Last week, Sunoco LP (NYSE: SUN) announced that it finally closed the sale of the bulk of its retail gas stations to 7-Eleven. While the two companies initially struck a $3.3 billion deal, Sunoco ended up receiving about $3.2 billion in cash because 7-Eleven couldn't acquire all the agreed-upon locations without harming competition in several local markets. That said, the still massive cash infusion gives Sunoco the money to shore up its financial situation while also helping out its sibling Energy Transfer Partners (NYSE: ETP). Because of that, their high-yielding payouts are now on a much more sustainable foundation.
Putting its windfall to work
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Last week marked a significant milestone in Sunoco LP's transformation to a more stable master limited partnership (MLP) focused on fuel distribution and logistics. Not only did the company close its $3.2 billion gas station sale, but it also completed a $2.2 billion private offering of senior notes. The company has big plans for this cash infusion.
First, it will use the new debt to redeem and replace all its legacy notes:
This move reduces Sunoco's blended interest rate on the notes from 6.09% to 5.28%, which will save it about $17.8 million per year in interest expenses. Further, it pushes out the maturity dates by several years.
Meanwhile, the company will use a portion of the cash received from 7-Eleven to repay a significant amount of its other borrowings, which includes a term loan due next year and a revolving credit facility. The company had more than $2 billion remaining on these debt facilities as of the end of the third quarter of 2017. By paying down this debt, the company should reduce its leverage ratio from a concerning 5.59 times EBITDA at the end of the third quarter to a more comfortable 4.0 to 4.5 times.
In addition to paying down debt, Sunoco LP plans to use part of its proceeds to buy back some of its equity. First, it will redeem the $300 million in preferred units owned by its parent company Energy Transfer Equity (NYSE: ETE). Meanwhile, it will repurchase more than 17 million of common units currently held by sibling Energy Transfer Partners for $540 million. In repurchasing this equity, Sunoco will reduce the amount of cash it needs to distribute to these entities each year. Those savings, when combined with the reduction in interest expenses, should enable the company to generate enough cash flow from its remaining businesses to cover its 10.3%-yielding payout by 1.1 times in the future, up from 1.04 times on a trailing 12-month basis through the third quarter. .
Keeping it all in the family
The more than $800 million in cash Sunoco will send to Energy Transfer Equity and Energy Transfer Partners will allow both to pay down debt. That's most important to Energy Transfer Partners, which has been working hard to reduce leverage while also financing a massive expansion program so that it could maintain its 11.3%-yielding payout.
While Energy Transfer Partners will lose the income stream earned on the $540 million in units to be repurchased by its sibling, it gains a bit more breathing room by using the cash to chip away at its debt. That's because it puts the company one step closer to hitting it leverage target of less than 4.0 times debt to EBITDA, which would be a meaningful improvement from 4.92 times at the end of the third quarter.
It's just the latest in a string of moves. The company also will receive $1.225 billion in cash from the sale of its compression business earlier this year, and it already picked up $1.48 billion from a preferred offering last November and $1.57 billion in October from the sale of a stake in one of its latest growth projects. These cash infusions, when combined with the earnings growth coming down the pipeline from its expansion projects, put Energy Transfer's balance sheet in a much stronger position than it was a few months ago, which increases the sustainability of its distribution.
Better but still a bit too risky
These moves are certainly steps in the right direction for both companies because they enhance their ability to maintain those lucrative payouts. That said, these high yields remain higher-risk options for investors; even if Sunoco and Energy Transfer hit their target levels for leverage and distribution coverage, those numbers wouldn't be quite as good as others in the industry since most companies are now aiming to get their leverage below 4.0 and maintain a distribution coverage ratio of more than 1.2 times. Because of that, neither seems worth buying since lower-risk, high-yield options are out there.
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