Sunoco-NuStar Transformation Will Fuel Growth And Secure Dividend

seekingalpha09-27 01:00

Sunoco LP's acquisition of NuStar Energy creates a vertically integrated oil and gas giant with a market cap of $7.36 billion and extensive pipeline and terminal assets.The Q2 2024 earnings report ...

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JHVEPhoto Sunoco LP (NYSE:SUN) is a midstream oil and gas master limited partnership (MLP) with a broad wholesale and retail fuel distribution network primarily serving convenience stores, dealers, and commercial customers in the US. SUN operates in over 40 US states, Puerto Rico, Europe, and Mexico. Following the acquisition of NuStar Energy, it now also has an extensive pipeline network of around 14,000 miles and over 100 terminals. The new combination of its midstream and downstream assets makes it a strong vertically integrated player in the oil and gas distribution business with a market capitalization of $7.36 billion. The transformational transaction between Sunoco and NuStar Energy has many implications for the financials that should be considered when deciding whether to invest. NuStar Energy Acquisition In May 2024, SUN completed the acquisition of NuStar Energy in a deal that was valued at around $7.3 billion. This included the following transactions:  NuStar common unit holders received 0.4 SUN common units for each single NuStar unit in a transaction valued at $2.9 billion SUN took on around $3.5 billion of NuStar debt SUN took on preferred units of $800 million  The acquisition transfers the 9,500 miles of pipeline and 63 terminal and storage facilities over to SUN, which creates a diversified giant in the midstream and downstream oil and gas industries. In 2023, NuStar reported full-year revenues of over $1.63 billion and a net income of $273.7 million. It operated in three segments, Pipeline, Storage, and Fuels Marketing. The Pipeline segment saw a total crude and refined product throughput of 1.84 million barrels per day (b/d) which generated revenues of $873.9 million and an operating income of $483.2 million. The Storage segment saw total throughput of 448.3 thousand b/d, generating revenue of $319.6 million and operating income of $87.6 million. The smaller Fuels Marketing segment brought in operating income of $32.9 million on product sales totaling $440.7 million. As the map demonstrates, these operations are mostly concentrated in the center of the US, with some terminal assets on the West Coast.   NuStar Along with these new assets, SUN was also forced to take on a substantial amount of debt totaling around $3.5 billion broken down between about $135.4 million in current liabilities and $3.39 billion in long-term liabilities. The long-term debt includes $600 million in 5.75% senior notes that mature in October 2024 and $500 million in 6.00% senior notes that mature in June 2026 which now become SUN’s most current long-term notes to consider. This heavy debt became very expensive to hold as the Fed hiked interest rates in 2023. NuStar reported total interest expense of $241.4 million in 2023 which was an almost 20% increase over what was paid in 2024. It goes without saying that the main risk for SUN is the amount of leverage it is taking on in this acquisition. Q2 Earnings The most recent Q2 2024 earnings reported was the first financial update following the NuStar acquisition (which was completed in May 2024), and it largely suggested that the initial stages of the integration had been successful. Adjusted EPS of $1.48 was well above analyst expectations, and total revenue also came in with a $352 million edge over projections at $6.17 billion. On an unadjusted basis, SUN saw net income increase from $87 million in Q2 2023 to $501 million in Q2 2024, though those numbers were largely impacted by several one-off transactions impacting the bottom line after considering operations. Before those impacts, SUN shows that it saw 6.4% YoY growth in operating income, which came from positive performances across segments. The Fuel Distribution segment, the SUN segment least affected by the acquisition, showed solid growth despite the challenging oil and gas environment. Segment revenue increased 3.6% YoY to $5.91 billion on a 5.2% YoY increase in volumes. While fuel margins for the quarter edged down slightly from $0.119 in Q2 2023 to $0.118 in Q2 2024, Fuel Distribution reported an adjusted EBITDA increase of 8.4% as it dropped expenses by about -10.8% YoY. The decrease in expenses was a result of SUN’s divestiture of 204 convenience stores to 7-Eleven (known as the “West Texas Sale”) which earned SUN a cash profit of $598 million and was the primary reason for the increase in the unadjusted net income gain. At first glance, the sale looks to have been a successful unloading of some expensive assets for some cash, while leaving fuel gallons sold largely unchanged.   Sunoco The NuStar acquisition had major impacts on the remaining two SUN segments, Pipeline Systems, and Terminals, and added profits totaling $261 million in Q2 2024. Pipeline Systems, which is an entirely new segment, reported a profit of $172 million and an adjusted EBITDA of $53 million, which includes a one-time transaction cost of $58 million. In Q1 2024, NuStar reported its Pipeline Segment operating income at $119.4 million. SUN’s Terminals segments were more developed before the acquisition but saw a sizeable increase of over 50% YoY in throughput due to newly acquired assets. This segment’s profits increased to $89 million while adjusted EBITDA of $22 million was mostly flat YoY but was impacted by a $21 million one-time transaction cost. NuStar’s Storage segment is most similar to SUN’s Terminals operations, and it reported operating income of $23.7 million in Q1 2024.   