDYCAR, distributes fuel to more than 9,200 convenience stores across the United States, and also delivers one of the highest dividend yields on the stock market. Those are a few solid reasons for investors to be interested in Sunoco LP (SUN 1.68%).

However, there's one big consideration to take into account when it comes to the high-yield stock: Shares of Sunoco LP have delivered a three-year total return (stock performance plus dividends) of just 13%, well below the 54% gain from the S&P 500 over the same span. In other words, despite a dividend yield of nearly 12%, investors would have been better off simply owning the index in recent years.

Does the future look brighter for the business? Is Sunoco LP stock a buy now?

A man staring at a chalkboard with question marks and money bags drawn on it.

Image source: Getty Images.

By the numbers

Sunoco LP has undergone a radical change in 2018. The business sold its retail fuel locations to 7-Eleven in exchange for a 15-year fuel supply agreement. That simplified the business model by allowing the company to mostly focus on fuel distribution (wholesale), although it still owns a small presence in retail with the A-Plus (with 21 locations in New Jersey) and Aloha Petroleum (with 54 locations in Hawaii) brands.

That led to a huge surge in total revenue in the first half of this year. However, fuel sales are inherently low-margin -- and since profits translate to cash flow, which is needed to support the 12% distribution yield, that's where investors should focus their attention when evaluating the company's financial performance.

Metric

First Half 2018

First Half 2017

Year-over-Year Change

Total revenue

$8.3 billion

$5.7 billion

46%

Gross profit

$606 million

$515 million

18%

Operating income

$224 million

$36 million

522%

Net income

($247 million)

($204 million)

N/A

Adjusted EBITDA

$249 million

$375 million

(33%)

Distributable cash flow

$183 million

$235 million

(22%)

Source: Press release.

Sunoco LP reported greatly improved operating income in the first half of 2018 compared to the prior year, but a $94 million impairment charge in the year-ago period accounted for half of the difference. Meanwhile, there was a $52 million drop in distributable cash flow between the comparison periods, although debt repayments and refinancings lowered the company's interest expense by $42 million in that span.

It's important to note, however, that the business sported a relatively strong distribution coverage ratio of 1.24 in the second quarter of 2018. The company thinks that should remove any doubts about the sustainability of its distribution for the time being. Going forward, management believes that cleaning up the balance sheet and gobbling up smaller fuel distributors to expand its network will make up for lower-margin business. But there's a lot of ground to make up, as a 39% decrease in fuel margin per gallon -- from $0.162 per gallon in the second quarter of 2017 to $0.099 per gallon in the most recent second quarter -- demonstrates. The decrease is mostly attributable to the loss of company-owned fuel locations.

SUN Total Return Price Chart

SUN Total Return Price data by YCharts

Management thinks the pain from the latest pivot will be temporary. When the transaction with 7-Eleven closed in January of this year, the company didn't waste much time putting the $3.2 billion in gross proceeds to good use. Sunoco LP made a host of moves that reduced long-term debt and borrowings under credit facilities, with the total going from $4.4 billion at the end of 2017 to $2.6 billion at the end of June.

That's a step in the right direction, but $2.6 billion is still a healthy amount of leverage. The net debt to adjusted EBITDA ratio (the metric that concerns creditors) also improved from 5.58 times to 4.52 times in that span, and an expanding footprint could help with balance sheet-cleanup duties.

After lowering its leverage, Sunoco LP pulled the trigger on two fuel distribution companies with approximately 315 million gallons of combined annual fuel sales. Considering the company sold 7.9 billion gallons of fuel in 2017, the acquisitions represent a roughly 4% increase to the network. While the transactions are seemingly insignificant, the idea is that the business can now make additional acquisitions by drawing down from available credit facilities or using excess cash flow.

A man refueling his car.

Image source: Getty Images.

Investors should stay on the sidelines

Could the current strategy prove successful and get Sunoco LP back on track to deliver superior long-term total returns? Sure -- management might just need a little more patience from unitholders to demonstrate progress.

However, investors would probably prefer that the business doesn't get too carried away with new debt while expanding its fuel distribution infrastructure, especially considering recent history and the fact that the company's latest business model -- going all-in on low-margin wholesale fuel sales -- is still unproven. Therefore, individual investors attracted to the impressive distribution yield may be better off waiting for concrete results before jumping into a position.

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