(Published Jan. 12 by The Financial Canadian)
To be considered a Dividend Achiever, a company must have at least 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, Financial), an MLP with 14 years of consecutive dividend increases. We will cover the investment prospects of Sunoco in detail.
Business overview
Sunoco Logistics is a midstream energy master limited partnership that is part of the Energy Transfer Equity LP (ETE, Financial) family of oil and gas assets. Energy Transfer Equity is an MLP with the following ownership:
- 100% of Energy Transfer LNG (which is expected to be a new standalone MLP)
- 2% Limited Partner, 100% General Partner with IDR in Sunoco LP (SUN, Financial)
- 1% Limited Partner, 100% General Partner with IDR in Energy Transfer Partners LP (ETP, Financial)
- 90% General Partner with IDR in Sunoco Logistics Partners
(Side 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 approximately $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 was announced. Energy Transfer Partners is also a member of the ETE family. The fact that both companies come from the same 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
After the transaction, the new entity will have significant geographic scale. The 71,000 miles of pipeline that will belong to the Sunoco 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), the company was expected to cut their dividend by 10% to 15% (which would trigger a sell-off according to The 8 Rules of Dividend Investing).
After the merger, the shareholders of both entities are expected to benefit immediately.
Energy Transfer unitholders can rest assured in the renewed safety of their distributions.
Sunoco investors will be pleased to hear the deal is expected to be immediately accretive to the MLP’s distributable cash flow and the distributions per unit (more on that later).
Growth prospects
Sunoco’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 Sunoco and outline forecasted business growth prospects.
The first benefit of this transaction is the synergies that will result from the 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. After the 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 – Energy Transfer Partners 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 acquisition history of the two MLPs in recent years.
Source: Sunoco Logistics Investor Presentation, slide 12
As 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, Sunoco’s management stated they expect the transaction to close in the first quarter of 2017.
If this transaction is completed, it will certainly be a driver of growth for this company moving forward.
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 expect. In the oil industry, Sunoco operates particularly in the midstream subsector (think pipelines). This means that Sunoco’s earnings are tied to its ability to transport oil – not related to its ability to sell oil at market prices.
This business model insulates Sunoco 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 are not fantastic, the MLP was able to continue growing dividends over this period while many of its competitors went out of business.
Sunoco is also appropriately leveraged (with a debt-to-EBITDA of 3.6x as at Sept. 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 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, further reducing 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% to 12% distribution growth (as forecasted by management)
In the long run, Sunoco’s investors can expect total returns in the range of 18.5% to 20.5%. These projected returns, however, are highly contingent on the closure of the Energy Transfer Partners-Sunoco transaction and will look dramatically different if the transaction were to fall through.
These risks are offset by the company’s attractive valuation, which will boost returns in the long run.
Final thoughts
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, as mentioned previously. The new Sunoco will have a market capitalization of $27 billion.
These factors combined make Sunoco a top 10 5%-plus 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.
Disclosure: I am not long any of the stocks mentioned in this article.
Start a free 7-day trial of Premium Membership to GuruFocus.
