On Monday, April 28, 2014, Energy Transfer Partners (NYSE:ETP) announced a merger to acquire Susser Holdings (NYSE:SUSS) and in turn become general partner of Susser Petroleum (SUSP). This offer valued at approximately $1.8 billion consists of either $80.25 in cash or 1.4506 ETP common units, or a combination of both, for every share. In addition, ETP will become the general partner of Susser Petroleum, owning approximately 11 million SUSP common units, for about 50.2% ownership.
Susser Petroleum Partners LP is a fee-based wholesale distributor of motor fuel to Susser Holdings Corporation and other third parties. Additionally, Susser Petroleum receives rental income from real estate holdings and sale/leasebacks to Susser Holdings, third-party dealers, and independent operators of consignment shops. Susser Petroleum produces a margin by buying motor fuel from major oil companies and independent refiners, and selling the fuel to retail outlets in Texas, New Mexico, Oklahoma, and Louisiana. Susser Petroleum is also among the largest distributors of Valero and Chevron branded motor fuel.
Susser Petroleum was formed as a master limited partnership with Susser Holdings as the owning partner. An MLP is a publicly traded limited partnership in which the general partner (GP) is accountable for managing the MLP's affairs, and the limited partners (LP) are the parties that provide equity capital to the MLP. Susser Holdings is the sole owner of the GP. In addition, Susser Holdings owns 50.2% of the LP. The GP receives compensation based on performance of the MLP and the LP receives periodic income distributions from the MLP's cash flows.
I established a 12-month target price of $39.40 and a hold rating. The future success of Susser Petroleum depends on maintaining its master limited partnership status, buying and leasing additional Stripes stores to Susser Holdings, maintaining long-term contracts, and increasing fuel distribution volume. Therefore, Susser Petroleum's growth depends on Susser Holdings. An investor in Susser Petroleum must be aware of the long-term fuel distribution and sale/leaseback arrangements between these two companies. Recently, Susser Petroleum acquired Gainesville Fuel in September 2013. This business supplies approximately 60 million gallons of diesel to oil field producers. Margins on these gallons are higher due to the extra service of getting fuel where it is needed. This acquisition increases Susser Petroleum's volume of motor fuel sold.
Susser Petroleum's MLP structure benefits investors because it combines the tax benefit of a partnership, the limited liability of a corporation, and the liquidity of a publicly traded company. Limited partners, or unitholders, pay taxes at the individual level, avoiding the double taxation at the company level, but assuming the tax liability at their individual rates. Firms switch to the MLP structure to avoid taxes, as there is no partnership equivalent to corporate income tax. Susser Petroleum must also pay out a majority of its income to unitholders. SUSP announced today that the Board of Directors of its general partner has approved its quarterly distribution for the first quarter of 2014 of $0.5021 per unit, providing a yield of 4.75%. This yield provides a steady stream of income to investors in an uncertain investment environment.
As an MLP, Susser Petroleum is not subject to state and federal tax, with the exception of Texas. In Texas, a 0.5% tax on gross margin exists. Susser Petroleum must also derive less than 10% of its total gross income from non-qualifying activities. Therefore, 90% or more of its revenue must come from qualifying cash flows such as real estate, natural resources, and commodities to qualify as an MLP. Since Susser Petroleum derives more than 90% of its revenue from commodities and real estate, it retains its MLP status.
Susser Petroleum has a unique arrangement with Susser Holdings under the Omnibus Agreement, in which Susser Petroleum receives a three-year option to purchase from Susser Holdings up to 75 new or recently built Stripes convenience stores. Susser Petroleum could buy up to 75 Stripes gas and convenience stores by 2015. Susser Petroleum would buy the stores at Susser Holdings' cost and lease the stores back for a 15-year initial term at an annual lease rate of 8%. The Omnibus agreement affords Susser Petroleum the opportunity to grow its rental income. Meanwhile, the distribution agreement gives Susser Petroleum the exclusive right to provide fuel for Stripes convenience stores.
Through the MLP with Susser Holdings, Susser Petroleum is the sole supplier to Stripes convenience stores, which makes up 59% of the Company's oil distribution. Susser Petroleum's agreement with Susser Holdings provides Susser Petroleum a fixed profit of three cents per gallon. If Susser Holdings develops more Stripes stores, Susser Petroleum will benefit as the exclusive provider of motor fuel to any additional Stripes stores developed. Susser Petroleum provides motor fuel to an increasing number of locations, growing from 420 total locations in 2000 to 1,171 locations in 2013. Consequently, the increase in locations from 2000 to 2013 corresponds to a compound annual growth rate (CAGR) of 8%.
Susser Petroleum's long-term fuel distribution contracts with Susser Holdings and other third-party affiliates state that the Company will distribute motor fuel at a fixed, volume-based profit margin. Accordingly, Susser Petroleum's gross profit depends on the volume of motor fuel distributed as well as the potential for growth, with a compound annual growth rate of 7.2% from 2009 to 2013. Susser Petroleum's two largest suppliers of motor fuel are Valero (35%) and Chevron (20%), providing long-term stable contracts with discounts based on volumes purchased. The Company minimizes commodity risk by selling most fuel loads on a cost plus margin basis, passing the total cost on to the end customer. These supplier contracts allow Susser Petroleum to be more competitive.
