Sunoco (SUN 0.04%) has had its share of struggles in recent years. The fuel distribution-focused master limited partnership found itself saddled with too much debt after acquiring several portfolios of gas stations. Those borrowings weighed on the company's balance sheet, which put pressure on its unit price.
Sunoco, however, has made several moves in recent years to bolster its financial situation. It's in a much better spot these days, which has helped fuel a 15% gain in its unit price this year.
Here's a look at the case for and against buying this high-yielding MLP.
Image source: Getty Images.
The bull case for Sunoco
The main attraction with Sunoco LP is its distribution, which yields an enticing 10.6%. That payout appears to be on a sustainable footing. That's because the company generated enough cash during the second quarter to cover its distribution by 1.17 times. That number would have been even higher if it wasn't for a one-time $8 million expense relating to a contractual dispute. Meanwhile, it produced enough cash flow over the past year to cover its payout by an even more comfortable 1.35 times. That's well above its 1.2 target level and a big improvement from its dangerous position at the end of 2017.
Meanwhile, the company's balance sheet has improved, thanks in part to the sale of the bulk of its gas station business to 7-Eleven last year. That helped push its leverage ratio down from a worrisome 5.58 at the beginning of last year to a more comfortable 4.2 times debt-to-EBITDA at the end of the second quarter. That's well below its long-term leverage target of 4.5 to 4.7.
Because of its stronger financial footing, Sunoco has more flexibility to invest in growing its operations. The company currently expects to spend at least $100 million this year on organic growth projects. That includes a joint venture with its parent Energy Transfer (ET 0.47%) to build a new diesel fuel pipeline in West Texas. Energy Transfer started that pipeline up in August. Projects like that one should enable Sunoco to grow its cash flow, which will further improve the long-term sustainability of its high-yield payout.
Image source: Getty Images.
The bear case for Sunoco
While Sunoco is investing in organic growth projects, the company's main source of fuel is acquisitions. It has completed several deals over the past year, which have boosted its fuel distribution and storage businesses. The company's acquisition-driven growth strategy, however, is riskier than one fueled primarily by organic expansions. That's because it needs to not only continue finding good deals but also quickly integrate the new assets into the fold.
Another concern with Sunoco is that while its financial profile has significantly improved over the past year, the company's balance sheet remains weaker overall. For starters, its credit rating remains in junk territory, which makes it costlier to borrow money. Meanwhile, its 4.5 to 4.75 leverage target range is well above the 4.0 comfort zone of most MLPs. So if market conditions weaken, the company could find itself in trouble once again.
Finally, Sunoco focuses primarily on fuel distribution, which is the transportation of gasoline and diesel from refineries to retail gas stations. While it can be a lucrative market, it's a small part of the overall midstream segment of the energy sector. That means the company lacks the growth potential of other MLPs. Its parent Energy Transfer, for example, is investing billions of dollars to build new oil and gas pipelines, export terminals, gas processing plants, and a whole host of other assets. Those projects are giving it the fuel to grow its earnings at a double-digit annual rate. Sunoco's cash flow, on the other hand, declined by 5% in the second quarter, due in part to that contract dispute. The company's limited organic growth prospects make it a less appealing option.
The verdict: Sunoco isn't a buy
While Sunoco offers investors a double-digit yield that seems to be on solid ground, it has a weaker balance sheet and dim growth prospects. So it doesn't seem to be a compelling buy.
A much better opportunity, in my opinion, is its parent Energy Transfer. That MLP pays a well-supported 8.7%-yielding distribution and is on track to grow its earnings 15% this year. Meanwhile, it has plenty of fuel to keep growing at a fast pace over the next few years. As a result, it could potentially generate higher total returns than Sunoco.
