Sunoco LP (SUN) 2018 Q3 法說會逐字稿

Greetings, and welcome to the Sunoco Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Scott Grischow, Senior Director, Investor Relations and Treasury. Please go ahead.

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. 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.

A reminder that the information reported on this call speaks only to the company's view as of today, November 8, 2018, so time-sensitive information may no longer be accurate at the time of any replay. You will find information on the replay in this quarter's earnings release.

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

Before I turn the call over to Tom, I would like to review some of the partnership's accomplishments and activities that took place during this very strong third quarter. First, we completed the Sandford Oil acquisition on August 1, which included a 115 million gallon a year fuel distribution business to exploration drilling and oilfield service customers primarily in Texas and Oklahoma. Then on October 16, we completed the acquisition of BRENCO Marketing Corporation's fuel distribution business, which distributes approximately 95 million gallons of fuel per year across a network of dealer, commission agent and commercial account locations in Central and East Texas.

Both acquisitions bring commercial and G&A synergies resulting in post-synergy multiples in mid-single digits. We funded both of these acquisitions with cash on hand and amounts available on our credit facility. We expect both acquisitions to be accretive to our unitholders in the first year.

These acquisitions, along with the Superior acquisition in the second quarter, are examples of the types of opportunities we continue to see in a fragmented industry. We will maintain a robust pipeline of potential acquisition targets and will only pursue the most attractive opportunities that will allow us to capitalize on our scale and to meet our financial goals.

Moving on to an update on the tax impact of the divestiture of our retail operations to 7-Eleven earlier this year. Through the end of the third quarter, Sunoco LP made a total of approximately $370 million in tax payments related to the 7-Eleven sale. Our estimates for the total 2018 tax impact remains at $480 million, with the final payment due in mid-December.

Finally, I would like to wrap up my comments by addressing a news story that came out last week regarding the Federal Circuit Court of Appeals ruling about Sunoco Inc. The Sunoco Inc. entity is a wholly owned subsidiary of Energy Transfer Operating, L.P. As such, the court ruling is unrelated to and has no impact on Sunoco LP.

I will now turn the call over to Tom.

Good morning, everyone. As Scott mentioned, last night, we reported strong third quarter results, building on a solid second quarter.

In the 2 quarters since our exit from operating 1,200 retail sites, we delivered financial and operational results demonstrating our ability to execute our strategy. We've controlled cost, made 3 roll-up acquisitions, captured strong margins and surpassed our leverage and coverage targets.

For the quarter, the partnership recorded net income of $112 million and adjusted EBITDA of $208 million, which includes $2 million of transaction-related expenses and a onetime cash benefit of $25 million from a settlement with a fuel supplier. Even without this onetime cash benefit, the business performed extremely well this quarter with strong fundamentals, including healthy fuel margins and flat sequential operating expenses.

These results drove leverage, as defined by our credit agreement, down to 4.27x. This was down from last year's third quarter result of 5.59x. Distributable cash flow as adjusted was $149 million, yielding a third quarter coverage ratio of 1.73x and 1.24x on a trailing 12-month basis. Last year at this time, our trailing 12-month coverage ratio was 1.04. If you remove the onetime cash benefit of $25 million, our coverage for the quarter would have been 1.44x and leverage would have been 4.44x, an outstanding quarter no matter how you look at it.

On October 26, we declared an $0.8255 per unit distribution, the same as last quarter. We are confident in the sustainability of our distribution at this level. Over time, we will manage leverage within the target range of 4.5x to 4.75x and a distribution coverage ratio of at least 1.1x. Our liquidity continues to be robust with $1 billion available on our 5-year revolving credit facility, which we extended in July.

Looking at our operational performance. Total fuel in the third quarter was a little over 2 billion gallons, a 1.4% increase over the second quarter. For the third quarter, fuel margin, includes the $25 million adjustment, was $0.127 per gallon. Removing the onetime $25 million, our margin would have been approximately $0.114 per gallon, which is a very solid margin on its own.