Recent Acquisitions Increase Volume
In November 2013, Susser Holdings and Susser Petroleum announced that Stripes convenience stores would acquire all assets and distribution contracts for Sac-N-Pac Convenience Stores and 3W Warren Fuels, Ltd. Sac-N-Pac controls 47 convenience stores in Texas between San Antonio and Austin. 3W Warren Fuels is the wholesale supplier for Sac-N-Pac convenience stores. 3W Warren Fuels provides approximately 65 million gallons of motor fuel annually to all 47 Sac-N-Pac locations and an additional 20 independent dealer locations. This acquisition provides Susser Petroleum with 3W Warren Fuels and the associated 20 independent dealer locations and Stripes with the 47 Sac-N-Pac locations. Then, Susser Petroleum provides fuel to all 67 locations. With this acquisition, Susser Petroleum expands its retail and wholesale operations in a growing Texas market.
I based my 12-month price target on forecasts of motor fuel revenues and costs, use of the Company's credit line, distribution growth, and real estate holdings.
Motor Fuel Revenues and Costs
I projected Susser Petroleum's motor fuel gallons sold by first forecasting gallons sold per store to affiliate stores (Stripes convenience stores) and third party average gallons sold per location. Going forward I projected 1.6% long-term growth in gallons sold, and 25 new or converted Stripes stores a year, based on management estimates. I then forecast the cost of motor fuel by using the U.S. Energy Information Agency short-term estimates for refiner prices, and the long-term margins between the price of motor fuel at the pump and the refiner price. Next, I determined revenues by multiplying our projected motor fuel gallons sold by the refiner price of gas with a $.03 margin for affiliates and a $.05 margin for third parties.
Use of Credit Line
An additional assumption is how Susser Petroleum will use its $400 million revolving line of credit. I assumed each year that the Company would borrow the amount necessary to maintain a positive cash flow while being able to pay off all other obligations. I forecast the company borrowing up to a total of $359.6 by 2019, then paying back an average of $8.5 million each year through 2023.
Susser Petroleum generates its revenue primarily through fixed-margin motor fuel distribution to their affiliates, third party dealers, and consignment locations. Accordingly, SUSP's revenues are largely dependent on the volume of motor fuel distributed. Volume of fuel distribution can increase by organic same store growth, acquisitions, and growth of new contract locations. Affiliate growth is dependent on the number of stores bought and leased back to Susser Holdings each year. Each year I assumed Susser Holdings plans to expand by 27-33 Stripes stores going forward, therefore I assumed Susser Petroleum's distribution to affiliates would grow by 27 stores per year. I also assumed based on historical data that Susser Petroleum's third party distributions will increase by an average of 10 stores each year.
Real Estate Holdings
I assumed real estate holdings income would grow at a similar rate to the company's addition of Stripes buy/leasebacks. I assumed the company would continue to lease at an annual lease rate of 8%, as per the Omnibus agreement. However, real estate is a small revenue stream for Susser Petroleum, making up less than 0.25% of revenue.
I established a hold rating with a 12-month target price of $39.40 using the dividend discount model and discounted cash flow valuation methods and weighting each method equally.
I used the dividend discount model because SUSP pays out roughly 90% of its net income as quarterly distributions. Accordingly, the most common valuation method used by other equity research reports was the dividend discount model. Due to the MLP status, I forecast quarterly distributions to grow at a similar rate as net income. I used a discount rate (after-tax WACC) of 8.49%, a 2014 expected distribution of $2.01 per unit, and a terminal dividend growth rate of 3.45%. The single stage dividend model resulted in a price target of $39.92.
Since Susser Petroleum intends to maintain stable and steady growth through quarterly distributions, the discounted cash flow method is a logical valuation choice. I used an after-tax WACC of 7.49% and a liquidity risk premium of 0.50%, leading to a discount rate of 7.99%. Susser Petroleum has a low WACC due to its MLP status as well as a low liquidity risk premium since a majority of its income is paid to unitholders in the form of distributions. The DCF method resulted in a target price of $45.65.
Recent Stock Activity
As of the close on May 7, 2014, SUSP was trading at $42.50, an increase of $6.50 and 17.81% increase from the ETP announcement. I anticipate a majority of the yield in the next 12 months to be due to the quarterly distributions, most recently SUSP approved its quarterly distribution for the first quarter of 2014 of $0.5021 per unit.
Due to Susser Petroleum's MLP status, the stock price is less important than the quarterly distributions, and the corresponding dividend yield. Susser Petroleum was spun off from Susser Holdings specifically because SUSP is a more stable company. The market was not valuing the wholesale motor fuel and real estate holdings segments of Susser Holdings properly prior to Susser Petroleum's IPO in September 2012. The ETP announcement does not greatly impact Susser Petroleum since Susser Petroleum will continue business as usual.
I believe my hold rating is relevant because Susser Petroleum was not bought directly. Susser Petroleum will still operate as it did before the announcement; the only difference is ETP will now own 50.2% of SUSP rather than Susser Holdings. Susser Petroleum continues to have solid growth potential. Accordingly, if Susser Holdings develops more Stripes stores, Susser Petroleum will benefit as the exclusive provider of motor fuel to any additional Stripes stores developed. Additionally, ETP plans to sell its combined retail businesses to Susser Petroleum. By dropping down Sunoco (NYSE:SUN) from ETP and Susser Holdings to Susser Petroleum, SUSP will increase its scale and geography. Any comments and critiques are appreciated to better my writing and analysis.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in SUSP over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.