Greetings, welcome to the Sunoco fourth quarter 2018 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Scott Grischow, Vice President of Investor Relations and Treasury. Thank you, Mr. Grischow. You may begin.
Thank you. Before we begin our prepared remarks, I have a few of the usual items to cover. A reminder that today's call will contain forward-looking statements. These statements are based on management's beliefs, expectations, and assumptions. They may include comments regarding the company's objectives, targets, plans, strategies, costs, and anticipated capital expenditures. They are subject to the risks and uncertainties that could cause the actual results to differ materially, as described more fully in the company's filings with the SEC. During today's call, we will also discuss certain non-GAAP financial measures, including Adjusted EBITDA and distributable cash flow as adjusted. Please refer to this quarter's news release for a reconciliation of each financial measure. A reminder that the information reported on this call speaks only to the company's view as of today, February 21st, 2019. The time-sensitive information may no longer be accurate at the time of any replay.
You will find information on the replay in this quarter's earnings release. On the call with me this morning are Joe Kim, Sunoco LP's President and Chief Executive Officer, Tom Miller, Chief Financial Officer, Karl Fails, Chief Operations Officer, and other members of the management team. I would like to start with a brief review of some of the partnership's activities and accomplishments from the fourth quarter. First, we completed two fuel distribution acquisitions with post-synergy multiples in the mid-single digits. On October 16th, we purchased BRENCO Marketing Corporation's fuel distribution business. This business distributes approximately 95 million gallons annually across a wholesale account network in Central and East Texas.
On December 18th, we closed on the acquisition of the fuel distribution business from Schmitt Sales, Inc., which distributes approximately 180 million gallons to a network of dealer and commission agent locations, primarily in the New York and Pennsylvania markets. Importantly, this acquisition complements the Superior Plus acquisition, which we completed earlier this year, with the ability to leverage the terminals from that acquisition for incremental gallons of throughput. In addition to the wholesale fuel distribution acquisitions, we also expanded our midstream business with the acquisition of two product terminals from American Midstream Partners, which closed on December 20th. One of the terminals is located northeast of Dallas, Texas, and the other is in North Little Rock, Arkansas, and both have pipeline access. This acquisition is consistent with our strategy of adding fee-based logistics assets to provide further portfolio diversification and income stability.
More recently, on January 29th, we closed on the acquisition of five locations in New York State from Speedway LLC. We funded all acquisitions with cash on hand and amounts available on our credit facility. We expect all of the acquisitions to be accretive to our unit holders in the first year. Finally, on January 18th, we announced the execution of a definitive asset purchase agreement with Attis Industries Incorporated for the sale of our ethanol processing plant in Fulton, New York. Total consideration for the divestiture is $20 million, and we will use the proceeds to repay amounts outstanding on our revolving credit facility. I will now turn the call over to Tom, who will cover this quarter's financial and operating results. Tom?
Thanks, Scott, good morning, everyone. We delivered strong financial and operational results again in the fourth quarter. In 2018, we completed the transformation of Sunoco from a retail-centric MLP to a partnership focused on fuel distribution and logistics. For the quarter, the partnership recorded a net loss of $72 million, which includes a $135 million non-cash inventory adjustment. As a reminder, this adjustment does not affect our Adjusted EBITDA, DCF, or cents per gallon. Adjusted EBITDA was $180 million, compared to $158 million a year ago, driving our leverage ratio as defined by our credit agreement down to 4.16. This is down from last year's fourth quarter result of 5.58. Distributable cash flow, as adjusted, was $114 million.
Our distribution coverage ratio for the quarter was 1.33 and 1.32 for the full year. In 2017, our coverage ratio was 1.15. We are delivering on the financial goals we outlined for you. On January 25th, we declared an $0.8255 per unit distribution, the same as last quarter. We are confident in our ability to sustain this distribution. Our liquidity remains strong with approximately $800 million available on our revolving credit facility at year-end. Looking at our operational performance, total fuel volume in the fourth quarter was approximately 2 billion gallons, a slight increase from the third quarter, and up 2.5% from a year ago, driven by the contribution from the 2018 acquisitions and other organic growth. The fuel margin environment was particularly strong across all channels in the fourth quarter, largely resulting from declining crude prices.
