Published January 12th, 2017 by The Financial Canadian
To be considered a Dividend Achiever, a company must have 10+ years of consecutive dividend increases and meet certain size and liquidity requirements.
You can view the list of all 272 Dividend Achievers here.
This consistency in increasing dividends is indicative of a strong underlying business. Companies would not be capable of consistently raising distributions to shareholders if the underlying business was not performing well.
Right now, one Dividend Achiever has a yield that stands out above the rest. Best of all, the company is involved in a large accretive merger and is attractively valued.
That company is Sunoco Logistics Partners LP (SXL), an MLP with 14 years of consecutive dividend increases. This article will cover the investment prospects of Sunoco in detail.
Sunoco Logistics is a midstream energy MLP that is part of the Energy Transfer Equity LP (ETE) family of oil and gas assets. ETE is an MLP with the following ownership:
- 100% of Energy Transfer LNG (which is expected to be a new stand-alone MLP)
- 2% Limited Partner, 100% General Partner with IDR in Sunoco LP (SUN)
- 1% Limited Partner, 100% General Partner with IDR in Energy Transfer Partners LP (ETP)
- 90% General Partner with IDR in Sunoco Logistics Partners (SXL)
Note: IDR is an acronym for International Depository receipt and gives the general partner increasing shares of distributable cash flow as business grows.
Sunoco Logistics has a market capitalization of ~$7.8 billion, with operations diversified into the following segments:
- Crude Oil (57% of total EBITDA)
- Natural Gas Liquids (29% of total EBITDA)
- Refined Products (14% of total EBITDA)
In November, Sunoco’s intention to merge with Energy Transfer Partners (ETP) was announced. ETP is also a member of the ETE family. The fact that both companies come from the ETE family is expected to smooth the transition for the MLPs.
A summary of the pro-forma organizational structure is outlined in the following diagram.
Source: Sunoco Logistics Investor Presentation, slide 6
Post-transaction, the new entity will have significant geographic scale. The 71,000 miles of pipeline that will belong to the pro-forma SXL entity is outlined in the following diagram.
Source: Sunoco Logistics Investor Presentation, slide 6
From a financial standpoint, the main goal of this merger is to preserve the cash reserves at Energy Transfer Partners. Without some sort of intervention (such as this merger), ETP was expected to cut their dividend by 10% to 15% (which would trigger a sell according to The 8 Rules of Dividend Investing).
Post-merger, the shareholders of both entities are expected to benefit immediately.
ETP unitholders can rest assured in the renewed safety of their distributions.
SXL investors will be pleased to hear that the deal is expected to be immediately accretive to the MLP’s distributable cash flow and their distributions per unit (more on that later).
SXL’s growth prospects are mostly related to the pending transaction with Energy Transfer Partners. In this section, I will discuss two merger-related drivers of growth for SXL, and finish off by outlining forecasted business growth prospects.
The first benefit of this transaction is the synergies that will result from the ETP-SXL merger. As the following slide illustrates, there are four main synergy opportunities:
- Permian Crude Gathering and Mainline Optimization
- Gulf Coat NGL Projects
- Marcellus Optimization
- Cost Reduction Opportunities
Source: Sunoco Logistics Investor Presentation, slide 11
These synergies are expected to drive cost savings in excess of $200 million by 2019.
Other than synergies, the second main benefit of this merger is the resulting economies of scale and market leadership for the ‘new’ Sunoco Logistics. Post-merger Sunoco will be the largest midstream MLP based on EBITDA and the second largest MLP based on enterprise value.
This will allow the company to have increased operational diversity, which will reduce the risk of an investment in Sunoco (each individual operation is a smaller component of overall cash flows).
This diversity is magnified by the complimentary operations of the two MLPs – ETP is primarily involved in natural gas distributions, while Sunoco is primarily involved in liquid distribution. The overall effect of the new business mix will be to increase the stability of future cash flows.
