Sunoco LP (SUN) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Sunoco LP Third Quarter Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Scott Grischow, Senior Director of Investor Relations and Treasury. Thank you, Mr. Grischow. You may begin.

Thank you. Before we begin our prepared remarks, I have a few of the usual items to cover, a reminder that today's call will contain forward-looking statements.

These statements are based on management's beliefs, expectations and assumptions. They may include comments regarding the company's objectives, targets, plans, strategies, costs and anticipated capital expenditures and anticipated timing for the completion of the announced and prospective retail divestment transactions. They are subject to the risks and uncertainties that could cause the actual results to differ materially as described more fully in the company's filings with the SEC.

During today's call, we will also discuss certain non-GAAP financial measures, including adjusted EBITDA and distributable cash flow, as adjusted. Please refer to this quarter's news release for a reconciliation of each financial measure.

Please note that last quarter, SUN moved the operating results, assets and liabilities of our operation that are part of our retail divestitures into discontinued operations. As such, the results presented on today's call are based on continuing operations, unless otherwise noted.

Also, a reminder that the information reported on this call speaks only to the company's view as of today, November 8, 2017. So time-sensitive information may no longer be accurate at the time of any replay. You'll find information on the replay in this quarter's earnings release.

On the call with me this morning are Bob Owens, Sunoco LP's Chief Executive Officer; Joe Kim, President and Chief Operating Officer; Tom Miller, Chief Financial Officer; and other members of the management team.

I'd now like to turn the call over to Bob.

Thanks, Scott. Good morning, everyone, and thank you for joining us. This morning, we will review the financial and operating results for the third quarter, along with other recent activities.

I'd like to begin my comments by thanking the Sunoco family for quickly mobilizing efforts to aid those affected by hurricanes Harvey and Irma, getting us back in business to provide needed fuel and merchandise in the affected areas. Rarely do 2 storms hit within such a short time period in markets which we have high density. We're happy to report there were no employee injuries. Additionally, Sunoco partnered with leading community groups and vendors to provide assistance across affected communities.

The financial impact of the 2 hurricanes was modest in the third quarter. From a store perspective, we had about 150 stores that suffered some form of minimal damage and only about a 12 Sunoco stores requiring major repairs, while the cost to repair the affected stores will largely show up in the fourth quarter 2017, we expect the insurance proceeds to hit in the first half of 2018.

Now turning to third quarter results. In the third quarter of 2017, the partnership recorded net income of $138 million, including a $44 million impairment charge. This is compared to net income of $45 million a year ago. Tom will provide more detail later in the call.

Total adjusted EBITDA was $199 million, an increase of $10 million from last year, mainly due to strong wholesale operations, which increased wholesale adjusted EBITDA by $6 million from last year to $87 million. Distributable cash flow, as adjusted, was $132 million, an increase of $8 million compared to a year ago. The combination of higher adjusted EBITDA and lower maintenance capital expenditures of $10 million compared to $30 million a year ago contributed to the increase in distributable cash flow.

Sunoco's distribution for the third quarter remain unchanged from the second quarter 2017 as well as from a year ago at $0.8255 per unit. This distribution resulted in a 1.28x coverage ratio in the third quarter and a 1.04x coverage ratio on a trailing 12 months basis.

Now looking at operational performance. Total fuel volumes were 2 billion gallons, an increase of 1% versus last year. Retail gallons were 656 million, an increase of 5 million gallons or 0.8%. Wholesale gallons of 1.4 billion also increased 1% from last year. Total weighted average margin of $0.149 per gallon decreased $0.007 from a year ago due to lower margins in retail. Wholesale margin was $0.10 even, flat from a year ago, and retail cents per gallon was $0.253 compared to $0.275 a year ago.

Sunoco's wholesale business typically does not experience the same quarter-to-quarter fluctuation in gross profit cents per gallon margins as a retail business, which we view as favorable for our future. Merchandise sales of $618 million increased 2% from last year, with continued market share gains in packaged beverage, beer and restaurant sales. Merchandise gross profit margin of 32.1% increased by 0.3% compared to last year, and the third quarter margin was consistent with the second quarter.

