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Sunoco Logistics Partners L.P. (NYSE:SXL)

Q4 2009 Earnings Call

January 27, 2010 9:00 am ET

Executives

Deborah M. Fretz - President and Chief Executive Officer

Neal E. Murphy - Vice President and Chief Financial Officer

Michael J. Hennigan - Vice President of Business Development

Bruce D. Davis Jr. - Vice President and General Council

Analysts

Sharon Lui - Wells Fargo

Ethan Bellamy - Wunderlich Security

Ross Payne - Wells Fargo

Steven Lerner - Mt. Kellett (ph)

Barrett Blaschke - RBC Capital Markets

Louis Shamie - Zimmer Lucas Partners

John Tekland (ph) - Citi

Operator

Good morning, my name is Phyllis and I will be your conference operator today. At this time I would like to welcome everyone to the Sunoco Logistics Partners fourth quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background notice. After the speakers remarks there will be question and answer session. (Operator’s instructions). Thank you. I would now like to turn the call over to Deborah Fretz, President and CEO. You may begin your conference.

Deborah M. Fretz

Thank you, Phyllis. Good morning everyone, welcome to the Sunoco Logistics Partners conference calla to discuss our fourth quarter 2009 results. I’m Debby Fretz, President and Chief Executive Officer for the general partner. Joining me today on the call are Neal Murphy, Vice President and Chief Financial Officer, Mike Hennigan, Vice President of Business Development and Bruce Davis, Vice President and General Council.

In the course of our remarks and the subsequent Q&A session, we will be referring to slides that had been posted on our website entitled Fourth Quarter 2009 Earnings Conference Call, January 27, 2010. And we may be making some forward-looking statements. For purposes of facilitating a good discussion I’ll refer you to the forward-looking statement in Slide 2. And as referenced in this morning’s press release noting that our business is subject to a variety of risks and uncertainties. For fuller discussion of these and other risks that could cause our results to change, please see our September 30, 2009 SEC Form 10Q filed on November 4, 2009.

So, I’d like you to refer to the 2009 assessment that we have on Slide 3. 2009 was another record year for Sunoco Logistics with net income of $250.4 million compared to $214.5 million in 2008. We also had a record income in each our three business segments and record organic growth spending. We continue to have many excellent opportunities to help us continue our outstanding growth in cash flow.

For the fourth quarter 2009 net income was $54.4 million compared to $75.3 million in 2008. This $21 million decrease in earnings was a result of lower earnings in our crude oil pipeline segments which realized record earnings in the fourth quarter of 2008 from the extreme volatility in the crude oil markets as well as the timing of inventory accounting.

There is over $9 million in income related to contango positions that we had in 2009, but we’ll be deferred into 2010 because of inventory timing.

As a result of our continuing strong cash flow, we declared an increase distribution of $0.10 per LP unit to $4.36 per LP unit on an annualized basis. The quarterly distribution of $1.09 per LP unit will be paid on February 12, 2010 to unit holders of record as of February 8, 2010. This is a 10.1% increase over the fourth quarter 2008 distribution and a 2.3% increase over the prior quarters distribution. This is the 26th distribution increase in the past 27 quarters.

I’d also like to make some comments on the current acquisition environment. We expect that there will be many potential acquisition candidates in 2010 that will fit well with our existing asset base as we see some integrated companies divesting some logistics aspects and other opportunities which will appear on the horizon. Our conservative balance sheet coupled with the changes in our general partners distributions rights will allow Sunoco Logistics to better compete for these accretive acquisition opportunities.

Neal will discuss the IDR reset in more detail. But the points that I want to make are that it will immediately accretive to our LP unit holders and it will result in a lower cost of capital for Sunoco Logistics. Which will be helpful for us to remain competitive.

So at this point I’m going to turn the discussion over to Mike Hennigan to provide an update on the business.

Michael J. Hennigan

Thank you, Debby and good morning everyone. Our fourth quarter activities included the successful integration of the Excel crude oil pipeline acquisition in Oklahoma, the Romulus Michigan Refined Products terminal acquisition and the commencement of commercial activities for the Nederland (inaudible) to the Port Arthur pipeline.

As Debby mentioned, we’ve had record organic growth investments in 2009 and we see even more opportunity in 2010. We continue to expand our Nederland crude terminal adding additional tankage and installing rail unloading facility. This gives Nederland a broad array of oversea capabilities include ships, barges and rail as well as pipeline.

