Summary
- Despite CrossAmerica Partners enjoying a strong start to 2022, it still left their distributions skating on very thin ice.
- When conducting my previous analysis, they risked breaching the credit facility covenant at the end of the third quarter.
- To my surprise, they saw even stronger record-setting wholesale fuel margins during the third quarter, thereby resulting in surprisingly strong financial performance.
- This helped repay some of their debt and boosted their earnings, which averted this possible catastrophe.
- When looking ahead, they are still not fully out of the woods and thus I believe that only upgrading my previous sell rating to a hold rating is appropriate.
Introduction
Despite enjoying very strong operating conditions earlier in 2022, CrossAmerica Partners ( CAPL ) was still skating on very thin ice that as my previous article warned, left their distributions very risky. Much to my surprise and the relief of their unitholders, good fortunes came to the rescue with their already record-setting wholesale fuel margins climbing even higher during the third quarter, as discussed within this follow-up analysis.
Coverage Summary & Ratings
Since many readers are likely short on time, the table below provides a brief summary and ratings for the primary criteria assessed. If interested, this Google Document provides information regarding my rating system and importantly, links to my library of equivalent analyses that share a comparable approach to enhance cross-investment comparability.
Author
Detailed Analysis
After seeing extraordinarily good times during the first quarter of 2022 and continued improved cash flow performance during the second quarter, it seemed the best was in the past. Although to my surprise, this was not the case with the third quarter surpassing anything in their history and seeing their operating cash flow climb to $126.5m across the first nine months, thereby more than doubling in only one quarter versus the $54.7m they generated across the first half.
Since they continued to keep their capital expenditure under wraps, this translated into free cash flow of $99.5m that for the first time in their recent history, not only covered their distribution payments but even provided strong distribution coverage of 166.69%. Apart from their subsequently discussed leverage and liquidity issues, they have always struggled to cover their distribution payments across any material length of time, as observed during 2019-2021 whereby their coverage peaked at a still weak 87.75% during 2020.
If viewed on a quarterly basis, the sheer size of their operating cash flow of $71.8m during the third quarter of 2022 is easily apparent as it beats anything in recent history. Admittedly, this was helped along by a sizeable $19m working capital draw but even if excluded, their underlying result of $52.8m is still far higher than their equivalent result of $34.1m during the second quarter, which at the time was already their highest result.
When viewed against their wholesale fuel margins, it easily becomes apparent why their cash flow performance was so strong during the third quarter of 2022, as they reached record-setting levels of $0.125 per gallon. Apart from far surpassing their usual sub-$0.10 per gallon margins, this represented a surprising increase versus even their already record-setting margins $0.188 per gallon during the second quarter. It should be remembered that as a price-taker, it was largely outside of the hands of management and thus this surprisingly strong financial performance merely stems from good fortunes.
These are well and truly extraordinary times and thus as a result, it makes it even more difficult than normal to predict what the coming quarters will hold. Whilst the fourth quarter may still be strong, it is difficult to see these record-setting wholesale fuel margins persisting well into 2023, thereby opening the door to possibly see their historically weak distribution coverage re-emerge. Regardless of the extent, generally speaking in the medium to long-term, their financial performance is far more likely to soften as wholesale fuel margins normalize than to strengthen further, or even maintain these recent levels.
Thanks to their surprising cash windfall during the third quarter of 2022, they were finally able to make solid inroads to reduce their net debt with it falling slightly more than 5% to $748.8m from its previous level of $790.2m following the second quarter. This amounts to a decrease of $41.4m and obviously looking ahead, the direction their net debt takes will depend upon their yet-to-be-known wholesale fuel margins but if nothing else, thankfully this bought them more time.
Quite expectedly, their surprisingly strong financial performance sent their leverage plunging, as the third quarter of 2022 ended with a net debt-to-EBITDA of 4.24, which is down significantly from its previous result of 5.54 following the second quarter and now beneath the threshold of 5.01 for the very high territory. Meanwhile, their net debt-to-operating cash flow saw a comparable drop to 5.02 from 6.69 across these same two points in time, thereby now sitting ever-so-slightly into the very high territory. The fact that even record-setting wholesale fuel margins and resulting financial performance still sees their leverage this high, indicates they have minimal scope for distribution growth in the foreseeable future, even if weak coverage does not return.
