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Executives

Brian P. MacDonald - Chief Executive Officer, President and Director

Michael J. Hennigan - Chief Executive Officer of Sunoco Partners Llc, President of Sunoco Partners Llc and Director of Sunoco Partners Llc - General Partner

Michael J. Colavita - Interim Chief Financial Officer and Vice President

Analysts

Evan Calio - Morgan Stanley, Research Division

Brian J. Zarahn - Barclays Capital, Research Division

Faisel Khan - Citigroup Inc, Research Division

Sunoco (SUN) Q1 2012 Earnings Call May 2, 2012 5:00 PM ET

Operator

Welcome to Sunoco Inc.'s and Sunoco Logistics Partners Q1 2012 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. [Operator Instructions] I will now like to turn the call over to Mr. Brian MacDonald, President and CEO. Sir, you may begin.

Brian P. MacDonald

Thank you, and good afternoon. Welcome to the quarterly conference call for Sunoco and Sunoco Logistics Partners, where we will discuss the company's first quarter results that were recorded today. With me are Mike Hennigan, CEO and President of Sunoco Logistics Partners; Mike Colavita, our Chief Financial Officer, Pete Gvazdauskas, Sunoco Logistics Partners VP of Finance; and Clare McGrory, Manager of Investor Relations.

As part of today's call, I would direct you to our websites, www.sunocoinc.com and www.sunocologistics.com, where we have posted a number of presentation slides, which may provide a useful reference as we progress through our remarks.

I would also refer you to the Safe Harbor statement referenced in Slide 2 of the slide package and as included in this afternoon's earnings release.

Now I'll begin by making a few brief remarks about the transaction announced earlier this week and what it means for Sunoco. And then, we'll move into the earnings and business update for both Sunoco Logistics Partners and Sunoco Inc.

As you are aware, on Monday we announced that Energy Transfer Partners will acquire Sunoco Inc. and create one of the largest and most diversified energy partnerships in the United States.

The combination with ETP is a strategically and financially compelling combination that provides substantial value creation opportunities for Sunoco shareholders, as well as ETP unitholders, and will improve the ability of Sunoco's logistics and retail businesses to deliver on their full potential.

We believe our shareholders will receive an attractive premium. Because the consideration to be received by Sunoco shareholders consist of both cash and ETP units, our shareholders can also benefit from the potential upside of ETP's attractive yield and improving growth profile.

As most of you recognize, Sunoco has transformed itself over recent years, and we have returned significant value to shareholders over that time. This deal is an appropriate next step for Sunoco.

From a business perspective, scale is vital. And by combining with ETP, we will dramatically expand our geographic reach and significantly diversify the opportunities for our business

Finally, we continue to be committed to the Philadelphia region, and believe that as part of a stronger company, Sunoco will be even better positioned to return economic benefit to the Philadelphia region.

Now moving onto the results from the first quarter. As you can see from Slide 4, Sunoco reported a net loss before special items of $53 million or $0.49 per share for the first quarter. As I look at our performance this quarter, I see 3 things. One, our Logistics business continues to deliver strong results and execute on growth opportunities.

Sunoco Logistics is progressing well on projects to grow their fee-based earnings and the $300 million in organic growth projects that had been guided on for 2012 are proceeding as planned. Mike Hennigan will provide an overview of the results of Sunoco Logistics Partners in a few minutes.

Two, our retail performance was challenged this quarter by rapidly rising wholesale gasoline prices. During the quarter, we experienced an unprecedented run up in spot gasoline costs of $0.67 per gallon. This is the highest increase we have seen during the first quarter period.

As we have said before, this business does see quarter-to-quarter volatility, but as our trend shows, the business tends to deliver consistent and stable earnings and cash flow year after year. And in April, we benefited from a slightly improved margin environment, as wholesale gasoline prices retreated.

Third, Refining and Supply had a poor financial performance this quarter. The business continued to experience challenging market conditions, but also was burdened by anticipated transition costs after the idling of Marcus Hook. Mike Colavita will explain some of the drivers of this performance later in the call.