I would like to provide some context for how we view and manage fuel margin. First, as we have mentioned in the past, we manage the business for long-term gross profit dollars, not margins and volume separately. We have added resources to optimize our gross margin, and we are very pleased with the results so far.

Second, we had an excellent quarter in all our channels. We employ a multi-channel strategy that balances highly ratable income, such as our 7-Eleven take-or-pay and our $140 million per year of rental income with channels and geographies that give us the opportunity to capture robust margins. West Texas, Hawaii and East Coast markets have had strong margins, which we expect to continue. Finally, our acquisitions of Superior and Sandford had a positive contribution to our fuel margin.

Moving on to expenses. Last December, we provided run rate estimates for several key modeling inputs. We have focused on controlling spending throughout the year. We expect to be within our December expense guidance, even with the addition of the 3 bolt-on acquisitions. During the third quarter, G&A expense was $34 million, in line with our $140 million annual guidance and flat to the second quarter. Rent expense totaled $20 million, also flat to the second quarter and within our annual guidance of $75 million.

Third quarter other operating expense was $86 million. Annualized, this number is above our $325 million run rate discussed last December. The nature and timing of certain expenses within the category will always result in quarter-to-quarter fluctuations. That said, we are very confident in our annual run rate of $325 million.

As I mentioned on last quarter's call, in the first half of the year, we revamped our capital allocation process, and this resulted in lower capital spend in the first 2 quarters. In the third quarter, we invested $30 million, $19 million of growth capital and $11 million of maintenance capital. We expect annual capital spend to be approximately $30 million for maintenance capital and approximately $65 million for growth capital. In December, we intend to provide updates of the key financial modeling inputs for 2019.

I will now turn the call over to Joe for closing thoughts. Joe?

Thanks, Tom. Good morning, everyone. The third quarter has historically been our most profitable time period, and our results this quarter reinforced our earnings power. The underlying business is strong, and we expect it to continue. Our October results were very encouraging, and looking forward, we expect the fourth quarter to be another solid quarter.

Last year, we outlined the plan, and this year, we're delivering on that plan. For 2018, we're either meeting or exceeding our guidance for gross profit, expenses and maintenance capital. As a result, our coverage is materially above 1.1x and our leverage is below 4.5x. We remain confident in our ability to sustain our distributions while still having excess cash that can be used for growth opportunities. And most importantly, we expect this to continue into the foreseeable future.

We're also delivering on our growth plan, completing 3 accretive acquisitions since April. Our pipeline remains robust, and we will continue to deliver on additional accretive acquisitions.

Let me close by stating that we are very optimistic about our future and our ability to deliver on our financial goals.

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

(Operator Instructions) Our first question comes from the line of Theresa Chen with Barclays.

Great to see the very strong CPG in third quarter, even ex the onetime effect. And Joe, just following up on your comment about expecting a solid fourth quarter. So when we look at the current period and the precipitous decline in wholesale product prices, can you talk about what you're seeing in terms of margin trends currently? And should we expect the fourth quarter CPG to be even stronger than third quarter?

