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The investment thesis for Sunoco LP (NYSE: SUN) is pretty much predicated on its dividend and its ability to keep that payout going for a long time. Based on the company's stock yielding more than 10%, though, it would seem that investors aren't putting a lot of faith in Sunoco's maintaining a stable, growing payout. Based on the company's financials and management's history, investors should be ready for the company not to raise its payout. Let's take a look at why this may be the case.
Things aren't looking great today
If we were to base a distribution raise on Sunoco's most recent results, then it looks as though a raise in payout would significantly compromise the company's balance sheet even more than it has. In the most recent quarter, Sunoco's distribution coverage ratio was a dangerously low 0.93 times. This means that it actually paid out more in distributions than in cash that is available to be distributed. To be fair, its distribution coverage ratio over the past 12 months was 1.2 times, but this most recent quarter was after the company had completed its major dropdown acquisition from parent company Energy Transfer Partners (NYSE: ETP). So in theory, its cash-generating ability should be much stronger.
The real issue at hand is that management has probably raised its payout too quickly, and the rest of the business has yet to catch up. This most recent distribution was 19% higher than the same quarter last year. Considering the amount of debt that it took on to complete that last transaction, it would seem that management may be a little too cavalier with its balance sheet. If we were to assume that EBITDA levels from this past quarter were to remain the same for four quarters -- something that may not necessarily be the case -- then net debt to EBITDA for the company would be 5.22 times.
Debt levels are important for master limited partnerships in general because they are used so much for capital expenditures, but they are doubly important for Sunoco and its future because organic growth opportunities are rather few and far between. The fueling station market is pretty saturated across the U.S., so there aren't a lot of opportunities for newbuilds. On the other hand, this is an extremely fragmented market. That means the biggest growth opportunities for Sunoco will come through acquisitions that will most likely be fueled by debt.
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If Sunoco wants to keep growing, it needs to get its financial house in order. Ultimately, that will mean it needs -- at a minimum -- to stop paying out more in distributions than what it's taking in. The quickest fix for that would be to keep its dividend payment flat for a while until its earnings power improves.
Parent company doesn't always raise payout
To some investors, the thought of a flat dividend for several years isn't exactly the most appealing offer, but it's not unprecedented for Sunoco's parent company. From 2009 to 2013, Energy Transfer Partners kept its per share payout steady at 0.90 per quarter. A large part of that had to do with tepid EBITDA growth from 2009 to 2012 and increasing debt to EBITDA levels. It didn't start raising it again until its earnings power had significantly increased and it was on more solid financial footing.
Today, Sunoco is in a similar situation where its growth opportunities are a little weaker and its debt is a little higher than desired. Based on this, it wouldn't be shocking if management used the same playbook to improve its financial position before attempting any drastic payout growth.
Keep in mind, too, that Sunoco's payout today yields 10.9%. That payout rate alone is in excess of the S&P 500's average payout. At that high of a distribution yield, investors can probably afford a year or two of flat payments while the company gets its financial house in order.
What a Fool believes
Since we don't have a Being John Malkovich-type door into the mind of Sunoco's management team, we can't say with any certainty whether the company will raise its payout or not in 2017. Looking at the company's recent financials suggests that it wouldn't be the best idea, and Sunoco's parent organization has been known to keep payouts flat for long periods of time to improve financials. If I were an investor in this company, I wouldn't bank on a payout increase next year. With a payout as high as it is already, there are bigger priorities for that cash in the business.
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