Wholesale Changes: Our Assessment Of Susser Petroleum Partners And Lehigh Gas Partners

Includes: CAPL, SUN, SUSS
by: Elliott Gue

Wholesale fuel distributors purchase diesel, gasoline and other products from refineries and resell them to retail outlets and operators of commercial fleets at a fixed or variable mark-up.

After many of the major integrated oil companies exited this business line in the mid- to late 2000s to concentrate on higher-margin opportunities, enterprising smaller operators gobbled up these assets and emerged as regional operators. Recently, a handful of names have spun off their fuel distribution businesses in an effort to lower their cost of capital, fund organic growth opportunities and drive consolidation in this fragmented industry.

We assess the growth prospects of two fuel distributors that recently debuted on the New York Stock Exchange as publicly traded partnerships.

Susser Petroleum Partners LP (SUSP)

Susser Holdings Corp (SUSS), which operates more than 540 Stripes convenience stores in Texas, Oklahoma and New Mexico, on June 21, 2012, disclosed that the firm would spin off its legacy fuel distribution assets (51.3 percent of 2011 revenue) as a master limited partnership and on June 22 filed an S-1 registration statement with the U.S. Securities and Exchange Commission (SEC).

Susser Petroleum Partners LP went public on Sept. 24, 2012, pricing its initial public offering (IPO) of 10.925 million units at $20.50 apiece-$0.50 per unit below the top end of its expected range. The transaction yielded net proceeds of $206 million, of which about $179 million was used to purchase U.S. Treasury securities to serve as collateral for a term loan agreement. Another $27 million was distributed to Susser Holdings as recompense for capital expenditures related to its contributed assets.

The MLP then disbursed $146 million of the aforementioned term loan to finance the acquisition of 41 owned convenient stores and fueling stations and 12 leased retail sites from its parent. Not only does Susser Petroleum Partners earn rental income by leasing or subleasing these properties to independent operators, but the publicly traded partnership also has long-term contracts for the wholesale distribution of motor fuels to these locations.

Susser Petroleum Partners purchases gasoline and diesel from refineries and resells these products to retail operators at a fixed margin. By outsourcing the transportation of these products and delivering them to market shortly after receipt, the company reduces its environmental liabilities and exposure to commodity prices.

The largest independent distributor of motor fuels in Texas, Susser Petroleum Partners' predecessor last year distributed 1.4 billion gallons of motor fuel to more than 550 Stripes locations (its parent's in-house brand), more than 480 third-party dealer locations, more than 80 consignment dealer locations and more than 1,300 fleet-operating commercial customers. Management estimates that about 90 percent of the firm's wholesale distribution contracts feature fixed fees.

Not only does this business stand to benefit from Texas' robust economic and population growth-key trends that bolster sales volumes of motor fuels-but the Lone Star state is also home to more than 14,000 convenience stores, providing ample opportunity for a well-capitalized operator to grow through acquisitions.

With Stripes-branded retail outlets accounting for 59 percent of Susser Petroleum Partners' fuel-distribution business, the MLP's growth prospects hinge in part on Susser Holdings' efforts to expand its footprint and retail sales via station upgrades, acquisitions and construction.

Over the past three years, Susser Holdings has invested heavily in building its store count and expanding fueling capacity at its existing locations. At the end of the third quarter, the parent boasted 552 locations (an increase of 11 stations since end of 2012), 408 of which offer diesel fuel (an increase of 45) and 68 of which can accommodate 18-wheelers (an increase of seven). These capital expenditures enabled Susser Holdings to grow its retail fuel volumes by 9.6 percent in the 12 months ended Sept. 30, 2012.

Susser Holdings plans to open a total of 25 to 26 new retail locations by the end of 2012 and another 29 to 35 in 2013. These new stores, which are two to three times larger than the company's legacy locations and often include in-store restaurants, tend to generate much higher fuel sales.

Besides distributing fuel to its parents' retail outlets, Susser Petroleum Partners also has the opportunity to purchase up to 75 of Susser Holdings' newly constructed convenience stores at cost and lease these locations back to its parent at an 8 percent rate for a 15-year period. These agreements also include five five-year extension options that feature escalating rates.

Susser Petroleum Partners has the option to purchase 15 of these retail outlets in the first year after its IPO, 25 stores in the second year and 35 in the third year. As of Dec. 21, 2012, the MLP had agreed to purchase eight of these properties, including two in Houston, one in the heart of the Eagle Ford Shale and one in Laredo, Texas. Management expects the publicly traded partnership to purchase another seven units by April of May 2013.

With a business that should generate enough distributable cash flow to cover the minimum quarterly payout by 1.2 times and a subordinated-unit structure that provides another layer of safety for the first few years, Susser Petroleum Partners is an attractive option for investors seeking steady distribution growth.

That being said, we harbor some reservations about the Susser Holdings' noneconomic general partner interest in the MLP-this structure means that the parent won't be required to contribute additional equity if Susser Petroleum Partners issues a secondary offering.

Nevertheless, the parent's stake in the MLP gives it ample incentive to pursue a strategy that enables the partnership to grow its cash flow and distribution; management has indicated that Susser Petroleum Partners has the wherewithal to grow its payout at a double-digit rate in coming years.