Our focus as also been on optimizing the asset basis in our refined product terminal system by adding ethanol facilities, vapor recovery units. And we have initiated a program to install bio diesel facilities at a number of locations.

Each of these activities is expected to be accredited to unit holders in 2010. We are also hopeful that the acquisition activity will pick up in 2010 as few of the integrative oil companies have already announced mid stream assets (inaudible) planned.

Lastly, I’d like to call your attention to Slide 5 which shows the crude oil market structure for the last few years. The market was in steep contango was a large part of 2009 and we’ve capitalized on this market structure by using our crude oil storage capacity to generate incremental EBITDA. Also the contango market has diminished in the fourth quarter, thereby reducing the contango contribution of fourth quarter profit. However, pushing inventory remains at high level. There’s potential opportunity for the reemergence to stronger contango during 2010.

Obviously contango is volatile and when it is there we’ll take advantage of the structure.

I’ll turn it over to Neal to discuss our financial results in more detail.

Neal E. Murphy

Thanks, Mike. Before I get into our 2009 financial results I’d also like to highlight the other announcement that we issued today concerning a reset of our general partners distribution rights. Which is summarized on Slide 4 of our slides. And also in the press release which we issued at the close of business yesterday. This change in the general partners incentive distribution rights will serve to reduce the incremental distribution requirement from 50% to 37% which will serve to lower our cost to capital allowing us to better compete for growth opportunities in the future. And as Debby mentioned, it’s also expected to be immediately accretive to LP unit holders.

The transaction was financed with a promissory note to Sunoco. And the terms of this financing provide us with a good deal of flexibility in terms of obtaining permanent financing at a future date.

Slides 6 and 7, show the summarized financial results for both the quarter and the year. As Debby noted, the partnership reported record net income of $250.4 million for 2009 compared to $214.5 million for the prior year.

As you can see on Slide 6, sales and operating income and cost of sales and other operating expenses are considerably lower for 2009 as compared to the prior year, due to significantly lower crude oil costs.

Other income increased by $2.2 million for the quarter and $3.6 million for the year due to stronger performance from our joint ventures. Depreciation and amortization increased by $2.2 million for the quarter and $8 million for the year, due mainly to the MagTex acquisition as well as additional tankage at our Nederland facility.

So general administrative expenses increased $1.2 million for the quarter and $4 million for the year, mainly due to higher employee costs.

Net interest expense for the quarter and for the year has increased by $4.2 million and $13.6 million respectively due to increased borrowing related mainly to the $185 million MagTex acquisition, increased (inaudible) inventory positions and organic growth projects.

Turing to Slides 8 and 9 for our CAP EX and debt overview. Maintenance capital expenditures for 2009 were $32.2 million. And we expect to be at approximately $32 million for 2010. For the full year 2009, expansion capital expenditures inclusive of our acquisitions in the third quarter were $193.6 million.

Our balance sheet remains strong with a debt to EBITDA ratio of 2.5 times. And as of December 31, 2009, we had total debt outstanding of $868.4 million. Which consisted of $599.4 million of senior notes and $269 million of borrowing under our revolving credit facility. This compares to $747.6 million at December 31, 2008. With the increase stemming largely from an increase in contango inventory positions.

As of December 31, 2009, we had available borrowing capacity under our revolving credit facility of $188.5 million.

Turning to the segment information, refined products, Slide 10 in our slide deck. For the quarter, operating income increased slightly to $10.2 million. Total revenues increased from $29.9 million to $33.1 million, primarily due to the additional of MagTex and higher tariffs across the rest of the system, partially offset by softening volumes on our North Eastern pipelines.

Full year operating income improved $10.3 million to a record high of $44.7 million in 2009. This increase was due primarily to the results from the MagTex acquisition, higher pipeline fees and a $4.1 million increase in other income related to increased equity income from our joint venture interest.

These increases were partially offset by a reduction in pipeline operating gains and reduced volumes on our North Eastern pipelines.

Turning to terminal facilities. For the quarter, operating income for the terminal facility segment increased by $4.9 million or 31% to $24.5 million compared to the prior year fourth quarter. This increase was driven by revenue growth, just over 20% or $8.8 million and the results from the MagTex’s acquisition.

Volume reduction realized as a result of previously announced oiling (ph) of the Eagle Point refinery, did not have a material impact on earnings for the quarter.

During the quarter, revenues and costs of products sold and operating expenses increased with the commencement of optimization products at our refined products terminal facilities. Year to date operating income for the terminal facility segment increased by $25.2 million to a record $83.7 million. The increase was due primarily to increase fees and additional tankage at the Nederland facility and results from the MagTex’s acquisition.

