Found Money at 7-Eleven

Sunoco (SUN) did the right thing at the wrong time, at least for me.

Over the many months of the steady decline in equity value, I’ve been asked repeatedly if the time was right to take the plunge. And I always responded with some variation of not yet, noting that Sunoco’s convenience store business was at risk in the event of a significant increase in gas prices.

So of course Sunoco went and sold most of its convenience stores, 1,100 in all to 7-Eleven, with 200 more on the auction block to reposition the partnership as mostly a wholesale distributor (and perhaps as a refinery logistics player.)

The hefty $3.3 billion sale price has been largely earmarked for the paydown of debt with the aim of returning leverage from deeply worrisome to something like acceptable.

Source: Sunoco presentation

And of course the deal got announced last Thursday while I was busy presenting at the Wealth Society summit. That meant I spent part of my weekend poring over Sunoco’s security filings to figure out how the new deal might shake out.

Management says that in addition to the reduced leverage the announced sale and the additional asset disposals to come will preserve the current distribution with a 1.1 coverage ratio.

Which, if true would sure be a pretty sweet deal given that SUN still yields 11.2% even after its 23% rally Thursday and Friday.

I also heard management hem and haw at every turn when asked by analysts to back up its breezy optimism with some numbers. Pro-forma EBITDA after selling off the stores? Sorry, no can do. Expected tax bill? Somewhere in hundreds of millions, maybe. They’ve got preliminary models with lots of unknowns, including the amount of proceeds from remaining store sales and the cost of potential acquisitions to rebuild the cash flow.

Because, as management grudgingly acknowledges, it will need rebuilding, the loss of the convenience stores, even with the new 7-Eleven wholesale supply contract, will cut Sunoco’s EBITDA by nearly 40% and its distributable cash flow by 30%. By my math, that makes management’s pledge to deliver 1.1x coverage on the current distribution a stretch but not a mission impossible. After paying down debt Sunoco would have approximately $640 million in cash to replace perhaps $130 million in forfeited distributable cash flow. If it borrowed as much to buy a refinery logistics partnership for $1.3 billion, that might just work. But, as I said, there are too many unknowns and modest changes in a few of the assumptions can lead one to very different conclusions.

The conclusion I’ve reached is that the 11% yield provides sufficient error margin for speculating on further upside, but not for a long-term commitment.

Beyond the haziness of management’s financial forecast looms existential risk from a general partner whose interests are not aligned with those of the LPs.

Energy Transfer Equity (NYSE: ETE) could opt to reset its incentive distribution rights, thereby diluting current unitholders. Alternatively. Energy Transfer Partners (NYSE: ETP) could sell some or all of its nearly 38% stake in Sunoco’s common units.

But I don’t believe either step is likely in the near term. The less remote risk is simply that Sunoco overpays for an acquisition in its haste to replace the convenience store income. But, again, that’s why the yield’s above 11%. I’m adding SUN to the Aggressive Portfolio with a limit of $33.

 

Stock Talk

Derek: Las Vegas, NV

Derek: Las Vegas, NV

Hi Igor, it was a pleasure meeting you at the summit; I enjoyed your presentations and #1 picks. You state that this trade would not be long term, what is your anticipated hold time and what news/developments would you need to see that would trigger a sell.

Thanks!

Derek

Igor Greenwald

Igor Greenwald

Hi Derek, really enjoyed meeting you and Capt. Alice as well! The event catalyst I’m looking for here is the sale of the remaining 200-some mainland gas stations and possibly an M&A announcement. They have to replace the sold cash flow somehow and the stated alternative, buying back units, makes no sense whatsoever for the sponsor. If sale, purchase and related tax hit prove favorable and the distribution is maintained as promised this thing could get to 35+ quickly, at which point I’d be looking to take a partial profit at least. And if there’s a hiccup the 8% or so yield it can deliver just from the retained wholesale business should cushion the downside.

Igor Greenwald

Igor Greenwald

In terms of actual timing the 7-Eleven sale is due to be completed before the end of the year and I’d expect more news before then.

Thomas Butch

Thomas Butch

Greetings,

I have been reading a great deal about the recent oil finds in the Permian Basis, together with a significant amount of activity there..

Could you please explain which MLPs are likely to benefit from these matters.

Thank you.

Igor Greenwald

Igor Greenwald

The Permian is absolutely the place to be in terms of current shale investment, and as a result it requires a lot of midstream assets to gather and process the gas and the NGLs, gather and ship the crude and do all the other things that must be done with hydrocarbons above the wellhead. Among current recommendations, EPD, ETE, ETP/SXL, MMP and PAA are most tied into that basin. I’ll just note that that Permian “story” is well known, so is unlikely to serve as a catalyst for appreciation. Higher energy prices would almost surely do the trick, though.

Igor Greenwald

Igor Greenwald

Two other biggies worth mentioning in connection with the Permian are KMI and DPM.

pipeline

pipeline

Igor
two questions ,
how often are you going to update your 2017 best buy list and how will we be notified?

Since the WNB /SE merger do you still like SEP as a conservative pick? or do you prefer EEP ?
I have lost money on EEP since owning it 3 yrs ago. Neither one is currently in your top 20

Igor Greenwald

Igor Greenwald

In recent years I’ve published a revised Best Buys list in the second half of the year, including some holdovers and some new picks. Don’t want to commit to one right now, but probably will need to do that again this year. On EEP vs SEP, very different risk profiles and therefore yields, obviously, even accounting for EEP’s telegraphed distribution cut. Also, SEP is a natural gas and NGL transmission play while EEP ships Canadian crude, mostly. They’re both moderately attractive buys at current prices and it’s hard to say more until we know more of Enbridge’s plans for both. I continue to hold EEQ in retirement accounts I manage for my parents, for what that’s worth.

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