Now turning to total retail same-store results. Total retail same-store gallons declined 2%, and same-store merchandise sales decreased by 0.1%. Sunoco's operation in Florida were negatively impacted by Hurricane Irma. That said, our Texas operations posted positive same-store trends during the quarter, despite the impact of Hurricane Harvey. Our approximate 140 retail stores in the oil-producing regions of Texas are primarily located in the Permian basin, with the remainder in the Eagle Ford. The market has improved notably over the last 6 to 12 months.

In the third quarter, same-store merchandise sales for our sites in the oil-producing region increased approximately 11%, getting progressively stronger throughout the quarter. Same-store fuel gallons for these sites also increased 8%, with particular strength in diesel gallons. As a reminder, our stores in the oil-producing regions turned the quarter in the first -- turned the corner in the first quarter and have posted positive trends each quarter since.

On Monday of this week, we put out a press release stating that Joe Kim will take over as CEO starting on January 1st of next year. Joe joined the Sunoco team in 2015 and has been responsible for business development and M&A activities across the partnership since that time. He brings a wealth of experience and expertise in strategic planning and execution of growth initiatives and is positioned to lead Sunoco on its transformation into a premier wholesale fuel distributor. Thus, this will be my last Sunoco LP earnings call, and I want to take a moment to thank the investors and analysts on the call, and also all the Sunoco dealer and distributor partners for their many years of support. And thanks goes to all the Sunoco employees past and present as well.

I will now turn the call over to Joe.

Thanks, Bob. On behalf of the entire Sunoco team, we want to thank you for your leadership and your 20 years of dedicated service. We're fortunate to have you consult for us for the next 2 years, and we'll definitely take advantage of your experience and expertise.

As you know, we are currently in the process of transforming Sunoco. Our roadmap starts with completing an efficient divestment of our company-operated stores. The proceeds from these transactions, along with any attached long-term supply agreements, will allow us to address our leverage and coverage ratios.

Our transformation also involves optimizing our overhead. We will rightsize our overhead for the going forward business and just as importantly, position us for efficient growth in the future. Our initial projection is to have the post-divestment run rate for G&A expenses about 50% less than our historic run rate. Tom will provide more details in his comments.

In addition, we're rightsizing our maintenance capital. For 2018, we're projecting maintenance capital to be around $35 million. This is half the run rate as compared to 2017 projections, and about 70% less than the 2016 run rate.

Growth capital going forward will also be significantly lower than in previous years. We're projecting around $90 million for 2018. Part of the reduction is from the exit of company operations, but some is from a more stringent return criteria. Based on the aforementioned, our new business model is clearly less overhead and capital-intensive.

Now let me provide you an update on the 2 divestment packages. First, the 7-Eleven package. Our team continues to work diligently towards closing. We believe the transaction is in the latter stages of the regulatory approval process with the FTC. We continue to work for the closing in late fourth quarter of 2017, subject to completion of the regulatory process. However, there is a possibility that closing does not occur until early first quarter of 2018.

As for the West Texas package, we're currently in full negotiations with a quality buyer. Upon the completion of due diligence and final negotiations, we estimate a signed purchase agreement sometime in the fourth quarter of this year, which will position us for a close in the first quarter of next year.

Similar to our negotiations with 7-Eleven, we're balancing the trade-off of a higher purchase price with retained EBITDA through a fuel supply agreement. We are on track to complete both transactions. The combination of the 7-Eleven and West Texas packages will contribute about 2.5 billion gallons of stable income for Sunoco. In total, we will distribute over 8 billion gallons of fuel annually. Scale is vital in this business, and we believe we can leverage our scale for accretive growth in the future.

With that, let me turn it over to Tom.

Thanks, Joe, and good morning, everyone. Before I discuss the financial results for the third quarter, I will touch on a couple of items related to our exit from retail company operations.

As we have stated in the past, the 7-Eleven asset purchase agreement requires us to obtain a consent or to discharge each series of notes using either the call feature or the make-whole provision as appropriate. We have issued a conditional call notice for our 2020 notes. On October 10, we launched the consent solicitation to amend our 2021 notes and our 2023 notes. We terminated that process, and instead, we intend to make whole on those notes.

