SUNOCO LP SUN
April 06, 2017 - 2:45pm EST by
Mason
2017 2018
Price: 28.40 EPS 0 0
Shares Out. (in M): 99 P/E 0 0
Market Cap (in $M): 2,800 P/FCF 0 0
Net Debt (in $M): 1,342 EBIT 0 0
TEV ($): 4,400 TEV/EBIT 0 0

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Description

Misunderstood transaction leads to highly compelling deleveraging and value creation opportunity.

Sunoco LP is still priced as a distressed MLP despite a highly compelling transaction with Seven & I Holdings.  The opportunity exists because there is significant confusion over the terms of the agreement with Seven & I Holdings.  Much of the market is assuming a 10-12x LTM EBITDA transaction multiple, but I calculate the multiple is over 15x LTM EBITDA.  This multiple is more in line with the cyclically depressed EBITDA levels in ’16 with the retail business EBITDA falling by nearly 21% y/y and likely the significant cost cutting and synergy opportunity for Seven & I Holdings. 

The source of the confusion is that management, for whatever reason, has been super cagey about this deal in the press release and the conference call that followed.  However, management did highlight a 2.2bn gallon wholesale long-term take or pay contract that SUN will benefit from as part of the transaction.  Management also highlighted this take or pay agreement is north of any internal margin given from retail to wholesale (which could be as low as 0 or even negative).  From our understanding of the 10-K and management commentary, we can assume that there is a 4c per barrel uplift to wholesale EBITDA (i.e., SUN’s retail assets benefitted from very beneficial COGS).  

This value discrepancy is significant as it de-levers SUN from 6.7x LTM EBITDA (unadjusted for the recent ETE preferred) to just 3x LTM EBITDA. 

I assume $200mm of taxes are paid on this transaction given management commentary and the likely built in gain and solve to a $3.1bn reduction in net debt to $1.34bn (unadjusted for preferred).  I estimate LTM EBITDA falls from $665 to $453mm with $300mm of lost Retail EBITDA offset by $88mm of wholesale EBITDA.  EV multiple has compressed from 11.3x EBITDA to 9.8x EBITDA, while business has gotten better through the disposal of the more cyclical retail, convenience store business.  Business will be primarily wholesale fuel supply which benefits from long-term fixed margin contracts. 

Management has committed to maintaining the distribution yield and solving to 1.1x coverage. 

I can solve to $3 LTM DCF if excess cash is used to either buyback stock or if company re-levers to 4x EBITDA.  However, this is based on LTM and street estimates have EBITDA increasing by $60mm due to cost savings program, which management believes has more firepower as a result of the disposal.  Also management appears to be conservative on capex requirements for the wholesale business, with that business just consuming $112mm of capital in 2016 (vs guided $140mm). 

On conservative estimates by using LTM math (vs. the incorporation of cost savings) and using $300mm (out of $330mm of total retail EBITDA despite Seven & I buying just 1,110 of the 1300 stores, we solve to a FCF yield ex. Excess cash of 13.9% at a leverage ratio of just 3x.  I can easily see management supporting the $3.30 dividend through the greater than $75mm cost savings program, capital allocation through buyback or M&A and through the sale of the incremental assets at a multiple north of the 9.8x LTM it is currently trading at. 

As the market digests the transaction, I believe the multiple will go to 11x EBITDA for near term upside to $34 or 19% on top of the $3.30 annual distribution worth an annualized 12%.  As Seven Eleven closes, the 200 other stores are sold, management comes clean about numbers and capital plans, I believe there is upside to $44 at a 7.5% distribution yield within a year.  Combined with the distribution itself, that’s 67% upside with your downside protected by a de-levered balance sheet and an 11% FCF yield (ex. Excess cash).

Key quotes from transcript to support my case:

First, the divestiture proceeds will allow us to reduce our leverage ratio. We expect to be in the 4.5 times to 4.75 times range. Second, after the debt reduction, we expect to have a coverage ratio in the neighborhood of 1.1 times. I should point out that these ratios won't be achieved in year one, as we will incur a significant deal related cost.

 

We expect our combined maintenance and growth capital expenditures to be around a

$150 million annually upon completion of these transactions.    

As we look at it, it'll probably be somewhere around $50 million on the maintenance side and about a $100 million on the growth side

 

Again, in February we talked about cutting operating expenses and G&A by $75 million. Once we complete this transformation, we expect to reduce G&A by significantly more than our $75 million target. 

 

By the end of the year, we expect to be a focused, streamlined, MLP qualifying business

the 15-year fixed margin take-or-pay fuel supply agreement provide stability of income with the ability to grow the business moving forward. We will continue to pursue supply agreements with fixed margins.

