Little Time to Lock in an 11% Yield
Today’s chart highlights one time-tested way to lock in big dividend yields: turnaround situations.
Turnarounds involve buying firms that have stumbled, spotted the problems, and developed a plan to overhaul their business. While these stocks come with more risk, they provide a chance to scoop up a business at a bargain price.
Take gasoline distributor Sunoco LP (NYSE:SUN). Executives spent billions of dollars on acquisitions over the last few years, which left the partnership mired in debt. Analysts worried that higher interest payments would force management to cut the distribution.
That outlook has started to change, though. Last year, Sunoco began the processes to slash costs, pay down liabilities, and sell off less-profitable businesses. These actions have put the firm on a sounder financial footing, and Wall Street has warmed up to the new plan.
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So can Sunoco turn its business around and still make payments to unitholders? Maybe. Let’s take a deep dive into this distribution.
The payout looks reasonably safe, for starters. Sunoco has refocused its business on wholesale distribution, which delivers gasoline to nearly 8,000 stations across much of the country. This business works largely on long-term supply agreements, ensuring a steady stream of cash flow.
Last year, the distribution far exceeded profits. Today, however, this income stream looks much more sustainable. The partnership generates $1.15 of cash flow for every dollar paid out in distributions, leaving management with a lot more wiggle room.
Executives have shored up the balance sheet, too. In January, Sunoco sold most of its retail locations to 7-Eleven, Inc. in a $3.3-billion cash deal. Those proceeds will put a big dent in the debt load, boosting the safety of the distribution over time.
The deal also makes the business more predictable. Retail sales suffer from wild swings year to year. While customers may have to keep buying gas through a recession, they don’t need to buy overpriced sodas and snacks.
That combination of volatile sales and lots of debt looked like a disaster waiting to happen. Executives have now gotten a handle on those two big problems. And, as you can see in the chart below, Wall Street has warmed up to these changes in recent months:
Chart courtesy of StockCharts.com
Of course, Sunoco still has more work cut out for it.
Convenience-store sales accounted for about one-third of earnings last year. You have a big hole to fill here. And even with the proceeds from the 7-Eleven deal, Sunoco still has a high debt load compared to its peers.
In other words, management has attempted the business equivalent of a three-point turn in a narrow parking space. It’s a tight squeeze. Executives must manage a smaller business while continuing to make payments to lenders and unitholders.
It can be done, and it looks like Sunoco will pull it off. But if anything goes wrong, this distribution could get cut.
Though, with a dividend yield topping 11.1%, this turnaround situation could pay off for unitholders.