However, I do want to note that the refinery operations were very strong in the first quarter, which owed to the great focus of our employees and management at the refinery in what is a very challenging period for them. Additionally, we are pleased to see improved market conditions in the second quarter and are working hard to realize the potential market opportunities through continued strong operations and sharp focus on optimization of the product supply.

I'll take the time now to talk about the status of our refinery exit process, which we have been focused on for some time.

As we announced last week, we have entered into exclusive discussions with The Carlyle Group regarding the potential joint venture involving the Philadelphia refinery. Such a transaction would entail Sunoco contributing its refinery assets in exchange for a minority nonoperating stake. Sunoco would have no ongoing capital obligations with respect to the refinery.

If a suitable transaction cannot be completed, we will idle the refinery in August of 2012. We believe that having a strong partner like The Carlyle Group is necessary to preserve the future of the facility.

At this time, I'm going to turn the call over to Mike Hennigan, who will provide an update on Sunoco Logistics Partners' strong business results.

Michael J. Hennigan

Thank you, Brian. Sunoco Logistics continues our momentum with another strong performance in the first quarter of 2012. Our EBITDA was $161 million, and we had record distributable cash flow of $122 million. All of the areas that are part of our strategic focus are delivering results.

The main driver for our results continues to be our crude oil business. Demand for West Texas crude continues to be at a very high level, translating into tremendous demand for our transportation services, including our proprietary pipelines, our West Texas Gulf and Mid-Valley Pipeline joint ventures and our trucking services.

Our expansion of our West Texas system continues on track to meet the market needs and is expected to start up in the first quarter of 2013. We've completed 2 open seasons and are in the process of a third, which in total, will deliver approximately 110,000 barrels per day to the market. Third open season is expected to be completed in mid-May. We also continue to look for other opportunities to complement these projects. In addition, our crude oil acquisition and marketing business continues to deliver excellent results.

Market conditions continue to be favorable for our business. To date, the WTI LLS spread in the second quarter is wider than it was in the early part of the first quarter.

In our NGL business, our Mariner West project, the first ethane pipeline solution in the Marcellus area that will deliver ethane to the Sarnia marketplace, is on schedule for a mid-2013 startup.

We also remain excited about the conversion of our Eastern pipeline related to the growing development of the Marcellus and Utica Shale areas. We are still confident in our Mariner East project as our ability to access waterborne markets will be important in the future as we expect NGLs to be exported as Marcellus and Utica production continues to grow.

On our distribution, we've announced an increase to $1.71 per common unit on an annualized basis, which is a 7% increase year-over-year. The quarterly distribution of $0.4275 per common unit will be paid on May 15 to unitholders of record as of May 9. This represents our 28th consecutive quarterly distribution increase.

We remain confident in our strategic direction. We continue to progress projects to grow our fee-based earnings, and our $300 million organic growth plan is well underway as we see 2012 setting the stage for substantial growth in the future.

Our 2012 organic growth plan includes Mariner West, the West Texas crude projects, butane blending, Eagle Point and Nederland. Our financial flexibility continues to be strong. Our balance sheet finished the quarter with a 2.6x debt-to-EBITDA level and our distribution coverage ratio was 2x, putting us in a very strong position as our major projects materialize. We're confident our growth strategy's on track and we're committed to growing our cash flows over the long term.

At the same time, I also want to mention how excited we are at Sunoco Logistics to a future with Energy Transfer as our general partner. Sunoco has been very supportive of our growth, and we see that support continuing from Energy Transfer.

I'll turn the discussion over to Mike Colavita, who will continue the update on the Sonoco business results and financials.

Michael J. Colavita

Thanks, Mike. As Brian noted earlier, for the first quarter, Sonoco reported a net loss of $53 million attributable to Sunoco shareholders, excluding special items.

Pre-tax income from special items totaled $493 million, including a $497 million LIFO inventory gain and a $104 million pre-tax gain related to a participation payment received in connection with the sale of the Toledo refinery in March 2011.