The increased size of the pro-forma entity will facilitate access to the capital markets, helping the MLP to finance future growth.
Investors will also benefit from both parties being very experienced in integrating acquisitions into their operations. The following slide illustrates the extensive combined acquisitions history of the two MLPs in recent years.
Source: Sunoco Logistics Investor Presentation, slide 12
As I’ve mentioned in the business overview, the financials behind the merger are very attractive. The company expects the transaction to be immediately accretive to Sunoco’s distributable cash flows, and can drive “low double digit” distribution growth in the short-term.
Please consider that this transaction is in no way guaranteed. Many investors have been burned in the past by relying on the closure of transactions in the financial markets.
That being said, SXL’s management has stated that they expect the transaction to close in the first quarter of 2017.
Source: Sunoco Logistics Investor Presentation, slide 14
If this transaction is completed, it will certainly be a driver of growth for this company moving forwards.
Competitive Advantage & Recession Performance
As an energy MLP, Sunoco is accordingly vulnerable to fluctuations in underlying commodity prices (particularly crude oil).
However, their business model is actually less risky than one would suspect. In the oil industry, Sunoco operates particularly in the midstream subsector (think pipelines). This means that Sunoco’s earnings are tied to their ability to transport oil – not related to their ability to sell oil at market prices.
This business model insulates SLX from fluctuations in the oil markets more than many of its energy MLP counterparts. Consider Sunoco’s distributable cash flow over the past few years (during the continued downturn in oil prices):
- 2012: $3.18
- 2013: $2.91 (8.5% decrease)
- 2014: $1.80 (38.1% decrease)
- 2015: $1.81 (0.6% increase)
- 2016 (expected): $2.25 (24.3% increase)
While these numbers aren’t fantastic, the MLP was able to continue growing dividends over this period where many of its competitors went out of business.
Sunoco is also appropriately leveraged (with a debt-to-EBITDA of 3.6x as at September 30, 2016), and has a reasonable distribution coverage ratio, paying $1.98 in expected distributions for 2016 with $2.25 of expected cash flow per unit. This means that Sunoco’s distributable cash flow payout ratio is 88%, which is certainly sustainable for an MLP.
The post-merger entity is expected to have a distribution coverage ratio in excess of 1.0x (meaning a payout ratio of less than 100%).
The company is also expected to slowly deleverage after the transaction is complete, which would further reduce the risk in this company.
Valuation & Expected Returns
Since Sunoco Logistics is an MLP, one of the easiest ways to assess its historical valuation is to compare its current dividend yield to its historical dividend yield.
Source: Sure Retirement Newsletter
Since inception, Sunoco Logistics has traded at a median dividend yield of 6.1%. While this is certainly a high yield on an absolute basis, it pales in comparison to Sunoco’s current dividend yield of 8.5%. Based on this metric alone, Sunoco appears significantly undervalued at current prices.
Total returns for Sunoco Logistics’ investors will be composed of:
- 8.1% dividend yield
- 10%-12% distribution growth (as forecasted by management)
In the long run, Sunoco’s investors can expect total returns in the range of 18.5%-20.5% However, these projected returns are highly contingent on the closure of the ETP-SXL transaction and will look dramatically different if the transaction were not to complete.
These risks are offset by the company’s attractive valuation, which will boost returns in the long run.
Sunoco Logistics is a strong dividend stock, with an 8.1% yield and 14 years (46 consecutive quarters) of consecutive dividend increases.
The company stands to benefit from a pending merger with Energy Transfer Partners, which would make the pro-forma entity the largest midstream MLP based on EBITDA and the second largest MLP based on enterprise value. The ‘new’ Sunoco will have a market capitalization of $27 billion.
These factors combine to make Sunoco a top ten 5%+ yielding stock using The 8 Rules of Dividend Investing – which means the company is a buy at today’s levels for investors looking for high income and strong total returns.