SUN - Sunoco: Income Investors Should Take Note Of This Undervalued Opportunity

2023-06-02 22:05:50 ET

Summary

• Sunoco LP is a major player in the US oil and gas industry, with a diverse range of products and services, and a strong logistics infrastructure.
• SUN has seen consistent revenue growth over the past decade and recently closed its second acquisition in six months, purchasing 16 terminals from Zenith Energy.
• Despite potential risks from a US recession, Sunoco is well positioned for growth and investors should be confident in the company's leadership and strategy.

Note: SUN is a Master Limited Partnership and pays a distribution on a K-1, not a traditional dividend. This may not be appropriate for all tax situations nor is it generally appropriate in retirement accounts. Do your research prior to buying this ticker.

Thesis

Sunoco LP (SUN) is a well-run, and well-known, player in the energy industry. As such they've positioned themselves well in the industry and have been a stalwart payer of a distribution for many years (which they raised in the last quarter).

In this article we'll explore their range of products and integrations, their revenue, debt, distribution increase, and valuation. They're expanding, carry low debt, and have a very nice valuation. By the end you'll see why SUN stock is a decent add to any income portfolio.

Company Overview

Sunoco LP is vertically integrated into the midstream and downstream sectors of the oil & gas industry. The company is one of the largest independent fuel distributors in the United States, providing motor fuel to convenience stores, independent dealers, commercial customers, and distributors in more than 33 states and growing.

The company offers a diverse range of fuels – from branded to unbranded fuels to race fuels and specialty canned fuels. Sunoco LP offers one of the most diverse range of products and services in the industry.

But the company does more than just fuel. In fact, Sunoco owns and operates 27 terminals and four transmix facilities. On top of the fuel and reclamation sides of the business, Sunoco LP also has an enormous presence in retail solutions within the oil & gas industry.

The company also owns a portfolio of non-fuel products and convenience store solutions - including value added food & beverage services for convenience stores, gas station retail services, gas station equipment, and even offers commercial real estate services. Sunoco LP has an impressive logistics infrastructure as well - in both the midstream and downstream market.

Operations

Midstream Market

Sunoco has an extensive logistics infrastructure that supports their downstream business segments. The company owns 42 refined product terminals and features around 20 million barrels of total storage capacity.

The company also owns four transmix facilities located strategically around major oil and pipeline hubs throughout the United States. When you factor in the company’s transmix and reclamation segment of business, the company certainly is well integrated.

Downstream Market

Sunoco is vertically integrated into both the downstream and upstream markets, with their fuel distribution segment boasting claim to America’s largest independent fuel distributor. Sunoco has distributed around 8 billion gallons of fuel to their approximate 7,400 customers comprised of dealers, distributors, and commission agent customers – and to top it off the company has approximately 1,600 commercial customers.

Transmix & Reclamation Facilities

Transmix is a term people use when multiple fuel products are distributed through a common pipeline and transportation mixing occurs – hence the term transmix. Transmix is an unusable mixture of gasoline, diesel, and jet fuel that no longer meets the specifications of any original fuel product. In essence, transmix is generally considered the waste or unusable product.

But with Sunoco’s transmix facilities, a company dealing in petroleum transport can reprocess and reclaim this fuel that is also referred to as off-spec fuel. This allows customers to dispose of off-spec fuel in an environmentally responsible, yet profitable manner. Sunoco buys this transmix from terminal facilities, pipeline operators, fuel transport companies, and petroleum retailers all across the country. These facilities would likely remain profitable even in an economic downturn.

Revenue

Note: Data for 2015 is missing in the above chart. Their revenue was $12.28B that year.

Over the last ten years we see exactly what we want to see in a profitable company here - the "upwards and to the right" revenue curve.

Let's have a look at their segment revenue from their latest 10-Q :

We do see their revenue falling a little bit YoY for Q1 on a GAAP basis, however during their conference call, which we'll talk about below, they referenced an increase with adjusted EBITDA using non-GAAP measures. You can find that here.

Either way I'm not concerned about the overall growth of SUN as they've done a good job increasing their revenues in the past and all indications are that they will continue to do so.

Debt

SUN carries relatively little debt, especially compared to peers in the midstream and downstream markets. They have only $3.5B, a comparatively small amount that they can easily service. They've done an excellent job of keeping leverage multiples low and with an interest coverage ratio of 3.1x they have the payments well in hand.

Returning Value to Shareholders

They finally, for the first time in years, increased the dividend. It's been a very long time coming. It's a modest increase at only 2% however. Still, better than nothing. According to their Q1 earnings call (emphasis added by author):

On April 24, we declared an $0.842 per unit distribution, a 2% increase over last quarter. We plan to evaluate future distribution increases annually in the first quarter, balancing our financial metric targets and investment in growth opportunities.