So good question. First of all, as I mentioned in my prepared remarks, the third quarter has historically been the best quarter for fuel distribution companies and for retail-centric companies. With that said, I think the way to look at it is look at our business on an annual basis, where typically, the third quarter is the best, the second quarter is the second best, and the fourth quarter is the third best, then the first quarter is just typically the lowest-margin period. But if you look at that in totality and you look back at kind of the recast base of our business over the last 4 years, what you'll find is -- and what I mean by recast is take the 7-Eleven agreement and push it back retroactive to 4 years. What you'll find is that our annual average over 4 years has been slightly above $0.095. Then if you kind of look back over the last 2 years, our business is actually yielding more towards $0.10. Then if you look at 2018, we're actually slightly above 2017 on a margin basis. And I think the key point is this is partially a very solid industry fundamentals, but there's also some proactive steps that we've taken. We did those 3 bolt-on acquisitions. The blended margin of these acquisitions is actually higher than our base business, so you're going to see an uptick on that. Secondly, as Tom mentioned in his prepared remarks, we've gone through this volume-margin optimization. And as I stated previously and as Tom stated, the early results have been very encouraging given that there's gross profit increase. And finally, if you think back to December, when we announced like our West Texas deal, we stated that we selectively picked out key markets that we want to have the ability to capture the full margin. And West Texas, Hawaii and the New Jersey Turnpike are 3 very robust margin areas, and we proactively, strategically picked these out. These are niche markets, really strong, and we expect that to continue. You put that into totality, I think you'll see why our margins were so strong in third quarter. I wouldn't get overly caught up into quarter-to-quarter. What I would really focus on is, over the course of the year, we've delivered. Over the last 4 years, over 9.5%. And I think this year's result makes a very compelling case that it's going to be above that number.

Got it. And related to the settlement with a fuel supplier, can you just provide some history and context of how that came about?

Sure, Theresa. This is Karl. The settlement really relates to fuel purchases from one of our major suppliers. As you think about our business, we've told the market that one of our strategic advantages is our scale and the fuel purchasing power that provides us. We do a lot of things day to day to continue to ensure that we capture that purchasing power with our fuel suppliers. So that settlement is related to -- this year, we resolved an open issue with one of our suppliers on fuel purchasing price, and that settlement was finalized in the third quarter. So if you retroactively apply that settlement across the last few years on our volumes, that would have increased our average margin by about $0.001 per gallon. So last thought I'd say is I'd reiterate again what Tom said in his prepared remarks that even without this settlement, we had a very solid quarter.

Understood. And given just the very healthy coverage year-to-date, can you talk about what your plans are for the excess cash? Are you looking at potentially growing the distribution again? Or do you think the cash would be better spent reinvested in the business?

Theresa, it's Joe. If you look at our excess cash, first of all, our solid results are going give us -- I think we targeted 1.1. But if you look at kind of market sentiments, I think the market is more leaning towards higher coverage versus an increase in distribution. And if we did increase our distribution, I don't think it necessarily gives us a lower yield, resulting in lower cost of capital. So as of right now, I think the opportunity for us is to take this excess cash and apply it to grow it or to our balance sheet.

Our next question comes from the line of Jeremy Tonet with JPMorgan.

This is Charlie on for Jeremy. One quick one for me. Just thinking about Energy Transfer family and kind of everything is simplified there with no IDRs. Is SUN going to request an IDR elimination? I understand that you're going to say that, that's -- talk to Energy Transfer, but I'm trying to understand from your perspective if that's something that you're proactively pursuing.

Charlie, so first of all, I think no effort is being spent by neither SUN or Energy Transfer on IDR elimination. I think the second thing that you have to take into consideration is that we put together an executable strategy to grow the company and to create value for both our LP and for our GP. And I think you look back since the 7-Eleven transaction, I think we have definitely had 2 quarters, the second and third quarters, showing that we can deliver on that. And as I've said in my prepared remarks, expect another solid fourth quarter. And as I stated, I'm very optimistic about the future. So the fact that we're delivering, we did 3 acquisitions since April even with a very -- I would say, a yield that I think we're justifying should be lower, and yet we still did 3 accretive acquisitions. I mentioned that we have a robust pipeline. I think what we're showing is that even with the high yield and with IDRs, we're growing and delivering on our plan.

Great. And then one more for me on expense savings. You've done a good job there. Thinking about -- in context of the recent acquisitions, is there any foreseeable savings that you could capture maybe looking forward into 2019?

Let me answer that 2 ways. We feel comfortable with the guidance we've given you for the remainder of the calendar year. As for 2019, we're in the process of pulling together our budget, and we'll be sharing that with you in December. Just one final point on that is when we make the acquisitions, we would normally expect that to be able to have some synergy.

The next question comes from the line of Patrick Wang with Robert W. Baird.