We believe it is in our stakeholders' best interest to refinance them in today's strong high-yield market. Additionally, on October 16, we amended our credit facility agreement, satisfying a necessary condition to close the 7-Eleven transaction. We continue to estimate the combined tax impact of the retail divestitures to be roughly 20% of gross proceeds. We expect to provide additional color on this matter after the sales process for the West Texas assets wraps up.

As for use of proceeds, we are committed to reducing debt first. Our leverage target is to carry debt in the amount where it's between 4.5x and 4.75x adjusted EBITDA. The remaining proceeds will be used to either repurchase equity or to fund accretive acquisitions. As a reminder, we are required to repurchase the $300 million Series A preferred equity before we can repurchase any common units. If we proceed with the common unit repurchase, we would expect ETP to participate in a meaningful way. Going forward, we will target a distribution coverage ratio of 1.1x.

Moving to liquidity. We ended the quarter with total debt to adjusted EBITDA calculated in accordance with our credit agreements of 5.6x. This is down from 6x at the end of the second quarter and down nearly a full turn where we started the year.

Total debt, as of September 30, was $4.2 billion, including $644 million drawn under the revolving credit facility. We also had $9 million in standby letters of credit. This leaves the unused capacity on our credit facility at $847 million. The weighted average cost of debt at September 30 was 5.2%. As Bob previously mentioned, distribution coverage was 1.28x in the third quarter and 1.04x on a trailing 12-month basis.

As Scott mentioned earlier, we have classified operating results, assets and liabilities associated with our retail divestitures as discontinued operations. Revenue from continuing operations from the third quarter was $2.6 billion, an increase of 18%. Gross profit from continuing operations were $251 million, an increase of 31%, driven by wholesale inventory valuation adjustments. Additionally, net income from continuing operations for the third quarter was $134 million compared to $33 million a year ago.

Third quarter G&A expense was $30 million, down $15 million from a year ago, which included the cost of relocating headquarters to Dallas. Required overhead going forward will be significantly less than what was previously required. We project annual ongoing G&A expense of approximately $140 million, which is half our historical run rate.

Revenue from discontinued operations was $2.3 billion, an increase of 17%. Gross profit from discontinued operations was $385 million, flat to last year. GAAP net loss from discontinued operations was $27 million, driven by a $44 million impairment charge. That compares to net income from discontinued operations of $12 million a year ago.

Total adjusted EBITDA for the third quarter was $199 million, an increase of $10 million from a year ago. Adjusted EBITDA from our Retail segment was $112 million, an increase of $4 million from a year ago. Retail fuel margin averaged $0.253 per gallon compared to $0.275 per gallon a year ago. Retail merchandise gross profit was $198 million, a $7 million increase from a year ago. Gross profit margin was 32.1% compared to 31.8% a year ago.

Now turning to the wholesale business. Adjusted EBITDA for the third quarter was $87 million, up $6 million from a year ago, primarily due to increased gallons sold. Wholesale motor fuel margin was flat with a year ago with $0.10 per gallon. In the third quarter, Sunoco invested $41 million in capital expenditures, consisting of $31 million of growth capital and $10 million of maintenance capital.

For 2017, we continue to expect approximately $150 million of growth capital, and we are lowering our maintenance capital projection to approximately $70 million. More importantly, I would like to restate what Joe said earlier. Annual maintenance capital for the go-forward business will be about $35 million. Our total reported 2017 and 2018 growth and maintenance capital will depend on when we complete these transactions. Longer term, we will evaluate any capital spending with a capital structure that maintains leverage in that 4.5x to 4.75x range.

Last quarter, we promised an update on our wholesale margin guidance. For the past couple of years, we have consistently been above our $0.06 to $0.08 per gallon guidance. We continue to assess future wholesale margin guidance to reflect the increased ratable nature of our post-divestiture wholesale-focused business. We expect we will raise that guidance once we have finalized the West Texas sale, but we cannot be more specific at this time. We will provide regular updates to that range as the business grows.

