A little knowledge can be a dangerous thing. And if all you knew about Sunoco LP (NYSE: SUN) was that it yielded above 10%, you might already be sold on the investment.
But your view on Sunoco might change once you found out that the company had underperformed not only the S&P 500 in 2017 -- by more than 25 percentage points, I might add -- but also many other companies in the "downstream" sector of the oil industry, such as Marathon Petroleum (NYSE: MPC). Here's why Sunoco investors should be ready to forget 2017 and be hopeful -- but not ecstatic -- about 2018.
Continue Reading Below
Hot... or not
The downstream segment of the oil and gas industry -- which comprises the refining and marketing of petroleum products -- was red hot in 2017. Marathon Petroleum had a pretty typical 2017, with shares gaining 31%.
The big reason Sunoco underperformed Marathon and other downstream companies is that it was petroleum refining that saw the biggest gains in 2017 -- and while Sunoco is a wholesaler and retailer of refined petroleum, it doesn't do any refining itself. Instead, Sunoco made most of its 2017 profits through three avenues: wholesale distribution of fuel (28% of 2016 profits, the last full year for which figures are available), retail gas sales (also 28% in 2016), and convenience-store sales at its retail gas locations (32% in 2016), with less than 10% of profits coming from other sources in 2016.
So it's no surprise that Marathon and other refiners left Sunoco in the dust last year. The good news for Sunoco is that it did manage to outperform other energy master limited partnerships such as Enterprise Products Partners (NYSE: EPD) and Magellan Midstream Partners (NYSE: MMP), most of which are engaged in the midstream transportation and storage of oil and gas.
But all that could be about to change.
A radical transformation
In 2017, Sunoco inked a deal with 7-Eleven to sell the vast majority of its retail fuel locations -- and their attached convenience stores -- to 7-Eleven in exchange for a 15-year "take or pay" deal for Sunoco to provide wholesale fuel to those locations. The deal closed in late January.
Sunoco received $3.3 billion in cash, plus a payment for inventory and gasoline at the stores. In addition, it transforms itself overnight into primarily a gasoline wholesaler. Not only should that play to the company's strengths, but it will probably inject some stability into Sunoco's business model. Convenience-store sales are far more volatile than gasoline sales, and more susceptible to economic changes.
But there's a catch. While Sunoco isn't losing its retail profits -- which, through the long-term agreement with 7-Eleven, are just being converted into wholesale profits -- it is losing its convenience-store sales, the largest chunk of its 2016 profits. Certainly, the $3.3 billion sale price ought to help mitigate that loss -- but there may be a more pressing need for that money.
Deep in debt
Sunoco is carrying a hefty debt load of more than $3.5 billion, thanks to numerous acquisitions in recent years. That's high. In fact, its debt-to-equity ratio is 1.16, far higher than Marathon's 0.37, Enterprise Products Partners' 0.44, or Magellan's 0.27.
Obviously, a $3.3 billion infusion of cash would go a long way toward paying off that debt, but it's unclear how much of it the company plans to use for debt reduction and how much it might use for further acquisitions. It's also unclear whether the company will be able to cover its big 10.3% dividend yield without the revenue from those convenience stores it sold.
In other words, there are lots of moving parts here, and although the transaction is probably, on balance, a good move, the uncertainty surrounding it is certainly something investors will want to kiss goodbye along with 2017.
Sunoco and its unitholders probably won't shed many tears to see 2017 in the rearview mirror. The question now is whether the transformative moves Sunoco has made will pay off in 2018. That looks like an iffy proposition, although it's possible everything will go smoothly and Sunoco will finish the year in a much stronger position than it started it in.
However, with so many other master limited partnerships -- including Enterprise and Magellan -- to choose from whose balance sheets are in much better shape than Sunoco's, I would think long and hard before buying into Sunoco. I just don't think it's worth the risk.
10 stocks we like better than SunocoWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Sunoco wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of January 2, 2018