Great to see these numbers. If we could look broadly at your M&A framework, what type of cost equity do you assume when assessing potential transactions under that [50-50] equity framework? And then at what distribution yields would you believe you could achieve accretive M&A through equity rather than entirely on the revolver?

So first of all, I want to reiterate that we don't see a need for 2018 equity. As we look forward to 2019, we're committed to maintaining the leverage targets of 4.5 to 4.75 over a long period. As we look at attractive acquisitions, we do look at it on a 50-50 capital basis. And given, right now, where our yield is, we would probably be looking at a preferred to help fund the acquisition. We feel like the -- it's just a better use of capital right now.

Okay. That makes sense. And staying on this topic, is there a certain [bump yield], let's say, something larger in the terminals area? Is there anything sizable (inaudible) that may require some equity or some preferred equity alongside debt let's say in [2019]?

So Patrick, it's Joe. I think the way to look at our M&A is that it's kind of 2 parts. One part is the fuel distribution. I think we're starting to build a good resume of delivering on attractive multiples, accretive acquisitions. On the midstream side, we're definitely looking at midstream assets. And as far as giving specific color on a specific target, I think it's way too early on that one, but I think what you can take away is that we're looking. When we find the right assets, the right financial fit, we'll go after those assets.

(Operator Instructions) The next question is from the line of Mike Gyure with Janney.

Can you talk a little bit about, I guess, working capital requirements? And I guess, in general, for your conversion to the full wholesale model, do you think there's any benefits that you can sort of wring out of the working capital within the network? Or I guess, how are you feeling about the working capital in general?

The working -- the good thing about the wholesale side of the business is it has a much more rapid cycle, where things are paid quickly. It is an area that we're looking at. We have been looking at it in great detail. We'll be advancing that over the next couple of quarters. But it's not real high on the priority list, though.

Okay. And then on the operating front, can you tell me if you had any, I guess, benefit or headwind from the hurricanes in any of your regions or markets this quarter?

Yes. This is Karl. I would say there's no material impact, either positive or negative, from the storms this quarter.

The next question comes from the line of George Wang with Citigroup.

I just want to hone in on the future roll-up acquisitions. So is this a post-synergy mid-single-digit sort of [full] multiple still a firm guidance and the target you guys are looking at? Like just -- I'm sure you guys are looking at different targets. Like are you guys still seeing a bunch of attractively valued acquisition targets you guys can roll up?

George, this is Joe. Yes. So obviously, we continue to find assets that are synergized mid-single digits. Obviously, those are attractive to us. And as I've said, we built up a good pipeline of these types of fuel distribution targets. And what we'll do is we'll pick the best out of the ones that comes presented to us. But secondly, I think it's a very important point. Our goal, long term, is to become more diversified and become a larger, stronger MLP. And that means that we're going to also balance that out with some other traditional midstream targets that might trade at a slightly higher multiple. And then the good news is that the same type of synergies that we bring to the table for fuel distribution, that's also applicable to some midstream assets, such as product terminals. So the goal, obviously, is to purchase assets that have carried low multiples, but depending upon the quality of the assets and how that enhances our overall portfolio, I think we'll be looking at the whole range.

Got you. That makes sense. And then are you guys still looking at 4 to 5 deals a year? I don't know if you guys are still speaking to this quantity of guidance. And since you guys have done kind of 3 deals so far, I mean, do you think -- is it fair to assume you guys may still announce 1 to 2 deals this year?

I don't think the 4 deals will be -- I think guidance might not be the right word, but I think the -- if you put together a good pipeline, you built the capabilities, I think although M&A is not ratable, I think we put together a program where we really yielded 3 since April, which is -- I think that's strong accomplishment. And when the pipeline continues, this -- our approach is really evolving away from necessarily building up the pipeline. We have a pipeline. Our path forward is making sure we pick the best out of our pipeline and also enhance our fuel distribution business with other businesses that can balance our portfolio.