Regarding first quarter pre-tax business unit results attributable to Sunoco Inc.'s shareholders, I direct you to Slide 9.

Our Logistics segment earned $57 million during the quarter and our Retail Marketing business reported a pre-tax loss of $6 million during the quarter. Sunoco's share of SXL earnings driven by our GP ownership and LP holdings are reported through our Logistics segment, which earned $57 million during the quarter.

As Mike Hennigan outlined, SXL continues to deliver strong results to execute on its growth strategy and to maintain financial flexibility and a strong balance sheet.

Retail Marketing reported a loss during the quarter as wholesale gasoline prices were climbing throughout the quarter, putting significant pressure on gasoline margins, which averaged $0.059 per gallon.

Across the industry, demand continued to be weak in the first quarter. On a same-store sales basis, our gasoline volumes trended lower by approximately 2.1% versus the same period last year. This is consistent with what's reflected in the latest available industry data.

As Brian indicated, the April margin environment improved with wholesale gasoline prices following the decline in crude oil in the second quarter.

Refining and Supply incurred a loss of $87 million pre-tax in the first quarter of 2012. As Brian noted earlier, our business performance was negatively impacted by cost related to the transition to a terminal operation after the idling of the Marcus Hook refinery.

The transition also impacted margin capture as we ran a suboptimal product slate at the Philadelphia refinery to manage contractual commitments for petrochemicals and other products.

I'll wrap up by addressing our financial position in the status of our strategic initiatives that were announced in early February.

As shown on Slide 10, as of March 31, we had approximately $2 billion of cash on Sunoco's balance sheet. In the first quarter, we generated cash of approximately $120 million at the Sunoco parent level after repayment of $131 million in debt. Cash flow during the quarter was driven by inventory liquidations related to the idling of the Marcus Hook refinery and the early repayment of the $182 million note receivable from PBF related to the March 2011 sale of the Toledo refinery.

Let me take a minute to provide an update on our strategic initiatives that were announced in early February. During the first quarter, we established the VEBA trust and contributed $200 million to prefund our post-retirement liability. Our liability for post-retirement medical obligations is now capped at this funding level.

We also retired approximately $130 million of debt during the quarter, consisting of industrial revenue bonds of approximately $100 million and a capital lease obligation tied to the Marcus Hook refinery for approximately $30 million.

We also put cash to work in repurchasing shares utilizing $50 million in the first quarter and another $50 million in the first half of April. We repurchased a total of approximately 2.6 million shares at an average price of $39 per share.

We do not expect to repurchase additional shares in light of the announcement of the planned acquisition of Sunoco by Energy Transfer Partners.

We also do not expect additional debt repurchases or contributions to the environmental remediation fund prior to the closing of the acquisition.

We expect that Energy Transfer Partners will evaluate these initiatives as part of their overall business objectives.

In April, we also received $104 million in proceeds from PBF related to the earnout provision from the sale of the Toledo refinery. We are eligible for up to an additional $21 million in proceeds if the facility achieved its profit targets in any of the next 4 years.

Now I'll pass the discussion back to Brian MacDonald for closing comments.

Brian P. MacDonald

Thanks, Mike. I want to talk about the path forward before we turn to Q&A. Over the recent years, we have taken a number of actions that have completely transformed Sunoco, and we have returned significant value to shareholders.

We now have 2 strong high-return businesses in Retail and Logistics. We continue to focus on ensuring these businesses are positioned to deliver strong results and to execute on their respective growth opportunities.

We also continue to work through the potential joint venture with Carlyle regarding the Philadelphia refinery. We believe that Carlyle can be a strong partner in operating the facility.

A concerted effort by all stakeholders is necessary to ensure the successful completion of the joint venture, and we continue to be encouraged by the offers of support by federal, state, local and labor officials.

Lastly, with regards to our announcement this week, we are very excited about the opportunity to join forces with ETP. As we move through the closing process, we will be working hard to ensure a smooth integration and to capture synergies through the combination.