 

all you smart people on the phone will continue to try to approach this differently and we're not

going to answer the question here this morning, we'll give more detail as time goes on, but remember, all these metrics will change depending on the results. We still got a lot of work to do selling the remaining assets. I think Tom said it exactly right. When we exit the retail business, our EBITDA will be lower. I told you, we're going to have a 1.1 coverage ratio. There are a couple of ways we can get there, we can reduce the divisor in terms of the outstanding shares where we can do M&A activity and we will do what we believe is optimum for all our – all our unitholders. So, I would encourage people to talk with Scott as time goes on as you guys refresh your models, but we're going to frustrate you here this morning with and not give you any additional specifics.

 

I think just in terms of clarity, this is not going to be billions of dollars of tax, but it's going to be hundreds of millions of dollars of tax, based on the basis. The base, we have in the assets that are being sold versus the proceeds.

 

<Q - Eric Genco>: Good morning. I was wondering if you could tell us historically when these – when some of these assets were affiliated the – the per gallon margin that you had agreed to was in the $0.03 to $0.04 range, can you tell us where that was before this transaction? Is that the right number to be thinking about?

<A>: No, remember these were company operated and the right number to think about here would be the $0.23 to $0.25 a gallon that came with retail gallons. Remember with retail gallons, two things, that those gallons are – the retail margin is not qualified. Secondly, we had the employee cost associated with it.

but in order to avoid intercompany eliminations, you just had – you just reported the retail

gallon.

So essentially, whatever math we do on this, if we say 2.2 billion gallons now supplied to 7-Eleven, we apply some margin and we add that to whatever we were – we had originally for wholesale as a pro forma, is that the correct thought process behind doing it?

<A>: Yes, I would say, if you look at the range that we talked about before, that would be a total. And so that you don't double count it, subtract your $0.03 to $0.04 of gallon from. Yeah.

<Q>: Right. And so then if we really think about this from a perspective of like what are you – what theoretically you gave up, you have – if we start with $0.24, we would assume that the buyer then would have to take out whatever this assumed number is, $0.03 to $0.04 out of that and that would be an incremental expense to them that wouldn't have necessarily showed up in your accounting, is that fair?  <A>: Well, I think that you – I'm not sure that any buyer would enjoy the same position that we enjoy in terms of cost of goods sold, so I don't think – this is not a zero-sum game here, in that regard.

<Q>: Okay. So, then you – okay, so essentially, we're thinking these are probably – this agreement probably comes somewhere north of $0.03 to $0.04?

 

<A>: Well, I think, Tom mentioned that it was within the – to think about it in the range that we've given people around wholesale and both he and I said this is a market related price, we think it's attractive for both parties given what their normal options would be and the different position that we're in as owner of the Sunoco brand for example, right

 

  Current Seven Eleven  
Price  $      28.40    $     28.40
Shares                99                  99
Market Cap          2,798            2,798
       
Total ETE preferred              300               300
       
       
Term Loan          1,243               (1,243)                 -  
Sale Leaseback financing              117                   (117)                 -  
2014 Revolver          1,000               (1,000)                 -  
6.375% Senior notes due 2023              800               800
5.5% Senior Notes due 2020              600               600
6.25% Senior Notes due 2021              800               800
Capital Lease Obligation                  1                    1
Total Debt          4,561               (2,360)          2,201
Cash              119                     740             859
Net Debt          4,442               (3,100)          1,342
       
Total EV          7,540            4,440
Total Assets          8,701    
Book Equity          2,196    
       
Wholesale EBITDA              337                        88             425
Retail EBITDA              328                   (300)                28
Total EBITDA              665                   (212)             453
       
Debt/EBITDA            6.68              2.96
EV/EBITDA          11.34              9.80
       
Transaction Value                    3,300  
x EBITDA                          16  
       
EV at 10x EBITDA              4,530
EV at 12x EBITDA              5,436
       
Market Cap at 10x EBITDA              2,888
per share              29.31
Market Cap at 12x EBITDA              3,794
per share              38.50

 

Distributable Cash Flow    
LTM EBITDA 453    
Interest   -134    
Maint Capex -50    
DCF   269    
Per Share             2.73    
         
Total Cash per share           8.72    
FCF yield ex cash 13.9%    
         
Buyback Scenario      
DCF   269    
PF Shares   72.5077   Bought at $33
DCF/share           3.71    
Yield   13.1%    
         
Releverage to 4x at 10x EBITDA purchase  
    Current Acquired Total
EBITDA              453            131            584
Interest            (134)            (23)          (157)
Maint Capex            (50)            (14)            (64)
DCF                  363
per share                 3.68
Distribution     330.0625
per share                 3.35
Yield       7.5%
Target               44.66

 

 

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

Catalyst

Managment PF numbers

Transaction for 200 more additional stores

Sell Side Awareness

Seven & I transaction closes

Maintenance of distribution

    sort by    

    Description

    Misunderstood transaction leads to highly compelling deleveraging and value creation opportunity.