Got you. Understood. My last question. So you guys talked about post synergy. I'm not sure if you can give more color just on how soon do you think you guys can achieve this 5 to 6x multiple after deal conclusion.

Yes. This is Karl. I'd say obviously, it depends a little bit on the individual acquisition. But in general, a good rule of thumb is that in year 1, we'll capture 50% of the synergy, and by year 2, we'll be at run rate. You think about the deals we've done so far this year, Superior has been in our portfolio about 6 months, and I'd say we're tracking maybe even a little ahead of that on our synergy. And then Sandford and BRENCO are both pretty recent, so I'd say it's too early. But those integrations are on plan. And the other thing I'd add is, as we do these, we'll generate better at them as well, so I'd expect, if anything, that our ability to capture those synergies and integrate them will accelerate.

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

Appreciate all the color around -- you provided a lot of detail around the drivers on the fuel margin. And you made one comment around one element of that driver was the added resources to optimize fuel margin. Can you give any specifics of that driver or what's -- or what that entails?

Sure, yes. This is Karl. I can provide a little more guidance. The basic idea behind our price optimization, the resources we've put on it, is you look at both margin and volume impacts when you set the price, not just one of those 2. So I'll give you an example. So in a lot of our locations in our -- where we set prices at an individual site, we've developed individual location-by-location elasticity curves so that when we set a price on a daily basis, we're taking into account what the anticipated volume impact of that is, and so we can look at the overall gross profit. So I guess the other color I'd say is we're adding more data analytics around choosing competitors and how we make that choice in local markets. So the underlying principle is really putting more data, more analytics with real business responses to drive those decisions.

Great. That's very helpful. And just one more for me, a minor modeling question. Within the wholesale segment, can you give some color on the "other category" that was around $7 million gross profit? So it's a small contributor relative to the fuel category, but it still fell off relative to -- sequentially from the second quarter. So just trying to understand some of the movement there.

Right. The second quarter -- well, first of all, what's in other income?

Yes, the other income.

Yes. The other income, that tends to be credit card, merchandise, food service, lotteries, things like that, things from running the stores. And we think that you probably should use this quarter as a run rate going forward as opposed to last quarter, which had some adjustments.

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

I was just wondering if you could maybe provide some color on volume trends. Q3 was up about 1% sequentially, but I thought it might have been higher given the acquisitions of Superior and Sandford. Maybe if you could just talk about, I guess, volumes this quarter and where you see volumes trending next quarter.

Sure. Sharon, this is Karl. You pointed out right. Our Q3 volumes did rise seasonally from Q2 and from our acquisitions. I'd say that's in the area of our expectation. And so a few points to give color on that. One, remember that our volumes with 7-Eleven, really, that's protected by our take-or-pay on an annual gross profit arrangement with them. We've also stated in prepared remarks and even in our Q&A this gross profit optimization strategy, where there are some trade-offs between margin and volume. So you should think about that. And then the last point I'd make is, really, our strategy is to continue to grow gross profit and to get a bigger piece of the pie, right, whether that pie is shrinking or growing, whether it's staying the same. And so I think, really, our gross profit delivery is really the focus, and that's what we did this quarter, and that's what you should look at going forward.

Okay. And then just a housekeeping item. The income tax expense was a little higher this quarter, I think, because of discontinued ops. What is a good run rate number for cash taxes going forward?

Right. We've talked about $12 million in the past. We think that's a good run rate. If you recall, last quarter, it was negative taxes. A couple of things this quarter. When you make money from your -- in your C corp., which we did, and we had a good quarter there, you pay more tax. And we also sold one of our -- where we had a gain, we sold one of our non-core assets.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd now like to turn the call back to Scott Grischow for closing remarks.

Well, thanks, everyone, for joining us this morning. Please feel free to reach out to me if you have any follow-up questions. This concludes today's call.

Thank you. Today's conference has concluded. You may now disconnect your lines at this time. Thank you for your participation.