...

Our base expectation has been enhanced by our most recent acquisition. As a result, we increased our guidance. These types of investments give us confidence that we will continue to deliver strong results year after year, thus, we announced a distribution increase.

Over the last 7 years, we have demonstrated our commitment to a secure distribution. We have never cut distributions even through unforeseen and challenging economic environments. Given that this is one of our key pillars, we’re very thoughtful as to any distribution increase. The decision to increase has to meet the following criteria, stay above our target coverage ratio, protect our balance sheet, remain a growth company, and, finally, a clear path to increase distributions again over a multiyear time frame. We’re confident the answer is yes on all of these factors.

Later on they took another question where they confirmed that they did have more runway than just the 2% increase, but wanted to keep the company's financials stable and not bite off more than they can chew.

Overall I believe this sounds like they're going to begin annual distribution increases, a huge boon for any investor that's in this name. Their distribution is already quite large, at present yielding 7.84%, and that growth in their distribution just adds icing to the cake.

Valuation

SUN is at its lowest EV/Revenue since Covid. Yeah, when oil briefly traded in the negatives. It's valuation is at the same level right now. I'll let that sink in for a moment.

It was worth $14 a share in the bottom of COVID, and it's worth $44 a share right now. But due to the changes in its Enterprise Value and strong increases in revenue it's actually valued about the same.

Now it has definitely made some big moves with recent M&A, so that's probably kept the price depressed relative to Revenue growth. Analysts are a little skeptical on revenue growth moving forward, but the company's guidance has increased after the acquisitions.

Normally you'd be right to be skeptical on the company's guidance - but in this case I'm not. They've made it very clear that cutting their distribution is not something that they want to do, so I find it hard to believe they would have increased it unless they were very sure of their guidance.

All in all I've got to believe that they're a bit undervalued here and a good buy at current levels.

Latest Earnings Call

There were a few key takeaways from the most recent earnings call that investors should take note of. Find the transcript here.

The outlook for the company remained positive throughout the call, highlighting a record adjusted EBITDA of $221 million, a 16% increase from the previous year. Additionally, the company sold 1.9 billion gallons of fuel last year, a 9% increase from the previous year. The company also announced a 2% distribution increase on the call, highlighting their commitment to providing a secure distribution for stakeholders.

Lastly, there was also discussion of the company’s plans for third-party business at the new terminals, and even expressed confidence in their ability to purchase terminals with a large third-party presence and grow that business with their third-party customers.

During the earnings call, the Senior Vice President and Treasurer for Sunoco Joe Kim spoke about the potential for more volume if more Americans start returning to the office rather than remotely. It's an interesting thought, but we'll need to see if that actually plays out. Personally I don't have any wish to ever work in an office again, and I know many others have followed suit.

Overall I think investors should be confident in company leadership and their growth strategy after having listened to the earnings call.

Conclusion

Sunoco is a name brand that a large majority of Americans would recognize immediately. They have an enormous retail presence to complement their vertically integrated combination of midstream and downstream business segments. Also they recently closed their second acquisition in the last 6 months with 16 terminals from Zenith Energy and have maintained a commitment to capitalizing on growth opportunities.

The major players in U.S. oil & gas are just itching for a sign or reason to avoid any production slowdowns and higher demand data would be the sign they want and need. If the American economic situation resolves and a recession possibility recedes into the background, the industry analysts and outlooks would stop hoping and relying on China demand to increase (as China has been so slow to recover after extensive Covid lockdown measures). And if this happens, Sunoco LP will be in line to see higher volumes, and thus higher revenues.

On the flip side of that hopefulness is the possibility of recession occurring in the U.S., and a slew of banking and market uncertainty. In the face of recession effects, Sunoco would certainly be affected as product margins will decrease and extended unemployment and reduced domestic demand would drop sales volumes for the company.

However, when compared to its peers Sunoco will be well shielded from potential negative effects as they own an enormous amount of storage capacity and also are into more than enough alternative markets with differing sources of revenue to avoid any catastrophic losses.

Current investors can hold happily and watch a strong balance sheet grow with continued secured distribution. Potential investors can also share in the growth excitement and could very well see only increasing profits – but investors should also know there could be safer value with less risk exposure found in other sectors of the oil & gas market that won’t be as directly affected by drops in demand and commodity price data.

For the least exposure to that sort of risk look at companies with mostly midstream assets. I recently wrote an article on EPD which is a great choice and very undervalued right now.

But overall, if you're looking to add another name to your portfolio, then I think SUN is a good choice for a buy, especially at this valuation. It's not the absolute best out there, nor does it have the least exposure to risk of recession, but it'll be a stable performer for the income minded investor.

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