Description

We highly recommend accessing the full version of this write-up via this Dropbox link: https://www.dropbox.com/s/g4p45jywg76t580/CAPL%20Investment%20Thesis%2006-29-15.pdf?dl=0

A summary of the thesis, which excludes key tables and diagrams, is below:

CrossAmerica Partners LP (CAPL) is the extremely misunderstood sponsored MLP of CST Brands (CST) with defensible cash flow characteristics and accelerating, highly predictable organic growth.  Due to a terribly botched dropdown transaction on 6/16/15 in which CAPL issued more MLP units to the public without doing any marketing, CAPL’s units are on fire sale right now (down 17% since the unaffected price pre-deal on 6/15/15) and represent an incredibly attractive risk-reward.  Over 18 and 30 month time horizons, we expect the following return profile: 

Assumptions used for each of the above cases are conservative with Base Case assuming the MLP grows at a 12% 2016-2018 distribution CAGR, Upside case assuming a 21% distribution CAGR, and Downside Case assuming a 5% CAGR.  As liquidity increases in CAPL and CST does a better job marketing the story, we believe MLP funds and other institutional investors will gravitate towards this attractive absolute return that has an incredibly low risk profile and re-rate the units substantially higher.

Variant view:

·        In the short term, CAPL 2015 distribution guidance is for 7-9% YoY increase. Based on the 6/16/15 dropdown, we believe CAPL can easily exceed this distribution growth.  CAPL has ~$200MM of revolver capacity at a 4% cost of debt that we believe the company will be use to handily beat this guidance and generate 2015 distribution growth of 15%-20%+ this year without participating in any further capital markets transactions

·        CAPL has the firepower to sustainably grow its distribution for many years given its enormous dropdown inventory and will set a more aggressive distribution growth target for 2016.

·        The market only sees $100MM EBITDA of remaining 2015 dropdown inventory left available to be dropped from CST to CAPL growing to $140-150MM by 2018.  Based on our analysis of CST’s asset base, we see $285MM of dropdown qualifying assets today growing to $350MM+ by 2018.  SUN, the best comp, has a smaller dropdown inventory relative to MLP EBITDA than CAPL (1.3x more inventory at SUN’s parent ETP vs. the SUN MLP level compared to 3.0x+ more inventory at CAPL’s parent CST vs. the CAPL MLP level).  However, SUN has a much more attractive cost of equity than CAPL (SUN at a 5.8% current yield vs. CAPL at 8.0%) given SUN’s higher guided to distribution growth. 

·        CST/CAPL should raise its MLP distribution guidance to 20%+.  Increasing the distribution growth at CAPL would set off a virtuous re-rating cycle for CST/CAPL whereby the CAPL cost of equity would re-rate in anticipation of higher future growth, which in turn would lead to higher accretion per unit for every $ of EBITDA dropped from CST.  Higher CAPL accretion would increase CST’s GP distribution growth and value substantially.

·        CST is acutely aware that once it hits the 50% IDR splits, it cannot maximize the value of its GP without having a more attractively priced MLP equity currency.  On 6/4/15, CST appointed Steven Stellato, VP and Controller of Energy Transfer Partners, as VP and Chief Accounting Officer of CAPL’s GP.  ETE is arguably the most aggressive and tax efficient midstream GP in the country, and we view the hiring of Mr. Stellato as an important step towards more aggressive distribution growth and marketing of the CAPL story over time.

·        Street is extrapolating the 11.0x dropdown multiple for the June 2015 dropdown for future drops.  However, adjusting for 3^rd party acquisition mix shift, we will show that a more appropriate multiple is 10.0x EBITDA and thus Street forward accretion per dropdown is too low

·        CAPL sponsored dropdowns from CST are real estate and a wholesale distribution business.  While real estate is a well-known attractive asset class for yield focused investors, the wholesale distribution business is a diamond in the rough.  The CST wholesale fuel contract generates $0.05 per gallon for CAPL with CST as the counter-party.  While the market views wholesale fuel as perhaps a 1% annual secular decliner (due to issues such as increasing fuel standards leading to lower gasoline consumption), CAPL will benefit from accelerating organic growth as CST builds an increasing number of stores annually at the C-Corp level and includes the volumes from those stores on the existing fuel supply contract that is dropped to CAPL. 

·        As such, the economics of the wholesale distribution business is similar to a pipeline business with annual price escalators, and the CAPL MLP is similar in nature to the high quality sponsored dropdown MLPs like MPLX, VLP, PSXP, and SHLX that trade at 2% yields due to long-term visible double-digit distribution growth from the parent’s dropdown inventory.  

Background

CST is the retail fuel business of Valero Energy (VLO) that was spun-off from VLO 5/1/13.  CST is one of the largest independent wholesaler and retailer of motor fuels and convenience merchandise in the US and eastern Canada with 1,043 retail sites in the US and 862 sites in Canada.  On 8/6/14, CST acquired the General Partner (GP) of LeeHigh Gas Partners for $85MM, which gave CST control of the LeeHigh Gas MLP that CST subsequently rebranded CrossAmerica Partners, or CAPL.  The rationale for the transaction was that CST had a 2-year restriction post the spin-off from VLO that prevented the company from taking public its own MLP.  Acquiring a GP and gaining control of the re-named CAPL MLP gave CST a faster route to market and an advantaged cost of capital to execute wholesale and retail acquisitions in an extremely fragmented marketplace.  There are ~128,000 C-stores offering fuel sales, and only 17% of stores are controlled by chains operating 500 stores or more.  An astonishing 58% of the market is controlled by mom and pops with only 1 store, and CST believes it has a decade long runway to roll-up this industry, benefitting from synergies and economies of scale.

