Lock In a 9.0% Distribution Yield on This MLP Before It Falls Further

As the S&P 500 has doubled off its bottom last year, it has become hard for income investors to identify solid high dividend stocks. In the current environment, when a stock offers a high yield, it usually signals that a distribution cut may be just around the corner. Sunoco LP is a bright exception. The master limited partnership (MLP) is offering a 9.0% distribution yield, which should be considered safe for the foreseeable future. This makes Sunoco highly appealing for income investors looking for higher yields in today's market. Business Overview Sunoco LP, which was founded in Texas in 2012, is an MLP that distributes a range of fuel products through its wholesale business units. It purchases fuel products from refiners and sells those products to both its own and independently owned dealers. Sunoco LP is one of the largest independent fuel distributors in Texas and is also among the top distributors of Chevron , Exxon , and Valero - branded motor fuel in the rest of the U.S. In 2019, it distributed approximately 8 billion gallons. In the fuel wholesale industry, a great scale is paramount, as it results in higher margins and a better negotiating position with suppliers. Most energy companies are greatly affected by the swings of the prices of oil and refined products. On the contrary, Sunoco LP earns a fairly stable margin from its gasoline sales, around $0.10 per gallon. If the price of gasoline rises or falls, Sunoco LP passes this change to its end customers. It thus enjoys fairly predictable and reliable cash flows, regardless of the cycles of the energy market. The reliability of the cash flows of the MLP is also enhanced by the long-term contract with 7-Eleven, which is obliged to pay a minimum amount to Sunoco LP every year, even if it purchases lower volumes than expected. Growth Prospects Sunoco LP benefits from favorable trends in its business. The demand for U.S. gasoline has grown consistently over the last two decades. It incurred a shock last year due to the coronavirus crisis but it has returned to 9.5 million barrels per day this year, close to its all-time high of 9.7 million barrels per day. As the recovery from the pandemic continues, the demand for gasoline is likely to post new all-time highs in the upcoming years. The demand for gasoline is expected to remain strong thanks to the continuing preference of consumers towards large vehicles and the healthy underlying economic growth. Furthermore, the consumption of diesel is likely to grow significantly in the upcoming years. Sunoco LP enjoys wider margins in diesel than it does in gasoline. It is also worth noting that Sunoco LP agreed to acquire eight refined products terminals from NuStar Energy for $250 million a few weeks ago. This acquisition is expected to be accretive to earnings immediately after closing. Overall, Sunoco LP can be reasonably expected to grow its cash flows in the upcoming years, albeit at a slow pace. Competitive Advantages As mentioned above, Sunoco LP is one of the largest independent fuel distributors in Texas and among the top distributors of Chevron, Exxon, and Valero. Its great scale constitutes a major competitive advantage, as it offers the MLP great negotiating power. Moreover, branded fuel offerings, such as the Sunoco brand, provide a margin uplift above unbranded fuels, as most consumers do not trust unbranded products and hence they are willing to pay a premium for branded products. Distribution Sunoco LP is currently offering a 9.0% distribution yield. Since its formation, in 2012, the MLP has never cut its distribution. On the other hand, it has frozen its distribution for four consecutive years, thus signaling that it is somewhat struggling to maintain its generous distribution. The abnormally high distribution yield has resulted from the cheap valuation of the stock, which is currently trading at only 6.4 times its expected earnings this year. The primary reason behind the low valuation is the material debt load of the company. The net debt of Sunoco LP (as per Buffett, net debt = total liabilities - cash - receivables) currently stands at $4.2 billion. As this amount is 140% of the market capitalization of the stock and 14 times the free cash flows in the last 12 months ($293 million), it is natural that it has led the investing community to be cautious in its valuation of the stock. However, investors should note that Sunoco LP has a healthy payout ratio of only 49% while its interest expense consumes only 25% of its operating income. Moreover, management has reduced its target leverage ratio (net debt to EBITDA) from 4.50-4.75 to 4.0, which has already been achieved. Furthermore, Sunoco LP has well-laddered debt maturities and enjoys much more reliable cash flows than most MLPs. To be sure, in the unprecedented downturn caused by the pandemic last year, the MLP grew its distributable cash flow per share 15%, from $5.42 to $6.23. That performance was in sharp contrast to the vast majority of oil companies, which posted material losses or saw their earnings collapse. To cut a long story short, the distribution of Sunoco LP should be considered safe for the foreseeable future. A potential risk factor is the growth of sales of electric vehicles, which is expected to take its toll on the consumption of gasoline at some point in the future. However, this transition is likely to be slow due to the low starting point of current sales of electric vehicles (1.9% in 2019). Even in a high-growth scenario, electric vehicles will comprise only 25% of the total U.S. fleet by 2040. Overall, the emergence of electric cars is likely to prove a very long-term threat for Sunoco LP. Another headwind is the increasing fuel efficiency of vehicles. However, this headwind has been offset so far by the shift of consumers to heavier vehicles over the last decade. This shift has partly resulted from the relatively low gasoline prices, which have prevailed over the last seven years. As gasoline prices are not likely to return to their highs posted in 2012-2014, Sunoco LP is likely to continue to benefit from the preference of consumers for large vehicles for the foreseeable future. Final Thoughts When a stock offers an abnormally high yield, most investors dismiss the stock, fearing that a distribution cut is imminent. While such a strategy is warranted in most cases, it does not apply in the case of Sunoco LP. The MLP covers its distribution with a wide margin of safety, with a payout ratio of 49%, and enjoys reliable cash flows thanks to its defensive business model, which is resilient to the downturns of the energy sector. Investors should lock in the 9.0% distribution yield of the stock before it falls further.

Lock In a 9.0% Distribution Yield on This MLP Before It Falls Further

This MLP covers its distribution with a wide margin of safety, making it highly appealing for income investors.

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