    Sunoco LP is still priced as a distressed MLP despite a highly compelling transaction with Seven & I Holdings.  The opportunity exists because there is significant confusion over the terms of the agreement with Seven & I Holdings.  Much of the market is assuming a 10-12x LTM EBITDA transaction multiple, but I calculate the multiple is over 15x LTM EBITDA.  This multiple is more in line with the cyclically depressed EBITDA levels in ’16 with the retail business EBITDA falling by nearly 21% y/y and likely the significant cost cutting and synergy opportunity for Seven & I Holdings. 

    The source of the confusion is that management, for whatever reason, has been super cagey about this deal in the press release and the conference call that followed.  However, management did highlight a 2.2bn gallon wholesale long-term take or pay contract that SUN will benefit from as part of the transaction.  Management also highlighted this take or pay agreement is north of any internal margin given from retail to wholesale (which could be as low as 0 or even negative).  From our understanding of the 10-K and management commentary, we can assume that there is a 4c per barrel uplift to wholesale EBITDA (i.e., SUN’s retail assets benefitted from very beneficial COGS).  

    This value discrepancy is significant as it de-levers SUN from 6.7x LTM EBITDA (unadjusted for the recent ETE preferred) to just 3x LTM EBITDA. 

    I assume $200mm of taxes are paid on this transaction given management commentary and the likely built in gain and solve to a $3.1bn reduction in net debt to $1.34bn (unadjusted for preferred).  I estimate LTM EBITDA falls from $665 to $453mm with $300mm of lost Retail EBITDA offset by $88mm of wholesale EBITDA.  EV multiple has compressed from 11.3x EBITDA to 9.8x EBITDA, while business has gotten better through the disposal of the more cyclical retail, convenience store business.  Business will be primarily wholesale fuel supply which benefits from long-term fixed margin contracts. 

    Management has committed to maintaining the distribution yield and solving to 1.1x coverage. 

    I can solve to $3 LTM DCF if excess cash is used to either buyback stock or if company re-levers to 4x EBITDA.  However, this is based on LTM and street estimates have EBITDA increasing by $60mm due to cost savings program, which management believes has more firepower as a result of the disposal.  Also management appears to be conservative on capex requirements for the wholesale business, with that business just consuming $112mm of capital in 2016 (vs guided $140mm). 

    On conservative estimates by using LTM math (vs. the incorporation of cost savings) and using $300mm (out of $330mm of total retail EBITDA despite Seven & I buying just 1,110 of the 1300 stores, we solve to a FCF yield ex. Excess cash of 13.9% at a leverage ratio of just 3x.  I can easily see management supporting the $3.30 dividend through the greater than $75mm cost savings program, capital allocation through buyback or M&A and through the sale of the incremental assets at a multiple north of the 9.8x LTM it is currently trading at. 

    As the market digests the transaction, I believe the multiple will go to 11x EBITDA for near term upside to $34 or 19% on top of the $3.30 annual distribution worth an annualized 12%.  As Seven Eleven closes, the 200 other stores are sold, management comes clean about numbers and capital plans, I believe there is upside to $44 at a 7.5% distribution yield within a year.  Combined with the distribution itself, that’s 67% upside with your downside protected by a de-levered balance sheet and an 11% FCF yield (ex. Excess cash).

    Key quotes from transcript to support my case:

    First, the divestiture proceeds will allow us to reduce our leverage ratio. We expect to be in the 4.5 times to 4.75 times range. Second, after the debt reduction, we expect to have a coverage ratio in the neighborhood of 1.1 times. I should point out that these ratios won't be achieved in year one, as we will incur a significant deal related cost.

     

    We expect our combined maintenance and growth capital expenditures to be around a

    $150 million annually upon completion of these transactions.    

    As we look at it, it'll probably be somewhere around $50 million on the maintenance side and about a $100 million on the growth side

     

    Again, in February we talked about cutting operating expenses and G&A by $75 million. Once we complete this transformation, we expect to reduce G&A by significantly more than our $75 million target. 

     

    By the end of the year, we expect to be a focused, streamlined, MLP qualifying business

    the 15-year fixed margin take-or-pay fuel supply agreement provide stability of income with the ability to grow the business moving forward. We will continue to pursue supply agreements with fixed margins.