Finally, I, too, would like to thank Bob. He brought me to Sunoco last year from the outside and has taught me about this business. For that, I'm grateful. Bob, I wish you the best. Tight lines.

Operator, that concludes our prepared remarks. You may now open the line for any questions.

(Operator Instructions) Our first question comes from the line of Andrew Burd from JPMorgan.

First, hi, Bob. It's been great working with you over the last couple of years. And we certainly were lucky to have you, and you'll be missed. So thanks.

Thank you, Andy.

So the first question, just on some of the softening fuel volume trends that you noted in the East Coast. Can you just clarify on these and expand a little bit? Are these competitive pressures or just declining demand in those markets? And maybe more broadly, thinking out into 2018, if you could look in your crystal ball and kind of give a sense to what you're thinking about directionally for fuel volumes across your entire footprint.

Well, Andy, the East Coast is a big area. And I guess, the biggest impact certainly was the hurricane, which hit us pretty hard volume-wise in Florida. But I guess I would start with this. My view is that the correct way for us to think about demand is essentially flat. I think we'll see continued positive trends from a total miles driven standpoint as the economy continues to improve. And we see gains in employment, and that will be offset by all of the trends that we read about, whether it's the shared economy, CAFE standards, the sharing economy, you name it. So that's how I view it. As I look up and down the East Coast, there are various competitive pressures. But I think Sunoco is positioned very well to compete, given the brand strength as well as the infrastructure that's in place. And from my perspective, the correct way for us to think about it is essentially flat demand and driving economies and taking advantage of our scale in the area.

Great. And following up on the hurricanes. Overall, I think total same-store sales for fuel gallons were down 2%. Appreciate that it's hard to quantify and parse, but do you know roughly what impact the hurricanes had on that 2% down number?

I don't, Andy. We'll -- Scott can get back to you on that. But we were -- I mean, it exceeded 10 million gallons overall in Florida. We had just -- well, with both hurricanes, we had hundreds of locations closed due to either power outages, flooding, road closures or ordered closures due to municipalities with both Harvey and Irma. So we can get back to you with a little bit sharper pencil on that if that would be helpful to you.

No, that's helpful. And then the last question maybe for Joe. Appreciate the comments on capital-light business next year and the reduced growth and maintenance CapEx. Maybe if you could just highlight some of the bigger, lumpier items for CapEx, and kind of what your thoughts are in terms of what that will be targeting as you're just finishing up the Illinois toll road ? Or is there -- you're allocating some to other areas as well?

Andy, I'll maybe break it down to 2 areas. On a maintenance capital basis, you got to remember, we still have terminals in Hawaii and we still have a retail business in Hawaii and we also have the transmix business in the U.S.. So a lot of the maintenance capital is really dedicated more towards kind of our hard asset business. And also, we have a -- in our future environment, we have dealer businesses, where we own the real estate and the land. This is a really good business for us, where we get rent revenue which is an incredibly ratable business for us. So we'll spend capital to maintain on our hard asset business, and that's really the bulk of our maintenance capital. On a growth capital basis, like Bob said, we have -- I think, we're very well-positioned on a going forward basis with the wholesale business, which is, if you look back at the last 8 quarters, 12 quarters, that has a very tight margin type of (inaudible) out there. And our growth capital really is, I would call it, more of a kind of an organic growth of us signing up new dealers and new distributors on a going forward basis. And with our scale, we should be highly competitive in signing people up, but part of that is using some growth capital.

Our next question comes from the line of Theresa Chen with Barclays.

I'd like to echo Andy's comments. Thank you Bob for your many years of service, and we wish you the best as well.

Thanks.

My first question has to do with the modest delay of the closing for 7-Eleven into early first quarter. Can you talk about -- given that you're in the latter stages of the regular process, can you talk about what key considerations are remaining? Any color on why there has been a delay from what you originally expected?