This produced a $0.124 per gallon margin for the quarter and $0.114 for the year. As we've discussed, our strategy of managing multiple fuel distribution channels allows us to balance ratable income streams such as the 7-Eleven take-or-pay contract and rental income with channels that generate higher margins in certain environments, such as the material and sustained drop in crude prices. Turning to expenses, we were able to control expenses even with the five acquisitions we completed in 2018. G&A expense was $38 million in the fourth quarter and $141 million for the full year, in line with our $140 million annual guidance. Rent expense totaled $18 million for the quarter and $72 million for the year, just under the $75 million annual guidance. During the fourth quarter, other operating expense was $93 million and $363 million for the year.
When you remove the $25 million of other operating costs we incurred in the first and second quarters to run the West Texas and FTC retail sites prior to their conversion to the commission agent channel of trade, the full number was slightly higher than our 2018 annual run rate guidance. The timing of certain expenses within the operating category will result in quarterly fluctuations. Moving to capital, we invested a total of $41 million in the fourth quarter, $26 million in growth, and $15 million in maintenance capital. During 2018, we invested a total of $103 million, $72 million in growth, and $31 million in maintenance capital. In December, we provided guidance for 2019. I want to take a moment to review those items.
We expect total fuel volumes to be between eight and 8.2 billion gallons, with annual margins in the $0.095-$0.105 per gallon range. As we've stated in the past, fuel volume and margins should be evaluated collectively as total gross profit dollars, not individually. 2019 guidance reflects higher gross profit dollars from our fuel distribution business, driven by the impact of completed acquisitions and our profit optimization strategy. We expect total operating expenses, including any incremental spend from acquisitions already completed, to be approximately flat to our 2018 guidance of $540 million. As a reminder, total operating expenses include G&A, rent, and other operating expenses. Our 2019 capital program will increase modestly from 2018 levels. We expect to spend $45 million on maintenance capital and $90 million on growth capital.
Our total 2019 capital spend could exceed $90 million if we find additional organic investment opportunities. As a reminder, our growth capital does not include third-party acquisitions. Finally, we also provided you with an Adjusted EBITDA range of $610 million-$650 million for 2019. That range includes all announced acquisitions. The anticipated divestiture of our ethanol plant that Scott discussed earlier does not impact this guidance range. We are confident that this guidance demonstrates our ability, over the long term, to remain safely within our target leverage of 4.5 to 4.75, and maintain a coverage ratio at or above 1.2. I will now turn the call over to Joe for closing thoughts. Joe?
Thanks, Tom. Good morning, everyone. The fourth quarter capped a transformative year for Sunoco. We outlined a plan in late 2017. We delivered on that plan in 2018. Now it's time to execute and focus on this year. Our underlying business is strong. We expect this to continue. First quarter results are meeting our expectations and reinforce our guidance for 2019. Our growth pipeline remains robust. First, we have positioned ourselves for additional acquisition opportunities. We'll only execute on these opportunities if they meet all our financial criteria. We've also positioned ourselves for increased organic growth. Having a combination of organic and acquisition opportunities increases our ability to grow in a consistent and balanced manner. Let me close by stating that we have established a track record of delivering on our targets.
We remain confident that we will continue to deliver in 2019 and beyond. Operator, that concludes our prepared remarks. You may open the line for questions.
Thank you. We will now be conducting a question and answer session. If you'd like to ask a question, you may press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Theresa Chen with Barclays. Please proceed with your question.
Morning. Thank you for taking my questions. First, just wanted to touch upon the margin optimization efforts you had previously laid out. Can you give us an update on how that's going, what inning we're in, and what do you see from there going forward?
Sure. Good morning, Theresa. This is Karl. As we've shared, our margin optimization effort really kicked off, I'd say, mid last year, and we've been focusing on trying to go channel by channel and site by site. As we've shared, we're continuing to make progress. We're partially through that process, and we are pleased with the results that we've seen. Our Q4 margin was strong, and that was one of the factors.
Got it. Then on the acquisition landscape, can you just give us some color on what you're seeing post having done four in 2018? Just what you're seeing for this year, maybe 2020, maybe touching on the acquisitions by channel or type of assets.