With that, I'll ask the moderator to open the lines for any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Evan Calio with Morgan Stanley.

Evan Calio - Morgan Stanley, Research Division

Hey, I wanted to -- I really want to congratulate you guys on the transaction, as well as your track record in shareholder returns. I think I'm going to miss this -- the 4:00 print and the 5:00 call slot clearly as well as covering SUN and wish the best to you both Brian and Clare. My one question is -- and I know I'll be able to read about this in the proxy, but I'm just hoping you'd provide a little more color on the sale process and if you were -- whether you were able to shop SUN before January due to the Sunoco spin and potential tax implications, and whether there were discussions with any other parties for the sale of SUN prior to the announced transaction.

Brian P. MacDonald

Thanks, Evan, for your kind words. You're right, there'll be more detail in the proxy. What I can say at this time is that, obviously, in the past year, we thoroughly reviewed our entire business, including conducting the publicly announced comprehensive strategic review. As a result, we have a very clear understanding of the industry landscape and our value. We believe the combination with Energy Transfer delivers unique synergies and benefits, which is why Energy Transfer's prepared to pay an attractive premium and why our board has determined that this is the best way to deliver value to our shareholders. There'll be additional information provided in the proxy when it's filed.

Operator

Our next question comes from Brian Zarahn with Barclays.

Brian J. Zarahn - Barclays Capital, Research Division

On your acquisition of SXL and the acquisition in marketing business, strong growth year-over-year. But quarter-over-quarter, EBITDA was down, even excluding the impairment charge and crude oil purchases were down, margins were down. Can you talk a little bit about what occurred from the last quarter?

Michael J. Colavita

Yes, Brian, it's Mike. The main driver were the market conditions and the best indicator is the WTI LLS spread. If you look at where Q4 was versus Q1, you see a pretty big difference. And the only thing I would caution is for you to look at the trade month, not necessarily the calendar month. Remember that in the trade there's about a 30-day delay. So the first quarter was significantly lower than the fourth quarter.

Brian J. Zarahn - Barclays Capital, Research Division

Just following up on that. Is there anything regarding trucking capacity? Is that constraint being eased? Is that impacting results at all, or is there still a shortage of trucking capacity?

Michael J. Colavita

No, it's not impacting results. As we talked about before, I mean, it's still an overall strong market. I had mentioned on previous calls that we had purchased some trucks and you had them coming online and that pretty much occurred in the early part of the quarter, et cetera. So it's still a good market for transportation services, pipeline, truck, rail. As you know, the market is just in a good spot for transportation in general.

Operator

[Operator Instructions] Next question comes from Faisel Khan with Citigroup.

Faisel Khan - Citigroup Inc, Research Division

Can you just confirm, was the M&A process, was it a -- was this an open bidding process or was it an exclusive negotiation with Energy Transfer?

Brian P. MacDonald

Faisel, all those details will be in the proxy when it's filed. As I said earlier, we have reviewed our entire business over the last year. We ran a comprehensive strategic review, and we feel that this transaction with Energy Transfer is a very good combination, delivering a significant value to our shareholders.

Faisel Khan - Citigroup Inc, Research Division

Okay, got you. And on the LIFO gain, is there any significant taxable -- is that net of taxes? Or what -- how should I look at that, that LIFO gain?

Michael J. Colavita

Yes, this is Mike Colavita. That's a pre-tax gain, so that is not net of taxes, the $497 million.

Faisel Khan - Citigroup Inc, Research Division

Okay, got you. And I assumed that, that would be that there -- you just take that as a taxable gain?

Michael J. Colavita

That's -- the booking is very close to the taxable gain, yes.

Operator

And at this time, I show no further questions.

Brian P. MacDonald

Well, thank you, everyone, for dialing in. We're going to close off now, and Pete and Clare will be available for questions. Thank you.

Operator

Thank you. This concludes today's conference. You may disconnect at this time, and thank you for your participation.

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