Lehigh Gas Partners LP (LGP)

Wholesale fuel distributor Lehigh Gas Partners LP went public on Oct. 30, 2012, raising $128 million from the issue of 6 million common units. The MLP will allocate $72.1 million of the proceeds to repaying debt obligations, $13.5 million to the mandatory retirement of preferred equity interest and $20 million to entities associated with CEO Joseph Topper Jr for assets contributed to the partnership. The portion of the proceeds related to the underwriters' exercise of their over-allotment went to Topper, related family trusts and board member John Reilly.

As of the end of September 2012, Lehigh Gas Partners distributed motor fuels to 728 sites, primarily in the Northeast: 229 locations run by independent operators; 228 retail sites owned or leased by the MLP but operated but operated by Lehigh Gas-Ohio LLC (LGO), an entity managed by CEO Joseph Topper; 140 leased or owned sites let to independent operators; and 67 locations through sub-wholesalers that purchase their fuel from the partnership. Management characterized 378 of the MLP's leased and owned service stations as being located in densely populated metropolitan and urban areas.

Like its peers that have converted to publicly traded partnerships, Lehigh Gas Partners ensures that its downstream activities generate qualified income by renting its owned properties to third parties and sub-leasing its leased locations to LGO and other entities.

While LGO retains all retail-related income generated at these sites, Lehigh Gas Partners collects rental fees and generates revenue from 15-year fuel-distribution contracts that provide for a variable-rate margin.

In comparison, the typical lease agreement with a third-party lessee on one of the company's owned or leased properties hovers around three years, with a current average duration of about 2.4 years remaining. Distribution deals with operators that own their own retail locations or lease them from another landlord usually have a 10-year term.

Operating primarily in the Northeast and Midwest, Lehigh Gas Partners business footprint is concentrated in regions that boast high levels of motor fuel consumption. But these mature markets offer scant opportunity for organic growth, and the firm's predecessor dropped substantially all of its assets into the MLP; acquisitions represent the best option for the firm to increase distributable cash flow.

Lehigh Gas Partners' predecessor grew its portfolio of 182 service stations from 11 locations in 2004, following the lead of a number of smaller operators that in the mid- to late 2000s took advantage of the major integrated oil companies' exodus from retail fuel operations in favor of business lines that offered superior returns. Regional players have emerged in this vacuum, building a presence in major metropolitan areas that were formerly the province of the Super Oils.

Over the past three years, the company purchased 24 Ohio Uni-Mart locations for $12.1 million, 85 sites in Ohio and Kentucky from BP (BP), and 26 service stations from Motiva Enterprises. Convenience Store News estimates that 76 percent of operators own 50 stores or less, providing ample opportunity for Lehigh Gas Partners and other ambitious operators to consolidate. The more stores that Lehigh Gas Partners acquires or leases, the more revenue it will generate from rents and fuel distribution.

Roughly three weeks after its IPO, Lehigh Gas Partners announced an initial agreement to acquire 24 retail stations and related assets from Dunmore Oil Company and Jojo Oil Company that will be leased to LGO. And in a conference call to discuss pro forma third-quarter results, CEO Joseph Topper Jr. indicated that a number of operators had contacted the firm about potential acquisitions and that the management team was working on two transactions that would likely be announced in the first or second quarter of 2013.

Without providing too many details on these potential deals, management indicated that future transactions would range between $25 million and $100 million. Topper also indicated that Lehigh Gas Partners wouldn't need to issue equity to finance additional acquisitions until the third quarter of 2013.

Thus far, Lehigh Gas Partners' fuel distribution and realty business lines have shown all signs of generating enough cash flow to cover the minimum quarterly distribution of $0.4375-equivalent to a 12-month yield of 10.8 percent at the current unit price. The MLP generated $7 billion in distributable cash flow in the third quarter-enough to cover the quarterly payout.

Equally important, the partnership agreement stipulates that during the subordination period, the Topper Group and Lehigh Gas Corp's subordinated units, which represent a 50 percent equity interest in the MLP, won't receive a quarterly distribution until the common units have received the minimum quarterly payout.

The incentive distribution rights differ slightly from the norm in that the general partner's stake in the MLP is noneconomic-that is, the general partner won't be required to purchase additional equity when Lehigh Gas Partners places a secondary offering. At the same time, the general partner won't receive an incentive distribution until the payout to common unitholders has grown by 15 percent.

Although Lehigh Gas Partners has ample opportunity to grow through acquisitions, the MLP's relatively high debt load will likely force it to issue additional equity sooner rather than later. The stock has consistently traded below its IPO price, though the units could receive a bump once Wall Street coverage of the stock improves; thus far, only the three underwriters have released research reports after the expiration of the quiet period.

Prospective investors should also note that in the years leading up to the IPO, the predecessor company posted a $3 million loss in 2010 before earnings rebounded to a$9.6 million profit in 2011. Lehigh Gas Partners' predecessor also divested 40 stores in early 2010 and another 26 in early 2011 in an effort to monetize assets and raise capital.

We'd stand aside from this MLP and instead focus on higher-quality names such as our favorite publicly traded partnership.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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