SUN - Sunoco: An Attractive Investment Prospect At An Unattractive Price Point

2024-01-19 11:37:35 ET

Summary

• Sunoco LP has delivered impressive stock performance, trading at historic highs and surpassing revenue expectations.
• Concerns for potential investors include a decline in YoY revenue and a high payout ratio.
• Sunoco has taken strategic actions to improve its financial health and growth opportunities, such as divesting convenience stores and considering the acquisition of international liquid fuel terminals.

A year ago, I introduced Sunoco LP ( SUN ), a Master Limited Partnership ((MLP)) in the energy sector, as a promising investment opportunity . The appeal was its generous dividend and potential for growth, driven by an aggressive acquisition strategy . Fast forward to today, the stock has delivered impressive total returns of 45.59% . Currently, Sunoco is trading at historic highs, and its FWD price-to-earnings ratio has increased since my initial coverage. This upward trend, however, has been accompanied by an increase in short interest from 1.13% to 7.8%, suggesting a shift towards negative market sentiment.

Areas of concern for potential investors are a YoY decline in revenue and the company’s high payout ratio. However, Sunoco has recently divested 204 convenience stores , generating proceeds of $1 billion, a strategic move that should improve its financial health. Additionally, the company’s acquisition intentions into international markets signals potential avenues for future growth. Despite these positive developments, the stock is currently trading above its average target price of $56.13. Given this scenario, I would advise a ‘wait-and-see’ approach, holding off on new investments until a more favourable price point emerges.

Company updates

In my previous article, I gave an overview of Sunoco . In FY 2022, Sunoco, like many oil companies, reported exceptional results, largely driven by high oil pricing . Although the YTD performance for FY 2023 is somewhat weaker, it still significantly outperforms the results from FY 2021. Over the past four quarters, Sunoco has consistently surpassed revenue expectations despite a year-on-year decline. However, it’s important to highlight that the company fell short of EPS expectations in two of the most recent four quarters.

Sunoco has also undertaken some actions that could impact its growth and profitability. Firstly, Sunoco has entered into an agreement to 204 convenience stores to 7-Eleven for an estimated $1.0 billion. This transaction is anticipated to improve Sunoco’s financial standing, decrease its leverage, and free up capital for prospective growth opportunities. Secondly, in a move to broaden its global footprint, Sunoco plans to acquire liquid fuel terminals from Zenith Energy in Amsterdam, Netherlands, and Bantry Bay, Ireland. These terminals are strategically situated and serve as pivotal hubs for the international energy market. This acquisition is expected to optimise Sunoco’s supply chain, diversify its portfolio, and generate a stable stream of midstream income.

In its December presentation , Sunoco reaffirmed its FY 2023 guidance and given an FY2024 EBITDA guidance range of $975 million to $1 billion. This projection reflects the company’s optimism in its financial outlook and indicates the potential for consistent returns for investors.

Financial updates

During the last seven years, Sunoco has shown remarkable growth with its top line more than doubling. Its TTM revenue stands at $23 billion, which is slightly lower than its FY2022 results. However, the company's bottom line is quite impressive with TTM net income of $555 million, surpassing its FY2022 results.

In Q3 2023 , Adjusted EBITDA and Distributable Cash Flow saw slight decreases compared to Q3 2022. TTM levered free cash flow is negative $76.6 million and we can see cash burn over the last four years. We can expect the sale of 204 of its convenience stores to help improve its cash flow.

As of November 30, 2023, Sunoco demonstrated sufficient liquidity under its $1.5 billion revolving credit facility. The company maintained liquidity of approximately $847 million at the end of Q3 2023. Additionally, the next senior note maturity of $600,000 is not due until 2027, providing further financial stability.

For dividend-focused investors, Sunoco continues to be an attractive investment. The company boasts a forward dividend yield of 5.42%. Despite a modest 5-year growth rate of 0.3%, Sunoco has consistently rewarded its investors, underscoring its commitment to shareholder returns.

Valuation

Sunoco’s stock has demonstrated a robust upward trajectory over the past year, consistently outperforming the S&P 500 index each quarter. This momentum has propelled the stock to trade above its average price target of $56.13 . The forward price-to-earnings (P/E) ratio has escalated to 10.70, up from 7.96 in my previous analysis. This surge in the P/E ratio could potentially signal an overvaluation, making the stock appear less attractive at its current price point. However, it’s worth noting that the P/E ratio still resides below its five-year average of 12.25, suggesting some room for growth.

In their December presentation, Sunoco’s management projected an Adjusted EBITDA CAGR of 8%. This projection would translate to an FY 2023 adjusted EBITDA of $935 million and a potential leap to $1 billion by FY 2024. This growth trajectory presents a compelling case for investment in Sunoco. However, given the current P/E ratio, potential investors might want to adopt a wait-and-watch strategy for a more favourable entry point.

Risks

Sunnova operates as a master limited partnership (( MLP) ), primarily focusing on the distribution of gas. Although MLPs trade similarly to common stocks, they have a very different ownership structure, which can impact your tax filings. Investors should be aware of the benefits and risks of MLPs . Furthermore, the rise of EVs could pose a risk to Sunoco’s gasoline distribution business. However, Sunoco estimates that even with strong EV sales, they will only account for around 25% of the U.S. automobile fleet by 2040 . While we have seen the company divest 204 convenience stores worth $1 billion, Sunoco could still face the risk of a dividend cut due to its high payout ratio, currently at 60.28%.

Final thoughts

Sunoco has been a rewarding stock over the past year, delivering total returns of 45.59% and trading at historic highs. Despite a YoY decline in revenue and a high payout ratio, strategic moves such as the divestment of 204 convenience stores and planned acquisitions in international markets indicate potential for future growth. However, I am cautious of an increase in short interest and that the stock is trading above its average target price. The company’s financial health is expected to improve with the proceeds from the divestment, and the acquisition of liquid fuel terminals should diversify its portfolio. While Sunoco’s FY2024 EBITDA guidance reflects optimism, due to the current trading price, I recommend a ‘wait-and-see’ hold approach.

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