Sunoco LP: Unique Energy Play Now Yields 10.4%
1 High-Yield Stock Worth Your Attention
Long-term readers of Income Investors would know that pipelines are my favorite type of energy business. Because pipeline companies are essentially running energy toll roads, many of them can generate stable cash flows and pay sizable dividends. Today, however, I would like to talk about a non-pipeline energy stock that also stands out when it comes to returning cash to investors: Sunoco LP (NYSE:SUN).
Sunoco is one of the most popular fuel brands in the U.S. It is the official fuel of NASCAR and the official fuel at over 500 American race tracks. In fact, Sunoco is the largest manufacturer of racing gasoline in the world. When consumers see that the brand is good enough for race cars, they are confident that it will be good enough for their passenger vehicles.
The neat thing is, even though people like Sunoco-branded fuel, Sunoco LP does not have its own production or refining business. Instead, it is a wholesale fuel distributor with a retail marketing platform. As a matter of fact, Sunoco LP is the only non-refiner wholesaler with its own fuel brand.
Sunoco’s business is quite easy to understand. The partnership purchases fuel in bulk and then sells it at branded prices. It’s a simple but profitable business model. And, because lower oil prices can drive up the demand for gasoline, the partnership can make money even during commodity price downturns. Historically, Sunoco’s fuel margins have proven to be resilient across economic cycles and commodity price cycles. (Source: “Investor Presentation,” Sunoco LP, last accessed January 18, 2018.)
This also means the partnership can afford to have a generous distribution policy. Paying $0.8255 per unit on a quarterly basis, Sunoco LP offers an annual yield of 10.4%.
The payout has been growing too. In the last three years—not exactly the best times for the energy sector, Sunoco’s quarterly payout went from $0.4687 per unit to $0.8255 per unit. That translates to an increase of 76%. (Source: “Quarterly Distributions,” Sunoco LP, last accessed January 18, 2018.)
Of course, like most double-digit yielders, SUN stock isn’t really known for its dividend safety. Back in 2016, the partnership had a distribution coverage ratio of 0.98 times, meaning it wasn’t generating enough cash to cover its payout. However, things have been improving; in the 12-month period ended September 30, 2017, Sunoco’s cash coverage ratio improved to 1.04 times, which leaves a margin of safety. (Source: “Sunoco LP Announces Third Quarter Financial and Operating Results,” Sunoco LP, November 7, 2017.)
Going forward, the payout is expected to become even safer. The partnership is selling approximately 1,110 of its convenience stores to 7-Eleven, Inc. in a deal valued at $3.3 billion. This will allow Sunoco to focus on the more stable side of its business: fuel distribution. Moreover, while Sunoco is divesting most of its convenience stores, it has secured a 15-year fixed-rate, take-or-pay fuel supply agreement with the buyer. This could further boost its distribution business. (Source: “Investor Presentation,” Sunoco LP, last accessed January 18, 2018.)
As a result, management expects the partnership’s distribution coverage ratio to increase to 1.1 times in the future.
That’s why, for those interested in investing in the energy sector, Sunoco LP could represent a unique income opportunity.
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