With a strong slate of organic growth projects and a very conservative Distribution Coverage Ratio (DCR) of greater than 2.0x in Q3:2012, Sunoco Logistics (SXL) is well positioned to increase its distribution per unit. These increases in distribution per unit could drive $25-30 of appreciation for SXL units in the medium term.
In its most recent quarter, SXL increased its distribution per unit 10% sequentially to $0.5175. This was the second consecutive quarter where the company sequentially increased its distribution by 10%. With a DCR of 203% in Q3:2012, and with seven organic fee based growth projects scheduled to be completed in the next 18 months, SXL seems poised to continue to dramatically grow its distribution in the short and medium term. Keeping that in mind, let's peel back the onion and take a look at the magnitude of potential distribution growth.
Current Operations and Distributable Cash Flow
Using Q3:2012 results as a baseline, SXL generated $188 million of EBITDA, while the company spent ~$25 million on interest payments. The company expects to spend ~$13 million per quarter in maintenance CAPEX, leaving the company with ~$150 million per quarter of Distributable Cash Flow (DCF), or enough cash flow to cover its current LP and GP distributions twice over. When compared to many of its peers whose DCR ranges from less than one times coverage to 1.3x coverage, SXL would certainly seem to have room to dramatically grow its distributions, even if the company's EBITDA does not grow.
However, due to management's conservative nature, the company has stated that it would not consider its market related cash flows when calculating its distributions. Though this would initially seem like a negative for SXL unit holders, it is not. Rather than having to raise equity via dilutive equity issuance, SXL will use its retained cash flow to fund much of its slate of organic growth projects.
When we adjust SXL's DCF for its market related cash flow, here estimated by the EBITDA from SXL's Crude Oil Marketing business, we see that SXL's Adjusted DCF decreases from $150 million to $96 million. A dramatic decrease, but still 1.3x its most recent quarterly distributions. Were SXL to have zero organic growth prospects, and thus little need to husband internally generated cash flow, we estimate this cushion could allow management to increase quarterly distributions per unit by $0.10 per unit while still keeping its Adjusted DCR greater than 1.0x. Though this may seem aggressive, keep in mind the company would still have the cash flow cushion from its Crude Oil Marketing business. Last quarter, this cushion would have been $54 million.
Estimated DCF from Organic Projects
Fortunately for SXL and its investors, the company has a robust set of organic growth projects which should drive significant future EBITDA, Adjusted DCF and Distribution growth. Since 2011, SXL has conducted seven successful open seasons, with one of these projects, the West Texas - Houston Access project, entering operation in Q2:2012.
In addition to the Houston Access project, SXL has six projects which have completed successful open seasons, and which are expected to be operational by mid-2014. Once operational, using a 7x investment multiple (management underwrites projects to a 6-7x EBITDA multiple), we expect these projects will generate almost $40 million of incremental quarterly EBITDA for SXL.
As mentioned above, given SXL's high level of retained cash flow, we do not expect that SXL will need to raise equity to finance these six projects and that SXL's low level of leverage will allow the company to fund the balance of the company's capital needs with debt.
When combined with SXL's low level of leverage (Total Debt of less than 2x LTM EBITDA), we expect that based on $720 of LTM EBITDA, SXL will have at least $1.4 billion of debt capacity to fund its slate of organic growth projects. Though the interest expense on this debt used to fund these projects will decrease DCF, SXL unit holders will not be diluted by an issuance of additional equity.
After we adjust the incremental EBITDA from these projects for additional interest expense from their debt financings and their associated Maintenance CAPEX, we calculate these projects could contribute $25 million of DCF per quarter. Based on SXL's Incentive Distribution Rights structure, we estimate a $25 million increase in quarterly DCF could increase DCF per SXL Unit by $0.12 per quarter.
When we combine this expected $25 million of incremental DCF with the $22 million of quarterly buffer which SXL has by keeping its DCR at 1.3x its fee based cash flow, we can see that the company will have the ability to increase distributions by over $45 million per quarter over the course of the next 18 months. Given this estimated increase in DCF, we estimate SXL could increase its per unit distribution by over $0.20 per unit per quarter over the next 18 months. Using a 5% dividend yield (Note: SXL currently trades at a dividend yield of ~4%), we calculate this incremental increase in distributions could increase SXL's unit price by $16 per unit over that time period.
Additional Upside form Additional Organic Projects
Permian Express 2. In addition to the seven organic projects above, SXL is completing its evaluation of the Permian Express Phase 2 project. Give the dramatic growth in crude oil production and the limited amount of takeaway capacity from the Permian Basin, we expect this project will be built, and that it will enter service in mid 2014. Given an estimated cost of $200 million and a 7x investment multiple, we estimate this project could generate $7 million of quarterly EBITDA. This could help to increase quarterly Distributions per SXL unit by $0.03.
Trunkline Conversion. SXL's parent company, Energy Transfer Partners (ETP) has announced that it intends to convert part of its Trunkline natural gas pipeline to crude oil service so that Canadian and Mid-continent crudes can be transported to the Eastern Gulf Coast refinery market. Given its low cost of capital and its expertise in crude oil transportation, SXL would seem like the logical home for at least part of the Trunkline conversion. The total project cost for the Trunkline conversion is expected to be ~$1.5 billion. Given a 7x investment multiple, we expect this project could generate more than $50 million of quarterly EBITDA. If SXL is the sole owner of this project, it is possible the Trunkline Conversion could increase quarterly DCF by more than $25 million, which could increase quarterly DCF per SXL unit by $0.10-0.15.
Using a 5% dividend yield, once Permian Express 2 and the Trunkline Conversion are operational, it appears as if the distribution increases driven by their results could help to increase SXL's unit price by an incremental $10-14 per unit.