Turning now to our crude oil pipeline system, Slide 12 of our slide deck. For the quarter, operating income for crude oil pipeline system decreased $22.2 million to $35.6 million. Driven primarily by lower lease acquisition results and reduced level of pipeline operating gains. Lease acquisition results in the fourth quarter 2008 were positively impacted by extreme volatility in the crude oil markets and timing of income recognition associated with lease acquisition activity.

As Debby mentioned previously, inventory timing issues resulted in $9 million in contango profits being deferred until 2010. And this represents roughly $0.29-$0.30 per LP unit.

On a year to date basis, operating income for the crude oil pipeline system increased to a record high of $166.7 million. The increase was primarily attributable to higher lease acquisition results, which benefited from the contango market structure and also higher pipeline fees.

And with that, my remarks are complete and I’d like to turn it over to Debby for some final comments.

Deborah M. Fretz

Thanks, Neal. Well, we’re very proud of our record performance in 2009. And as we look forward to 2010 we continue to think that the prospects for growth in our base business are excellent. And we are targeting at least 10% growth in distributions for the coming year. We also believe the incentive distribution reset agreement that was announced yesterday better positions Sunoco Logistics for growth from a cost of capital perspective. And will enhance our distribution coverage.

So with that, I’d like to open the line for any questions you might have.

Question-and-Answer Session

Operator

(Operator’s instructions). We’ll pause for just a moment to compile the Q&A rooster. Your first question comes from the line of Sharon Lui with Wells Fargo.

Sharon Lui - Wells Fargo

Just wondering what the board thoughts were on resetting the IDRs versus permanently eliminating the IRDs or just capping it at 25%?

Deborah M. Fretz

Well, the agreements were reached between our conflicts committee and Sunoco as the owner of the GP. And so really need to talk to Sunoco regarding those views on that.

Sharon Lui - Wells Fargo

Okay. I guess the second question I had was that you’ve provide, I guess, distribution growth of about 10% for this year. Just wondering whether you plan on maybe accelerating the growth rate or maybe just holding back from the excess cash to fund growth opportunities?

Deborah M. Fretz

Well, we have indicated in past December actually the Wells conference as well as today that we’re targeting at a minimum of 10% distribution. And I think that that would be all the guidance we will giving at this time. Obviously, if we end up executing distribution then we may do something different. But at this point that’s what our guidance is.

Sharon Lui - Wells Fargo

Okay. And I guess the final question is just some additional details, maybe on the promissory note, the term and the interest rate?

Neal E. Murphy

Yeah. The promissory note is arms length terms and is very flexibility. It’s really a vehicle to transition us some time down the road into more permanent debt financing.

Sharon Lui - Wells Fargo

Okay. So there’s not set term or interest payments high to that?

Neal E. Murphy

There is interest payments or some flexibility on the term. But beyond that, that’s all we’re prepared to comment on.

Sharon Lui - Wells Fargo

Okay. I guess, trying to just (inaudible) the CCF secretion would a rate in the 6%-8% range be reasonable?

Neal E. Murphy

Again, I think all the medley will be moving toward permanent financing. And you have a good sense of what the market prices are for that.

Sharon Lui - Wells Fargo

Okay. All right. Thank you.

Operator

Your next question comes from the line of Ethan Bellamy with Wunderlich Security.

Ethan Bellamy - Wunderlich Security

Sharon asked most of my questions but I basically wanted to see if there’s any more color you could give us on the promissory note. I mean, it’s real difficult to model the accretion without some type of interest rate. But barring that, Neal, what were the total payments to the IDRs in 2009, please?

Neal E. Murphy

Why don’t we come back to that. We’ll get you that number before the end of the call if you would.

Ethan Bellamy - Wunderlich Security

Okay. Thanks.

Operator

Your next question comes from the line of Ross Payne with Wells Fargo.

Ross Payne - Wells Fargo

First question is related to volumes. If you can kind of, MagTex op acquisitions, obviously, impacts that to some extent, I guess. But, in the North East, what have you seen in terms of year over year volumes?

Neal E. Murphy

Year to date non MagTex on our Eastern pipeline system the barrel a miles are down about 4%.

Ross Payne - Wells Fargo

Okay. That’s for the fourth quarter?

Neal E. Murphy

That’s full year. And the fourth quarter was really a continuation of the trend for that, for the full year.