As CST controls the GP of CAPL, it effectively controls the MLP and has set CAPL distribution growth guidance at 7-9% for 2015; growth targets should be met by a combination of dropping down portions of its wholesale business, dropping down its NTI real estate, and acquiring 3^rd party wholesale and retail businesses at the CAPL level. 

On 12/17/14, CST executed its first dropdown to CAPL, selling 5% of its fuel distribution business to CAPL for a price of 10.6x EBITDA.  CST’s stated strategy is to drop 100% of its fuel distribution down to CAPL over time and also each year drop down all of the real estate behind its New to Industry (NTI) stores that CST builds each year at the parent level at a stated 7.5% cap rate.  The logic for selling its NTI real estate to CAPL (as opposed to the real estate it already owns behind 1,000+ existing company stores) is that there is a full tax basis at newly constructed stores and thus dropping these assets to CAPL minimizes tax leakage to CST.  CST built 29 NTIs in 2014 and is guiding for an additional 35-40 NTIs to be constructed in 2015. 

It is also worth noting that CST’s 2023 bonds contain covenants restricting asset sales at CST and thus limit the amount of dividends and share repurchases that CST can undertake as a result of dropdowns with CAPL.  The bond indenture allows them to take 75% of asset sale proceeds in cash and 25% in units and to re-invest dropdown proceeds in the business, and CST is using these proceeds to build NTIs that provide further dropdown inventory to CAPL.  The bonds can be called on 5/1/18 at $102.50. 

Earlier this year, the CST/CAPL symbiotic relationship was an MLP/GP growth story that the market really liked.  In January 2015, CAPL closed its first CST related acquisition, buying 5% of CST’s wholesale fuel business.  CAPL traded up 55%+ above the unaffected price in August 2014 when CST acquired its GP.  The unit price high represented a 5.3% current yield as investors were willing to pay up for the growth visibility provided by the dropdown inventory at CST.

Rationale for the “Perfect Storm” Sell-off after CAPL’s Botched Equity Offering On 6/16/15

On 6/16/15, CST and CAPL executed a dropdown in which CAPL issued equity at a 5% discount to fund 3 accretive acquisitions.  CAPL broke through the deal price and is now trading at a 17% discount from the unaffected price on 6/15/15 despite the accretion.   We believe this is an extreme mispricing scenario brought about by the following factors:

(1)    Rebranded from being Leehigh Gas Partners after CST acquired LeeHigh’s GP last August, CAPL is a new MLP that has not yet been properly marketed to institutional investors.  Due to tax restrictions that just rolled off last month, CST decided to enter the MLP market through this backdoor transaction with LeeHigh rather than via the proper IPO channel with a roadshow to attract institutional investors. CST was restricted up until May 2015 from IPO’ing its own MLP (2 years post its spin-off from Valero (VLO)), and the LeeHigh transaction was a faster route to the market place.

(2)    As part of the repositioning of Leehigh Gas to becoming CAPL, Leehigh Chairmain and Founder Joseph Topper announced his retirement at the end of March 2015 with managers from CST taking the reins of CAPL operations.  From our own discussion with Topper, we learned that he believes that there has been some shareholder rotation out of CAPL as Leehigh Gas shareholders adjust to the new management change, which is consistent with CAPL’s underperformance even before the equity deal.

(3)    In addition to CAPL specific issues, the MLP market has broadly been weak on continued commodity price and interest rate concerns.  The Alerian MLP index is down 11.5% since the beginning of May while the S&P 500 is only down 1%.  However, CAPL is primarily a fixed fee business with de minimis commodity exposure, and high growth MLPs historically perform well even in rising interest rate environments.

(4)    CAPL did a poor job executing the transaction.  The deal press release on 6/15/15 was confusing as it did not disclose the full purchase price incorporating the One Stop 3^rd party acquisition.  The One Stop acquisition price was only disclosed after the market close separately in an 8-K, not giving investors enough time to properly digest the full transaction terms in time to put orders in for the overnight deal.

(5)    Lead underwriters Bank of America and Barclays failed to properly market the merits of the dropdown as well.  Market color we have received indicates that rather than being placed with institutional investors, the majority of the equity deal was sold through the retail investor channel that puked the stock after it broke the deal price of $30.45. 

(6)    CAPL is still an illiquid, unfollowed MLP, so the sellside has so far done a miserable job understanding the business given its lack of importance to them.  CAPL lead underwriters BAML and Barclays did not even understand how to model the accretion from the transaction despite having plenty of management and IR access.  In their 6/16/15 note, BAML writes that the drop-down asset mix “may indicate slower than expected drop-downs of additional CST Fuel Supply interests but more acquisitions of NTIs” and thought the Fuel Supply acquisition price “was a bit more expensive than we anticipated.”  Barclays wrote that “valuation was slightly more expensive” than they expected and that the dropdown deal was only “5% accretive to DCF per LP unit.”   On equity offerings, rarely do we see lead underwriters with numbers that are too bearish that undersell the merits of the transaction like this.  Despite the short-term underperformance, the merits of the transaction are sound as the dropdown accretion provides CAPL enough runway to soundly beat its annual distribution growth target of 7-9% and post 12-20%+ distribution growth in 2015 and beyond

Catalyst

• 3rd party M&A deals by CAPL in 2H15
• Realization of 15-20%+ 2015 distribution growth versus guidance range of 7-9%
• Initiation of double-digit distribution growth guidance for 2016 and beyond
• Increased marketing of the CAPL story by both CST and CAPL, which should create an institutional shareholder following for CAPL and increase unit liquidity