The recent market sell-off has hammered fuel distribution master limited partnership Sunoco (SUN 0.91%). It's down about 60% from its recent high. That sell-off has pushed the yield on its distribution up to an eye-popping level of more than 20%. 

That sky-high payout probably has income-seeking investors wondering if Sunoco is a screaming bargain or a dividend yield trap. Here's the case for and against buying the fuel distribution company these days.

Petroleum storage tanks with the sun setting in the background.

Image source: Getty Images.

The bull case for Sunoco

Sunoco, like many energy companies, has taken steps to shore up its financial profile following a historic downturn in the energy markets as a result of the COVID-19 outbreak. The company recently reduced its 2020 growth spending budget by 42% to $75 million. It also slashed its maintenance capital budget by one third and planned to cut other operating costs. These moves will improve the company's financial flexibility, giving it more cushion to maintain its sky-high payout. 

Sunoco also noted that it has ample liquidity under its $1.5 billion revolving credit facility -- with only $162 million borrowed against it at the end of last year -- and no debt maturing until 2023. That gives it lots of financial flexibility and ample time before it needs to worry about addressing any maturing debt. 

Finally, Sunoco generates relatively stable income. That's because a large portion of its revenue comes from real estate leases on the gas stations it owns and take-or-pay fuel distribution and storage contracts where customers pay it a set fee even if they don't use the services it provides. These sources of predictable cash flow help cushion the blow during periods of economic weakness.

The bear case for Sunoco

While Sunoco has lots of financial liquidity at the moment, it has a weak financial profile overall. For starters, it has junk-rated credit and an elevated leverage ratio of 4.61 times debt-to-EBITDA. That sub-investment-grade credit rating makes it more expensive and challenging to borrow money during good times and near impossible when markets are in disarray. Meanwhile, even though the company's leverage ratio is within its 4.5 to 4.75 target range, it's on the high side for an MLP, since the sector typically targets leverage of less than 4.0.

Sunoco's distribution coverage is also a bit of a concern. On the one hand, Sunoco generated enough cash to cover its high-yielding payout by a comfortable 1.32 times last year, which was within its target of over 1.2. However, with the COVID-19 outbreak significantly slowing the economy, it's cutting deeply into demand for gasoline, meaning Sunoco probably won't deliver on its guidance of distributing at least 8.4 billion gallons of fuel this year. Furthermore, fuel margins will probably be lower than its anticipated range of $0.095-$0.105 per gallon. As such, it will have a hard time delivering on its EBITDA guidance of $670 million-$700 million, which will impact its distribution coverage and leverage ratios.

Sunoco believes it will have a better idea of volumes and margins when it reports its first-quarter results in May. If its numbers come in weaker than expected, and fuel demand hasn't started to recover, then Sunoco might need to reduce its high-yielding distribution and use that cash to bolster its balance sheet. 

Verdict: Sunoco is too risky to buy

As tempting as Sunoco's 20%+ yield might be, it doesn't appear to be sustainable due to the company's weaker financial profile. Add that to the current uncertainty surrounding the extent of the COVID-19 outbreak, and Sunoco might have to cut its payout to improve its financial flexibility. That's why investors should steer clear of this dividend stock, especially since there are plenty of better ones to buy.