Theresa, this is Joe. Let me give you some color there. First of all, we're -- as I stated on the prepared remarks, we're definitely in the latter stages of the regulatory process. And the expected remedy that we think that we need in order to close, with think those are very minor. And we think it's just going through the more ordinary FTC process. And we expect this to close. We think the remedies are minor. We think from both parties, 7-Eleven and from Sunoco, is going to be very immaterial. We're just awaiting the process, and we wanted to kind of give you some better guidance.

Can you give any examples of what those minor remedies might consist of?

Out of respect for the FTC and the regulatory process, we really can't get into the details right now other than to provide you kind of the prepared comments that we gave you earlier.

Understand. In terms of returning to coverage post the transaction closing for both 7-Eleven and West Texas. To Tom's comments earlier about repurchasing common units, would that primarily consist of the units held at your parents given your comments that they will participate in a meaningful way? Should we read it as you will purchase up to the maximum taxable threshold at the parent and then the remainder as a much smaller portion would be to public unitholders? Or how do we think about the balance between purchasing at the parent versus the public?

Theresa, they own 45% of us approximately, and that doesn't leave us with a lot of float. So they will have to participate in a meaningful way. The amount that they are interested in above sort of their pro rata is still open, and we'll be discussing it over time.

Okay. In terms of the growth capital guidance for 2018, can you talk about -- Joe, can you talk about what you meant to buy more stringent return criteria? What exactly is that criteria going forward versus what have you had thus far?

I think when we say stringent, we obviously will use the traditional measures, NPV and IRR. But I think the other thing that we got to consider is that we can have a bunch of high net present value projects, but we want to make sure that not all of those are diluted for the first 2, 3, 4 years. We want to make sure that we balance that out with quicker accretive projects with longer-term accretive projects. And the other part of it is I see Sunoco as when we manage a portfolio of different income streams, we want to make sure that where we put our growth capital is distributed, so that we can manage volatility and manage some diverse income stream. So that's what I meant by a more stringent look at our growth capital.

Got it. And then lastly, can you quantify what the expected hurricane costs will be in fourth quarter versus what you will be receiving on the insurance settlement post deductible?

It's a rough estimate at this point, Theresa, but we're thinking kind of in the range of $20 million.

On a net basis?

Yes. Well, gross basis right now. As I mentioned in the prepared remarks, we're expecting insurance proceeds. Given the policy, my expectation right now is it covers half of that. We'll see that -- see those dollars in the next year.

(Operator Instructions) Our next question comes from the line of Patrick Wang from Baird.

So on the -- so we have the 7-Eleven sale and the West Texas sale. Could you just remind us on how many of the stores that were originally included in that 97 site portfolios still remain that haven't either been sold or moved into the 2 other packages?

Patrick, I believe you're referring to the NRC package that we have right now. And the exact number, the bulk of them, I think we still have how many -- Scott?

Yes, it's less than 10 are kind of outstanding. We -- I think around half of them went to the 2 divestitures. We've sold about 80% of the other half. So there's less than 10, I think, Patrick, that are outstanding at this point.

Right.

Okay. Great. That's helpful. And then just a more general question. So earlier you mentioned about thinking about total fuel demand as being flat longer term. Does that comment also apply to diesel volumes, which seem to have been a bit more resilient than gasoline and even talking outside of the resurgence you've been seeing in the oil patch?

Yes. I guess, from my perspective, I'm talking total motor fuel gallons. We've seen over the last decades kind of shifts with diesel popularity waxing and waning for passenger vehicles. Certainly diesel demand tracks the economy pretty well, and no better example of that than what we're seeing in the oil-producing regions where there's a significant surge in demand. So I haven't parsed it between the 2. I think, overall, assume flat from my perspective.

Our next question comes from the line of Sharon Lui with Wells Fargo.

Bob, also wishing you the best of luck with the future.

Thanks.

My question is about, I guess, the West Texas transaction. Just wondering if that guidance you provided in the 8-K is still a reasonable assumption of $620 million?

That estimate was in our consent solicitation. And the amount we're looking at, as you know, that's in the area is the right way depending on how the deal is structured. As Joe talked about, there's a balancing act of proceeds in future EBITDA.