Ross Payne - Wells Fargo

Okay. What are the expectations for 2010? I mean, some people are seeing some stability there, at least on the gasoline side? What are your thoughts there?

Michael J. Hennigan

I think you’re seeing some return to demand as the economy recovers. Our belief is it’s tied to the overall economy. But the market is settling out. Wherever refinery runs are settling in at that 80% utilization and then we expect it to come up from there once the market settles out.

Ross Payne - Wells Fargo

Okay. Obviously you’ve added a lot of capacity at Nederland. It looks like you’re import volumes are up. Just two questions on Nederland, what are expectations maybe for 2010 in terms of terminal volumes, import volumes across that facility? And second of all, where are you on a capacity utilization standpoint on your storage now and any expectations for 2010 in that regard?

Michael J. Hennigan

We continue to have a lot of interest in Nederland throughout 2010 and we’ll be disclosing that as we go forward. You’re right today the terminal has 21 million barrels of capacity in service. And like I said, we have plans throughout the year and we’ll give you updates as we go through.

Ross Payne - Wells Fargo

About how much of that capacity is taken right now?

Michael J. Hennigan

Yeah. That’s what I’m saying. All of that capacity is in service. 100%.

Ross Payne - Wells Fargo

Okay. Great. Been a pretty healthy appetite going forward. Also on the crude gathering, one thing we’ve heard – obviously heavy suit (ph) differentially have decreased and sometimes you have some mixing opportunities there that can create some benefit for you. Also maybe the contango market is not as steep as it used to be. But if you could kind of just talk in general about what the market for that segment looks like currently versus maybe a year ago? Just generally speaking.

Michael J. Hennigan

Obviously a year ago at the start of 2009 we had real steep contango. The market was in a lot different structure than it is today. Currently we’re around $0.45-$0.50 month one to month two. So I mean, the market right now is settled into a market that kind of equivalent to just the normal contango that we’ve seen throughout the year. So we don’t see it strong right at the moment. But as I mentioned (inaudible) inventories remain at the high end. So we expect to see windows of opportunity throughout the year where that structure will widen back out again. And we’ll look for times to capture that.

Ross Payne - Wells Fargo

Any thoughts to – obviously the acquisition market looks favorable. Any thoughts on what kind of size we might expect on the acquisition front?

Deborah M. Fretz

I think we have multiple companies announcing that they’re going to be divesting assets coming up, putting various packages of assets out. And until we can take a look at those it’s hard to see what kind of magnitude we’re talking about.

Ross Payne - Wells Fargo

All right. Thank you very much.

Operator

Your next question comes from the line of Steven Lerner with Mt. Kellett.

Steven Lerner - Mt. Kellett

You mentioned the change in the cost of capital a couple of times. Can you just give us some perspective on how the GP restructuring will lower your cost to capital?

Neal E. Murphy

Sure, Steven. Before I even address that, let me get back to the earlier question. The 2009 cash distributions to the general partner were $47.8 million. That’s actual cash paid out in 2009. So that would not include the distribution that we’ve just announced.

Yeah. In terms of cost of capital, under the previous split structure the general partner was receiving $0.50 on every incremental dollar of distribution. And so when you would look at our yield to the LP holders you have to gross that yield to the LP holders up for what the general partner was receiving. And so now that the general partners no longer receiving $0.50 on each incremental dollar distribution but rather receiving $0.37 on each incremental dollar distribution that’ll reduce our cost of equity and enable us to better compete for growth projects.

Steven Lerner - Mt. Kellett

And did you approach Sunoco to do this given your view of acquisition opportunities in 2010 and beyond?

Deborah M. Fretz

One of the things that the board has been discussing given what’s going on in the competitive landscapes of MLPs, is how to compete from cost to capital in what’s going on here and what some of our competitors and the steps they’ve taken. So all of that grew out of those discussions.

Steven Lerner - Mt. Kellett

I see. Okay. Well, congratulations on a great quarter. And thanks for taking my call.

Operator

Your next question comes from the line of Barrett Blaschke with RBC Capital Markets.

Barrett Blaschke - RBC Capital Markets

One quick question, is this kind of a repeatable transaction the way you’re restructuring, is this something that you see happening again as you kind of creep back up into the splits?

Neal E. Murphy

We really haven’t given that a lot of thought at this point. We’ve looked at this as an independent transaction at this point.

Barrett Blaschke - RBC Capital Markets

And just a follow up and that’s – was this at all kind of a financing transaction for the parent?

