There must be something wrong with Sunoco's (SUN -0.93%) business.
Its dividend is offering investors a fat 8.7% yield at a time when the S&P 500 Index is near all-time highs and yielding just 1.3% or so. Surely, a yield that high suggests the company is either in trouble or headed that way, right? Not really. Here's a look at why income-focused investors might want to consider Sunoco and its huge distribution yield today...and why they might not.
The core of the business
Sunoco is a master limited partnership (MLP) that is primarily focused on the distribution of gasoline. That said, its business falls into two categories. First, it actually trucks fuel to gas stations in 33 states. Second, it has been expanding into the pipeline and refined products terminals business, which is basically the step before you truck the gas to the station. They are complementary assets and allow Sunoco to grow its business in two different ways.
The key here is that gasoline is still a vital and dominant fuel and that's not likely to change very fast. In fact, Sunoco estimates that even if the sales of electric vehicles are very strong, EVs will only account for around 25% of the U.S. automobile fleet in 2040. If sales of EVs are slow, that number could be in the single digits, noting that in 2019 EVs represented less than 2% of vehicle sales -- a tiny number. But even if the 25% figure plays out, that still leaves 75% of cars using gasoline nearly 20 years from now and someone will have to make that gas available.
Moreover, with operations in just 33 states, there's still room for acquisition-led growth with Sunoco expanding via a spreading geographic footprint. That would be true on both the terminal and pipeline side as well as the gas distribution side of the business. So there are clean energy headwinds to consider here, but there also appears to be ample room for Sunoco to support a profitable and growing energy business, as well.
What about that distribution
Sunoco, with a less than decade-long history, hasn't been a publicly traded entity for all that long. Its big 8.7% distribution yield is toward the high end of that history, but it has been much higher before. In fact, the units are up some 50% over the past three years, having more than fully recovered from the dip during the 2020 coronavirus-led bear market. Investors appear to be getting more comfortable with Sunoco's business and growth prospects.
A key piece of that is the partnership's distribution, given that MLPs are specifically designed to pass income on to investors. The distribution has been stuck at $0.8255 per share per quarter since mid-2016. The distributable cash flow coverage ratio in the first quarter, meanwhile, was roughly 1.25 times. Historically speaking, that would be considered fairly strong coverage in the MLP sector that would leave room for some distribution growth. However, given the current environment, Sunoco is looking to get its coverage up above 1.4 times. In other words, don't expect distribution growth but do expect a safer distribution.
Leverage, meanwhile, is about in-line with the partnership's target, with the current debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio sitting at roughly 3.5 times. However, acquisitions are a key piece of the partnership's plan. And that means that Sunoco will likely be making use of its balance sheet to help finance future growth. This is one more reason why distributions are likely to remain stagnant, since cash that doesn't go to shareholders can be used to limit the leverage needed in future deals.
That said, there are some additional caveats here. For example, Sunoco sold off its gas stations to 7-Eleven in 2017 in what was a major strategic shift. Prior to that, owning and operating gas stations was considered a core growth initiative. Goals change, so this isn't the end of the world, but it was a material directional shift. Also, Sunoco's general partner is Energy Transfer (ET -0.77%), a name that doesn't have the best track record of putting unitholders first. This was highlighted by Energy Transfer's aborted attempt to acquire The Williams Companies last decade. It was a complicated break up, that, simplifying things, involved Energy Transfer issuing convertible debt that would have protected the partnership's CEO at the expense of shareholders.
Is it worth buying?
So, all in, this is not a good option for investors looking for dividend growth. For dividend investors focused on maximizing the current income their portfolios generate, however, it could be an interesting option. That said, it would be hard to call it a screaming buy, given that there are more diversified midstream partnerships with equally strong businesses, growing distributions, and similar, though perhaps not quite as high, yields. In the end, a generous yield is probably the most attractive feature here, a fact that will likely make this partnership desirable to only a modest number of investors given the other options available in the midstream space today.