Sharon, just to support Tom's comment as well. That, as we noted, was used -- we used the 7-Eleven dollar per store metric as a way to put an indicative value in there. It was not, I think, related to any outstanding offers or anything like that. It was based on the 7-Eleven metric as a directional estimate.

Okay. And so the, I guess, pro forma EBITDA does not include, I guess, a potential benefit from like a fuel supply agreement?

Sharon, this is Joe. Let me kind of give you guidance. Again, I think the key point is that we didn't have a deal in place for West Texas, and we underwent the consent process. So the most -- I think it was a good guidance as to use the 7-Eleven process. When -- if you take 3.3 divided by roughly -- a little bit over 1,100 stores, you come to $3 million. You times that times 208, and you're right at that 600 number out there. So -- and then we also use the same type of math to talk about potential fuel distribution contracts. Again, [directionally], as Tom stated, I think it's definitely in the ballpark. But to use that as a -- we have a firm deal and we're using that as the number going forward -- I think that wouldn't be that precise. Does that help?

Yes. No, that's helpful. And I was wondering if you have, I guess, an estimate on the make-whole premium on the bonds at this point.

Yes, that's going down, I think it's currently about $95 million if we made whole today. And that goes down roughly $6 million a month.

Okay. And just perhaps an update on the M&A market and your pursuit of more traditional type of midstream assets.

Sharon, I think I'll start kind of 2 parts. As far, as Bob mentioned, scale is still vital in this business. And we're going to distribute 8 billion gallons. So from an M&A standpoint, kind of sticking to what our core business is right now, fuel distribution, we have incredible scale and the market remains still very incredibly fragmented. So if you think about -- and they also trade at a very reasonable multiple fee. Fuel distribution area kind of trades somewhere between a 5 to 10x. You add our synergies on top of that, now you can see us going out there and doing M&A activity post synergies definitely in the single digits, which would be accretive acquisitions for us. So that's one area -- the obvious area that we'll look at. The other area is more on I would say more traditional fee-based type of activities, and a prime example probably would be product terminals. Given that we have an 8 billion gallon store, if you want to think of it that way, we bring our source to put some particular markets out there and connect it with a product terminal, then you can kind of see that there's some additional synergies for us. So we're definitely looking at our core business to fuel distribution. But at the same time, we want to diversify and we want to look at more fee-based to kind of balance off our portfolio. And we think that we have the synergies that we can bring while at the whole time, making sure that we maintain our balance sheet goals going forward.

Our next question comes from the line of Ben Brownlow with Raymond James.

Just looking at the redemption on the 2021 and '23 notes prior to the close. Any color on how you're thinking about that refinance rate? Or would you consider utilizing the revolver in the short term?

We would expect to refinance these with long-term notes. The high-yield market is particularly hot right now, and we would like to be able to take advantage of that. One of the good things here is we have a clean balance sheet coming out of here. We have no long-term debt and any short -- floating rate debt. We can always adjust as appropriate. So that will be one of the things we consider moving forward.

Okay. Is it fair to say that, given the redemption on the notes, really the balance between where you're targeting on equity repurchases versus debt it really hasn't changed overall?

Right. As I mentioned, we will target a debt level that's a multiple of our go forward adjusted EBITDA. And then what falls out of that is what we have to either invest in projects or to repurchase equity, including the preferred.

Okay. All right. And any color around same store sales kind of demand trends quarter to date?

Well, you saw kind of the numbers that we reported by different regions. Again, kind of echoing my remarks earlier around the impact of the hurricanes, certainly, that was felt in the stores as well. But our view going forward is that the convenience store remains -- well, not immune, certainly, one of the best retail offerings in the new economy to be resilient to going forward. We've seen decades of demand growth. People today, one of their dearest resources is time and the convenience store offering continues to have appeal. And we don't see that trend changing in the near term. So our view -- my view is it will grow with kind of the CPI, and pick a number, a percent better than that, half a percent better than that going forward.

There are no further questions in the queue. I'd like to hand the call back over to Bob Owens for closing comments.

All right. Well, thanks, everybody, certainly for your kind comments and your continued support. And this concludes our call. Thanks.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.