Neal E. Murphy

I really can’t speak for the parent. From an SXL or from a Sunoco Logistics perspective, we certainly felt comfortable in our capital structure that this was a very manageable and good investment for us.

Barrett Blaschke – RBC Capital

Okay. Thank you.

Operator

Your next question comes from the line of Louis Shamie of Zimmer Lucas.

Louis Shamie - Zimmer Lucas Partners

Congratulations on the transaction. So, Mike, my question is regarding what your view is on distribution coverage going forward and what kind of range of coverages do you feel is appropriate for the partnership?

Neal E. Murphy

Yeah. We tend to be a bit conservative on our distribution coverage. We tend to look at our coverage in the context of our rateable business. We have market related activities that we’ve spoken too on the past that we tend not to be as willing to distribute those funds because they’re a bit more volatile. So I see our distribution coverage coming down from 2010 levels depending upon how much more active related profits we have. And right now – as Mike had mentioned, market relate profits situation, contango has tightened up a little bit. It’s a little un predictable as to what they’re going to look like for the full year.

Louis Shamie - Zimmer Lucas Partners

Okay. I guess the way I look at it is with this transaction, if you weave the distribution policy, whatever you were intending to do next year, let’s say 10% from where it is up. You basically be able to pay out equivalent coverage but at a $0.20 higher distribution, roughly on the numbers that I’m running. So I guess the question is, is your policy going to be to kind of maintain the coverage as it would have been by increasing the distribution or is it to run at higher coverage and then over time –

Neal E. Murphy

That’s a fair question. I think that’s something we need to work through. I think your point is that the IDR reset transaction, by it’s accretive nature gives us more distribution coverage. But at this point we’re still guiding towards the minimum targeted 10% distribution growth for this year. But it does give us additional room flexibility going forward.

Louis Shamie - Zimmer Lucas Partners

Okay. That’s great. And I guess the last question I have is assuming that this you basically permanently fund this with $200 million of debt, how comfortable would you be with your leverage after that kind of permanent financing?

Neal E. Murphy

We would be very comfortable. I think we just laid over that 200 million on top of our 2009 capital structure we’re at 2 1/2 times debt to EBITDA at the end of 2009. And that includes some contango investments. And even this would be less than one turn. So we’d be in the low 3.1-3.2 times after this transaction. Which is still quite a bit below most of the competitors in our space.

Louis Shamie - Zimmer Lucas Partners

Great. That’s makes a lot of sense. All right. Thank you very much, Neal. Have a great deal.

Operator

Your next question comes from the line of John Tekland with Citi.

John Tekland – Citi

Good morning and congratulations. Couple of questions on – keep coming back to the promissory notes. Any idea when you might look to refinance that promissory note? Would it be this year? Secondarily when you view acquisition financing, you think as you’re current credit facility as being sufficient or do you believe that you go in – maybe possibly expand that credit facility prior to the transaction or would you look for financing once you’ve found the transaction?

Neal E. Murphy

Yeah, John, they’re all fair questions. At this point I’m going to defer most of those questions. I would say to you that the note gives us quite a bit of flexibility to go to the markets at such time as we would like to. I think our revolving credit facility is comfortable in terms of the room under it. We like to use that for contango and other opportunities?

John Tekland - Citi

Is it far like, given the fact that you have about $270 million drawn down on a $400 million credit facility that you had looked to finance transaction as you found it?

Neal E. Murphy

Not quite sure what you mean, as you found it?

John Tekland - Citi

Meaning that you’d finance a transaction as they came available. In other words, if it was larger than $130 million you would enter into some sort of financing along with the transaction.

Neal E. Murphy

Yeah. I think that’s a fair statements. Certainly we would not want to utilize all of our revolving liquidity for a transaction like this.

John Tekland - Citi

And then lastly any estimate in what you earn in contango profits in 2009 and how you view 2010 and what the potential there would be? Is there some minimum that you expect to earn in that business on an annualized basis?

Neal E. Murphy

In 2009, I don’t have the exact number in front of me. We did guide in December and it’s on our website as to what the market related profits were. That was predominantly contango profits. As far as 2010, we’re not guiding going forward. I think the market has come in quite a bit in recent months. But as we look – as Mike mentioned, as we look at kind of the macro situation we’re hopeful that it’ll come back out for us.

John Tekland - Citi

All right. Thank you.

Operator

(Operator’s instructions). At this time there are no further questions.

Deborah M. Fretz

All right. Well, we appreciate your calling in. And we’ll talk to you next quarter. Thank you.

Operator

This concludes today’s conference. You may now disconnect.

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