     

    all you smart people on the phone will continue to try to approach this differently and we're not

    going to answer the question here this morning, we'll give more detail as time goes on, but remember, all these metrics will change depending on the results. We still got a lot of work to do selling the remaining assets. I think Tom said it exactly right. When we exit the retail business, our EBITDA will be lower. I told you, we're going to have a 1.1 coverage ratio. There are a couple of ways we can get there, we can reduce the divisor in terms of the outstanding shares where we can do M&A activity and we will do what we believe is optimum for all our – all our unitholders. So, I would encourage people to talk with Scott as time goes on as you guys refresh your models, but we're going to frustrate you here this morning with and not give you any additional specifics.

     

    I think just in terms of clarity, this is not going to be billions of dollars of tax, but it's going to be hundreds of millions of dollars of tax, based on the basis. The base, we have in the assets that are being sold versus the proceeds.

     

    <Q - Eric Genco>: Good morning. I was wondering if you could tell us historically when these – when some of these assets were affiliated the – the per gallon margin that you had agreed to was in the $0.03 to $0.04 range, can you tell us where that was before this transaction? Is that the right number to be thinking about?

    <A>: No, remember these were company operated and the right number to think about here would be the $0.23 to $0.25 a gallon that came with retail gallons. Remember with retail gallons, two things, that those gallons are – the retail margin is not qualified. Secondly, we had the employee cost associated with it.

    but in order to avoid intercompany eliminations, you just had – you just reported the retail

    gallon.

    So essentially, whatever math we do on this, if we say 2.2 billion gallons now supplied to 7-Eleven, we apply some margin and we add that to whatever we were – we had originally for wholesale as a pro forma, is that the correct thought process behind doing it?

    <A>: Yes, I would say, if you look at the range that we talked about before, that would be a total. And so that you don't double count it, subtract your $0.03 to $0.04 of gallon from. Yeah.

    <Q>: Right. And so then if we really think about this from a perspective of like what are you – what theoretically you gave up, you have – if we start with $0.24, we would assume that the buyer then would have to take out whatever this assumed number is, $0.03 to $0.04 out of that and that would be an incremental expense to them that wouldn't have necessarily showed up in your accounting, is that fair?  <A>: Well, I think that you – I'm not sure that any buyer would enjoy the same position that we enjoy in terms of cost of goods sold, so I don't think – this is not a zero-sum game here, in that regard.

    <Q>: Okay. So, then you – okay, so essentially, we're thinking these are probably – this agreement probably comes somewhere north of $0.03 to $0.04?

     

    <A>: Well, I think, Tom mentioned that it was within the – to think about it in the range that we've given people around wholesale and both he and I said this is a market related price, we think it's attractive for both parties given what their normal options would be and the different position that we're in as owner of the Sunoco brand for example, right

     

      Current Seven Eleven  
    Price  $      28.40    $     28.40
    Shares                99                  99
    Market Cap          2,798            2,798
           
    Total ETE preferred              300               300
           
           
    Term Loan          1,243               (1,243)                 -  
    Sale Leaseback financing              117                   (117)                 -  
    2014 Revolver          1,000               (1,000)                 -  
    6.375% Senior notes due 2023              800               800
    5.5% Senior Notes due 2020              600               600
    6.25% Senior Notes due 2021              800               800
    Capital Lease Obligation                  1                    1
    Total Debt          4,561               (2,360)          2,201
    Cash              119                     740             859
    Net Debt          4,442               (3,100)          1,342
           
    Total EV          7,540            4,440
    Total Assets          8,701    
    Book Equity          2,196    
           
    Wholesale EBITDA              337                        88             425
    Retail EBITDA              328                   (300)                28
    Total EBITDA              665                   (212)             453
           
    Debt/EBITDA            6.68              2.96
    EV/EBITDA          11.34              9.80
           
    Transaction Value                    3,300  
    x EBITDA                          16  
           
    EV at 10x EBITDA              4,530
    EV at 12x EBITDA              5,436
           
    Market Cap at 10x EBITDA              2,888
    per share              29.31
    Market Cap at 12x EBITDA              3,794
    per share              38.50

     

    Distributable Cash Flow    
    LTM EBITDA 453    
    Interest   -134    
    Maint Capex -50    
    DCF   269    
    Per Share             2.73    
             
    Total Cash per share           8.72    
    FCF yield ex cash 13.9%    
             
    Buyback Scenario      
    DCF   269    
    PF Shares   72.5077   Bought at $33
    DCF/share           3.71    
    Yield   13.1%    
             
    Releverage to 4x at 10x EBITDA purchase  
        Current Acquired Total
    EBITDA              453            131            584
    Interest            (134)            (23)          (157)
    Maint Capex            (50)            (14)            (64)
    DCF                  363
    per share                 3.68
    Distribution     330.0625
    per share                 3.35
    Yield       7.5%
    Target               44.66

     

     

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

    Catalyst

    Managment PF numbers

    Transaction for 200 more additional stores

    Sell Side Awareness

    Seven & I transaction closes

    Maintenance of distribution

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