SUNOCO LP SUN
March 16, 2020 - 10:00am EST by
frankie3
2020 2021
Price: 16.50 EPS 0 0
Shares Out. (in M): 84 P/E 0 0
Market Cap (in $M): 1,381 P/FCF 0 0
Net Debt (in $M): 3,040 EBIT 0 0
TEV ($): 4,421 TEV/EBIT 0 0

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Description

Let's get to the point.  We are seeing one of the worst crises in our lifetimes, if not the worst.  Everything is at risk.  Staying in cash is probably the best thing you can do in the short run.  Why buy SUN when a lot of other companies are on sale right now?  

  1. The business has potential to remain "relatively" stable in current economic environment
  2. Pays a high distribution that should hold while you wait for eventual economic stability.  Currently at 20%

 

Brief Company Description

Sunoco LP is the nation's largest independent fuel distributor.  SUN distributes multiple fuel brands across 30 states throughout the East Coast, Midwest, South Central and Southeast regions of the continental United States and Hawaii.  It has an expansive fuel distribution network with control of significant real estate of over 950 locations.  It has 7,300 third-party dealers, distributors and commission agents, 2,600 commercial customers.  SUN also owns and operates 75 sites in Hawaii and on the New Jersey Turnpike.

 

SUN's units just got hit by a double whammy of lower oil prices and Coronavirus slowdown.  The price reaction between both of these factors is overblown.

Effect of recent decline in Oil Prices-Mixed Up with MLPs with commodity exposure

The sharp decline in oil prices hit the entire MLP sector.  SUN got washed up in this selloff even though the price of oil doesnt necessarily affect its business too much.  On 3/9 when the news of Russia's dropping out of OPEC agreement, the oil and gas sector got decimated.  Included with that was the MLP sector, which certainly DOES derive profits from higher oil prices, but the gasoline distributors can actually benefit from lower commodity prices in margin and volume.  Typically there is an elastic relationship between gasoline demand and price, albeit small.  The lower the gas price the more people will drive.  Given the oil price drop, you could see the price of gasoline drop 20% over the next few months which may spur more demand all things equal.  The other potential benefit to falling prices in the near term is that pricing volatility usually causes an improvement to margins.  This is a near term benefit.  One of the secular headwinds challenging SUN is the trend towards electric cars.  This headwind may be less if gasoline prices stay lower for longer.  Lower oil prices should actually help SUN not hurt it.

Effect of Coronavirus

Gasoline demand will go down in the near term because people are not going to work particularly in the hot areas of the county.  This is hard to predict but it will be worse than the post 9/11 and the credit crisis.  After 9/11, miles driven by vehicles actually went up.  During the credit crisis miles driven dropped only by about 1-2% over 2 years.  THIS IS TOTALLY DIFFERENT.  You could see a 10% drop in miles driven and gasoline demand across the country in the short term.  Offsetting this, I believe that more people will travel domestically via car for any business trips or summer vacations.  If domestic airports get shut down as it looks likely, passengers will either cancel or look to other means besides airplanes to travel.

 

Distribution should be safe under extreme assumptions--- Stress Testing SUNOCO's Model

At the midpoint of 2020 guidance, Sunoco was supposed to do $685mm of EBITDA.  Taking out their interest expense and maintainance capex, they are forecast to do $470mm in Distributable Cash Flow.  The amount needed to cover its distributions are $350mm, for a distribution coverage ratio of 1.34.  This is a healthy coverage ratio, with about $120mm of excess cash flow.  While Sunoco is usually a pretty stable distribution business overall, it has two aspects of its business that add a lot of stability.  First, it generates $145mm/year is lease payments from 950 locations throughout the US.  Second, it has a large 15 year take or pay contract with 7-Eleven (investment grade customer) for fuel distribution which represents about 2.3 billion gallons at a rate of .06 gross margin per gallon.  This would be another $138mm.  So out of the $685mm of EBITDA, $283mm is very secure.  Of at least 8.4 billion of forecasted gallons, 2.3 billion are take or pay, leaving 6.1 billion theoretically at risk.  If demand dropped 10% for an entire 12 months, you would lose $61mm in gross profit, and still cover the dividend 1.16x.  If demand dropped 20%, you would lose $122mm in gross profit and still essentially cover the dividend.   The biggest historical drop in gasoline consumption in US history going back to the 1940's occured during the 1978-1980 time frame when consumption dropped 5%, from '78 to'79, and another 6% from '79 to '80.  These consumption drops during the '79 Oil Crisis were related to price increases and gasoline shortages, in conjuction with a soft economy.  All else equal, we would have to see gasoline consumption drop 3-4X more than 1979 to be running up against distribution cover all else equal.  Obviously, this does not take into consideration unpredicted low margins, or massive credit crisis where SUNs revolver freezes.

Volume subject to demand shock

2020 Base Case 5% Vol. Decline 10% Vol. Decline 15% Vol Decline 20%Vol Decline
Total Motor Fuel Gallons Sold                         (in billions) 8.4        
Volume sold to 7-Eleven under take or pay  2.3        
Remaining Volume Subject to demand shock 6.1 5.8 5.5 5.2 4.9
Margin per Gallon $0.10 610 580 550 520 490
Profit Hit in $mm 0 30 60 90 120

 

Dissecting SUN's Earnings Model

2020 

In $mm

Existing Estimates

5% Vol.

Decline

10%Vol.

Decline

15% Vol.

Decline

20%Vol.

Decline

Income from Lease Payments 145

145

145 145 145
Income from Take or Pay 138 138 138 138 138
Remaining "at Risk" EBITDA 402 372 342 312 282
Total EBITDA 685 655 625 595 565
Interest 175 175 175 175 175
Maintenance Capex 40 40 40 40 40
Distributable Cash Flow (DCF) 470 440 410 380 350
SUN LP Unitholders Distribution 276 276 276 276 276
SUN GP Distribution 74 74 74 74 74
Total Distributions 350 350 350 350 350
Distribution Coverage 1.34 1.26 1.17 1.09 1.00

 

Note:  This shock analysis notably does not assume changes in gas distribution margin, nor mitigating cost reduction measures that would taken by the company.

 

Insiders are Buying

Clearly insiders can be wrong (and I have seen a company's management make a ton of bad insider purchases over the years), but nevertheless it is good to see multiple insider purchases from the CEO, CFO and a Board member.

More industry insiders also note a dislocation as there are also insider purchases in the comp CAPL.

 

Valuation

 

6.5X EV/EBITDA

4.6X Leverage

20% Yield

 

 

Risks

Levered at 4.6X. (No Maturities Until 2023)

Unable to access revolver for working capital

Force Majeurw on Supply Contracts

Unknown government intervention 

Major behavior change requiring people to drive 20+% less on a permanent basis.

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Volumes coming in better than feared.  Increased margin from commodity volatility.  Insider purchases.  Announcement that distribution remains the same next month.

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