Apart from sending their leverage plunging during the third quarter of 2022, their surprisingly strong financial performance also helped support their debt serviceability, which is becoming increasingly important to consider as interest rates climb rapidly. To this point, the third quarter saw interest expense of $8.4m versus the second quarter that was only $7.3m and whilst a $1.1m difference may not sound too much, the relative change of circa 15% is quite significant given it was across merely two sequential quarters. Since the Federal Reserve is still pushing interest rates higher, obviously this upwards pressure will continue into the foreseeable future.
Worryingly, even with their surprisingly strong financial performance, their interest coverage was still only 3.18 when compared against their accrual-based EBIT. Whilst this is sufficient, it would have been preferable to see a far stronger result given these best-ever operating conditions, as the likelihood of softer results going forwards leaves it vulnerable of falling back below 2.00 into dangerous levels. If comparing against their cash-based operating cash flow, it sees interest coverage of 5.66 and whilst this is better and considered healthy, once again, it remains lackluster given these operating conditions and thus along with their leverage, it sees weak prospects for distribution growth.
Whilst the benefits to their leverage are important, as anyone familiar with my previous article will likely remember, by far the most important aspect is actually their liquidity, which left them skating on very thin ice. Their issue did not stem from their current ratio of 0.66 but rather, it was due to the leverage ratio for their credit facility covenant of 4.85 following the second quarter of 2022 sitting above the limit of 4.75 that came into effect following the end of the third quarter. Since they rarely produce excess free cash flow after distribution payments and only see low cash ratio of 0.07, they are reliant upon their credit facility for liquidity and thus remain a going concern. Once again thanks to their surprisingly strong financial performance, they were able to achieve this feat and avert a possible catastrophe, as per the commentary from management included below.
“…our blended aggregate leverage ratio would be about 4.14 times compared to 4.85 times at the end of the second quarter of 2022 and 5.11 times at the end of the fourth quarter of 2021.”
- CrossAmerica Partners Q3 2022 Conference Call.
If not for this good fortune, their story would be vastly different right now as breaching these limits can even trigger bankruptcy and thus at best, unitholders would have been forced to endure a very large distribution cut or suspension. Thankfully, such an outcome did not eventuate and thus now their liquidity is adequate for the moment but obviously, if their financial performance softens going forwards, which in my eyes should be expected, their leverage ratio will climb higher once again. As a result, it means they are not necessarily out of the proverbial woods until they reduce more of their debt, which largely depends upon how long these record-setting wholesale fuel margins will last.
Since 2022 is far from a normal year, to make their distributions safe, their leverage ratio would have to remain below its limit of 4.75 when utilizing their full-year results for 2021, which saw broadly normal operating conditions. At the time, it saw a result of 5.11 and thus to achieve a safe margin below this limit, it would have to be no higher than 4.50. If holding the earnings component of this metric steady with 2021, this would require their debt to be reduced by circa 12% to $723m from its previous level of $821.6m at the end of 2021. This would represent a decrease of circa $37m versus where it ended the third quarter of 2022, which in theory, could be achieved during the fourth quarter if their record-setting operating conditions persist, as the third quarter saw a circa $40m decrease. It should be remembered that even if they reach this point, their historically weak distribution coverage could still re-emerge as operating conditions normalize, thereby seeing risks return.
When looking elsewhere, 2023 should be a relatively easy year to navigate as they face very minimal debt maturities. Although, if casting an eye on 2024, they see $607.8m of their debt maturing, which is the majority and thus unless this is promptly addressed, this time next year there will be fresh risks for their distributions.
CrossAmerica Partners Q3 2022 10-Q
Conclusion
Ultimately, only time will tell whether they can sufficiently reduce their debt to permanently shake the risk of breaching their credit facility covenant. Thanks to the good fortunes of their record-setting margins and thus surprisingly strong financial performance, they made solid inroads and bought more time. Since short-term risks have subsided, I now believe that upgrading my previous sell rating is appropriate but at the same time, medium to long-term concerns remain and thus I am only changing to a hold rating. At least with their unit price down mid-single digits following my previous article that issued the sell rating, nothing was missed, which also indicates the market is also skeptical that this one very strong quarter will persist well into the future.
Notes: Unless specified otherwise, all figures in this article were taken from CrossAmerica Partners’ SEC filings , all calculated figures were performed by the author.
For further details see:
CrossAmerica Partners: Good Fortunes Came To The Rescue