Quarter after quarter, retail fueling partnership Sunoco (SUN -1.00%) has been getting hit with operational challenges. The company has tried to power through them by way of acquisitions, but this quarter that all came to a head as it was forced to take some big writedowns and its cash flow dried up. If the company continues at this rate, that high yielding distribution won't be around much longer. Here's a quick run down of Sunoco's most recent results and why the company looks to be in real trouble.
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By the numbers
| Results* | Q4 2016 | Q3 2016 | Q4 2015 |
|---|---|---|---|
| Revenue | $4,306 | $4,317 | $4,077 |
| Adjusted EBITDA | $153.6 | $188.9 | $188.7 |
| Net income per share | ($6.32) | $0.24 | $0.13 |
| Distributable cash flow | $56 | $124.1 | $88 |
| Distribution coverage ratio | 0.61 | 1.25 | 1.04 |
*IN MILLIONS, EXCEPT PER-SHARE AND COVERAGE RATIO DATA. DATA SOURCE: SUNOCO LP EARNINGS RELEASE.
So there is one thing that is only sort of bad and one thing that is really bad in this earnings report. The sort of bad thing is that huge per share loss of $6.32. Most of that is attributable to $673 million in writedowns. More than $600 million of that was a goodwill impairment in its retail fueling business, which basically is an admission that it had overpaid on several of its recent acquisitions. From a numbers perspective, this is a one time, non cash thing that isn't going to change the day to day operations of the company. Although, it's not exactly encouraging that management -- a team that has made acquisitions a pillar of its growth strategy -- is already showing that it has been over spending on acquisitions.
The really bad thing in this report is the rapidly evaporating distributable cash flow. From an operating income standpoint, things aren't that bad. There was an inventory adjustment charge of $39 million in the quarter that lowered adjusted EBITDA, but these kinds of charges are common in the refining and retail business. This time last year, the company had a $64 million benefit from inventory adjustments. Ultimately, these things come out in the wash.
The real issue is that cash interest expenses have wildly outpaced operational income growth. Cash interest expenses in Q4 2015 were $27 million versus $53 million for this prior quarter. That, coupled with some newly issued shares, led to a distribution coverage ratio that shows the company isn't able to maintain its current distribution payments.
The (not so) highlights
This past quarter was a tough one, the company disclosed back in December that the company was at risk of violating some of its debt covenants, and therefore had to amend some of its credit facilities. As a result, the company has basically been put on a debt diet that it has to meet. Here's what that schedule looks like:
- SUN's Maximum Leverage Ratio will be increased to 6.75x beginning in the fourth quarter 2016 through 12/31/2017
- 6.50x at 3/31/2018,
- 6.25x at 6/30/2018,
- 6.00x at 9/30/2018,
- 5.75x at 12/31/2018,
- 5.50x at 3/31/2019 and thereafter
As part of that de-leveraging, the company has recently agreed to pursue strategic alternatives -- management speak for sell -- 99 real estate assets varying from company owned stores, greenfield sites, and other excess real estate. Basically, it's disposing of the assets it could use to grow the business without having to make acquisitions.
All of these things seem to suggest that a distribution cut is going to happen relatively soon. It can't meet the cash needs of its existing distribution with its high debt load, it can't issue debt to grow the business, and it needs to grow its cash flows to either lower those debt metrics or pay down debt absolutely. Aside from selling some of its few growth assets, it will most likely need to raise a lot of equity to meet these objectives.
What a Fool believes
Sunoco is in trouble, there is no getting around it. The underlying business isn't in trouble, but management has painted itself into a financial corner with too much debt and little options to grow without cutting its payout. Perhaps I'm wrong and the management team can pull this off while maintaining its distribution that yields close to 12%, but I'm not willing to make a financial bet on that outcome.
