VettaFi recently sat down with Karl Fails, COO at Sunoco LP (SUN). Fails discussed the company’s assets and businesses, NuStar acquisition, and capital allocation priorities.VettaFi: Can you provide a brief overview of Sunoco’s assets and businesses?
Fails: Our business is split between fuel distribution and critical midstream infrastructure. About half of our portfolio is focused on distributing refined products, gasoline, diesel, some jet fuel, and other products. We’re North America’s largest independent fuel distributor; we distribute about 9 billion gallons annually.
One of our unique aspects is we’re the only independent distributor with a recognized national brand. We have almost 7,500 branded locations – most of those are our own brand, but we also distribute other major brands, as well as unbranded fuel.
That fuel distribution portfolio is underpinned by a real estate portfolio of about 800 convenience store real estate assets that also provide stable cash flows.
Then the other half of our business, which is really integrated with that fuel distribution business, is midstream infrastructure. We have about 14,000 miles of pipeline systems moving refined products, crude, and ammonia. Then we have over 120 terminals that are both attached to our owned and operated pipeline systems, as well as other third party systems.
VettaFi: Can you talk more about the distribution and marketing business and how it makes money?
Fails: At its base, we buy, we move, and then we sell fuel. We do that through a number of different channels in various geographies. Our overall focus is on fuel profit dollars rather than just margin or just volume. The network we’ve built is set up across all those different geographies and the different channels to optimize fuel profit.
There are various levers or parts to our strategy that allow us to deliver this. First, our scale advantages us in purchasing and allows us to reduce our cost of goods sold. To support that we have a sophisticated supply strategy that includes buying a lot of bulk fuel, owning it, shipping it through pipelines, and blending it in terminals ourselves. We have cargo operations where we’re moving cargos in both the Atlantic and Pacific. A part of that strategy is focused on working capital efficiency. That is on the supply side and really helps expand the margin by purchasing more efficiently.
We also have sophisticated logistics capabilities to be able to move that, so we have the flexibility to source barrels in locations that are most cost effective and then move them to the areas we need them from a demand standpoint. Then we’re able to expand the margin on the sales side, because we own our own brand. The Sunoco fuel brand is over 100 years old, and we’re able to sell that fuel generally through long-term contracts. Our distributors or dealers sign seven to 10 year contracts with us, which means they exclusively sell our branded fuel. Like I mentioned earlier, we sell a lot of unbranded fuel as well, but having that branded part of our portfolio really expands our margin opportunity.
There’s one other dynamic that really helps – we’ve talked about it a lot over the past few years – which is what we call breakeven fuel margins. It’s been more apparent in the market since COVID, when volumes really fell off. But the idea is similar to a cost curve or supply curve, where in the market you have various different suppliers. You have some on one end of the curve that are very efficient and can do it at a lower cost. Then you have suppliers on the other end of the curve that maybe are smaller, not as well capitalized, or not as sophisticated. It’s really that marginal supplier that’s going to set the price, and that’s going to be focused on getting a certain return on capital.
Any factor – whether it’s inflation, during COVID it was volume falling off, maybe it’s higher interest rates – can lead to that marginal or less efficient operator having to take more margin to be able to get the same return on capital. But we, as one of the most efficient operators, benefit because of that scale of lower operating costs and our ability to optimize that we talked about earlier. I use the example that if margins have to go up a penny, we might only have our costs go up a quarter of a penny, and so we’re actually able to expand our margin in that environment.
VettaFi: Can you discuss the benefits of the NuStar acquisition?
Fails: That acquisition was really an opportunity to do three things.
First, it increased our cash flow stability. We have a much larger portfolio of fee-based, index-based assets.
Two, it strengthened our financial foundation as a result of that cash flow stability. We’re a larger company, and it was credit enhancing, so we were able to take advantage of all the benefits that come from that.
Then third, it really enhanced our opportunities for growth. We have more free cash flow that we can either share with the unitholders and/or reinvest in the business.
If you play all three of those out, we laid out synergy targets. In 2024, we delivered over $50 million in EBITDA synergies in just the first eight months of ownership. In addition, we had around $60 million in financing synergies, because we were able to take the stronger balance sheet of our combined company and refinance a lot of the higher cost debt that NuStar had.
As we go forward, in 2025 we’ll deliver over $125 million of annual synergies. In 2026, it’ll be over $200 million.
Then we were able to finish the integration really quickly. When we first announced the deal, we said that we would get our leverage back to our target of 4.0x within 12 to 18 months, and we were able to deliver that in less than six months. A big part of that was because of those synergies we were able to capture sooner.
VettaFi: What are your capital allocation priorities and outlook for the distribution?
Fails: The three pillars of our capital allocation strategy have really remained the same over the last few years and as we go forward.
First is maintaining balance sheet strength. We have a long-term leverage target of 4.0×. Even when we flex to do different things, whether we’re a little bit lower or we’re a little bit higher, we want to have line of sight to be able to maintain that target.
The second pillar is growth. We’ve been able to deliver on that tremendously over the last few years, both from organic projects and acquisitions. I think the best metric, from our perspective, is our ability to deliver growth in DCF [distributable cash flow] per common unit. A lot of companies can grow DCF or even grow EBITDA, but if they’re just issuing equity to do that, they’re not really accreting any of that growth to their unitholders. For us, we’ve been able, for the last eight consecutive years, to increase our DCF per common unit, and we’re the only AMZI constituent to have delivered that.
The third is having a strong, stable, and growing distribution while maintaining very strong coverage. On January 27th, we increased our quarterly distribution by 1.25% and shared that we have an annual distribution growth target of at least 5%. This is the third year in a row that we’ve increased our distribution. We also made the change to where we plan on increasing distributions quarterly instead of annually, and plan on growing distributions on a multi-year basis.
VettaFi: Is there anything you feel that the market may be overlooking about Sunoco?
Fails: I think there is. Over the last five plus years or so, I think Sunoco has gained a solid and well-deserved reputation as a defensive play given our ability to perform well in a variety of market conditions, different administrations, during COVID, after COVID. Some of those market conditions have been positive, some have been challenging, and we’ve been able to deliver in all of them.
But I think what might get overlooked is we’re also a growth play. Like I mentioned earlier, we’ve consistently grown EBITDA and DCF per common unit. Even more exciting to us, we feel like there’s ample opportunity for that growth to continue. Our bigger footprint enables us to have more opportunities for organic growth capital, and we still think there’s the opportunity to be a consolidator in both fuel distribution and midstream infrastructure.
We have many products that we distribute and that we transport through our midstream assets, but, at our core, most of what we ship, move, and buy and sell are refined products. Over 90% of transportation energy consumption across the world comes from refined products, and then another 5% comes from liquid renewable fuels, which we also distribute. As we look forward, we think the importance of those products is only going to continue, whether it’s in the U.S. or other parts of the world (as we have operations in the Caribbean and in Europe as well). We think the continued importance of refined products in the global energy mix is often overlooked and undervalued.
Sunoco is a holding in the Alerian MLP ETF (AMLP A-), comprising 11.3% of the fund by weight as of January 31. AMLP tracks the Alerian MLP Infrastructure Index (AMZI), a composite of energy infrastructure MLPs that earn most of their cash flow from fee-based midstream activities.
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