Sunoco, NuStar From an operational standpoint, the acquisition is starting off well. According to Q1 2024 total revenues of $390.9 million for NuStar and $5.499 billion for Sunoco, total revenues for Q2 2024 should have probably come in below $6 billion at just below $5.890 billion. This projection was confirmed by Wall Street analyst consensus expectations, which saw revenues of around $5.82 billion for the last quarter. In this context, SUN’s total revenue of $6.17 billion looks like a strong beat and a major source of optimism. Even when YoY growth in Fuel Distribution revenues of $203 million is removed from the total top-line number, the revenue number beats analyst expectations and is above the combined Q1 revenues at $5.971 billion. Debt While top-line performance is important, the key for SUN will be converting top-line success to cash flow to help manage its debt situation while maintaining cash flow for investors who are mainly investing for a strong dividend yield. The acquisition has come with a major increase in long-term liabilities, which will also include an increase in quarterly interest expenses, which will impact profits and distributions. Seeking Alpha recently ranked SUN as the 3rd best high-yielding dividend stock with a market cap of at least $1 billion, so this analysis is of utmost importance.   Sunoco, Seeking Alpha From Q1 2024 to Q2 2024, SUN’s long-term liabilities have surged from $6.27 billion to $10.14 billion as its long-term debt almost doubled to $7.16 due to the company taking on all the debt mentioned above in the acquisition discussion. The increase of long-term debt has led to the company’s reported leverage ratio, calculated as net debt to adjusted EBITDA, to increase to 4.1x from 3.9x a year ago and 4.1x from Q1 2024. This puts its leverage ratio above its target level of 4.0x as noted in a June 2024 investor presentation. This ratio was calculated according to its credit facility’s covenant. In my calculations using net debt and the adjusted EBITDA that excludes transaction-related expenses of $80 million as a projection of EBITDA for four quarters, the leverage ratio actually looks to be about 4.4x. This is the highest since the first quarter of 2022. Another concern for SUN is the rising cost of debt, as seen in the sharp increase in interest expenses in Q2 2024 from new debt obligations and high-interest rates. Net interest expense was reported at $95 million in Q1, up from $53 million in Q2. On a TTM basis, interest expenses have risen from less than $200 million at the end of 2022 to over $270 million now. That has caused SUN to be wary of its declining coverage ratio. The latest data has its interest coverage ratio dropping just below 3.0x, but largely maintaining that level. However, this ratio should improve as interest rates continue to decline with Fed rate cuts, and SUN can start to borrow at cheaper rates.   Sunoco, Seeking Alpha While the acquisition has caused a short-term deterioration in SUN’s debt position, the company’s credit rating has only gone up. Around the time of the completion of the acquisition, both S&P and Moody’s upgraded SUN’s credit ratings, noting that the addition of NuStar would not destabilize the company’s financials and, in fact, would be a major source of growth. S&P specifically noted that while leverage ratios would be in the “mid-4x area” in 2024, it sees SUN “deleveraging to about 4x by fiscal 2026” as it realizes synergies from more diversified operations and a new edge from vertical integration that would lead to “EBITDA expansion of roughly $200 million through fiscal 2026.” However, this optimistic outlook is based on the requirement that SUN keeps its leverage ratio in that mid-4x area. S&P notes that it could lower the rating back down if SUN’s leverage ratio “approached 5x.” What does all this mean for SUN’s dividend? Dividend The oil and gas MLP is mostly held for its strong dividend, which has been consistent for over a decade. SUN’s dividend payout had been unchanged at $3.30 annually from 2017 through 2022, even remaining at that level through the volatility of the pandemic. That changed in just the last two years, as SUN increased the dividend payout twice since the start of 2023, increasing the annual payout by 20 cents to $3.50. This payout puts the dividend yield at 6.56% as of September 25th which puts it slightly below the midpoint of the 52-week range of 5.39% to 7.52%.   Sunoco Based on the distributable cash flow reported by SUN, the recent dividend raises appear to be affordable. In Q2 2024, the first quarter of combining cash flows with NuStar, total distributable cash flow, adjusted for transaction costs was $295 million which puts the distribution coverage ratio at 1.9x. In the past three years, this is one of the healthier readings. SUN’s investor presentation noted that it would like to keep its coverage target above 1.4x, and when considering the four-quarter trailing average of this ratio, it is above target, though it has been decreasing over the last four earnings reports.  The good news is that realized synergies will fuel solid EBITDA growth that, combined with lower interest rates, should continue to support SUN’s dividend going forward. Even through the acquisition, distributable cash flow as a percentage of adjusted EBITDA (ex-transaction costs) was 74% in Q2 2024 which is consistent with the 70 to 75% range that has been observed since 2022. This allows management to easily cover current distributions and maintain a healthy debt position as the company continues to grow organically (S&P sees EBITDA expansion of $200 million through 2026 from organic growth) and through NuStar integrations. I assign Sunoco LP stock a Buy rating and agree with Seeking Alpha’s assessment that this is one of the most solid large-cap dividend stocks in the sector.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.28.1","shortVersion":"4.28.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2470036763"}