Sure. Hey, Theresa. It's Joe. Good morning. I think probably the best way to start off is talking about what our goal is. Our goal is to become a larger, more diversified, and more stable income MLP. The way that we can do that obviously is through M&A activity and organic growth. I think the two sectors that makes the most sense for us is obviously the fuel distribution channel. We have incredible scale, and I think as we demonstrated last year, we bring material synergies, and we can purchase fuel distribution assets that mid-single digit multiples and make it very accretive for us. Just as importantly, we want to focus also on the more traditional fee-based midstream assets. I think the two terminals that we acquired in December from American Midstream serves as a really good example.
With all that said, I mentioned on our prepared remarks that we have a very robust pipeline, what that does is puts us in position to capitalize on opportunities. We'll be very selective. We'll make sure it meets the criteria of financially fit. It also continues to improve our overall income portfolio. The way that I would think about this is that there's no certain number we're trying to do in 2019. What we've done is we've created the pipeline, we're positioned to do as much as it makes sense for us to do.
Thank you very much.
Our next question comes from the line of Ben Brownlow with Raymond James. Please proceed with your question.
Hey, good morning. On the Schmitt acquisition, you mentioned a mid-single digit multiple. I assume that's post synergies. Can you just talk about the ramp in synergies there?
Sure. This is Karl. Yes. Looks like mid-single digits, post synergy, and I'd say this acquisition is similar in synergy ramp up to most of our acquisitions where we target about half of those synergies by the end of year one and full run rate by the end of year two.
Okay. Is that margin, I know we shouldn't think specifically about the margin, but just directionally, on the 180 million gallons, is that wholesale margin similar to the base business?
Yeah, it's in the range. Generally, we don't give specifics as some of our different geographies and channels might be higher than our average range, some might be lower. What I'd say is our synergies come from two main areas. One of the big ones is on fuel margin, our being able to renegotiate purchase contracts and reduce the cost of goods sold there and expand the margin. Depending on the acquisition, there are some expense savings that we receive as well.
Great. That's helpful. Just one last one, if I could. The other OpEx line item, I know you mentioned the timing of expenses is there's some variability around the quarters there, anything specific that you could pull out that led the jump up quarter-over-quarter?
The other operating expense, as you did point out, is we would view it as one-time, we're looking at the 2019 guidance remaining where it is. The one-timers were both tax related. One was a sales and use tax, the other was a property tax adjustment.
Ben, I think the one thing I would add to that is that Tom mentioned in his prepared remarks that even with the five acquisitions, our guidance, we want to reinforce that our guidance that we provided back in December, whenever you look at OpEx, G&A, and rent expenses, we're keeping that flat with our 2018 guidance that we provided at the beginning of 2018.
Great. Thank you.
Our next question comes from the line of Patrick Wang with Robert W. Baird. Please proceed with your question.
Hey, good morning, everyone. Going back to that gross margin optimization program, can you discuss the impact of those gross margin optimization efforts in 4Q? You delivered both very healthy volumes in what's a normally seasonally lighter quarter, along with very strong margins. Would it be fair to say that margins could have been even more robust had you traded for lower volumes? Were the commodity dynamics just that strong during the quarter?
Yeah. Hi, Patrick, this is Karl. As you look at our gross profit, there are a number of factors, the two biggest ones are obviously the margin we take and the volume. As we look at Q4, in general, the contributors to our higher than guidance range margin in that quarter were a few. First, as we've added on these particular acquisitions, they were higher than average. Doesn't mean that every acquisition we do is going to be higher than average. Some of them will reduce our average, some will add to it. The margin volume optimization that you talked about. Obviously in Q4, as you guys looked at the market, we had the tailwind of falling prices. Crude prices fell nearly $30, and RBOB futures fell almost $0.80 a gallon from the beginning of the quarter to the end of the quarter.
We've stated that in our new strategy, we are not as exposed to those movements in commodity prices as we were when we had a large retail presence. Overall, it still was a contributor to our margin. You look at the 3 clean quarters that we put up in 2018. Q2, you had upward movements in prices. Q3 was pretty flat. Now Q4 was a large down movement. You saw us put strong numbers up in all 3 quarters, but obviously Q4 was aided by that.
Patrick, this is Joe. Go ahead, Joe.
Hey, Joe, I have one additional comment to what Karl said. We get this question quite a bit. I think a good way to think about this is, fourth quarter had some, as Karl noted, about RBOB drop and crude drop. That was some tailwind force. As Karl noted, at second quarter of last year, we saw crude prices and RBOB steadily go up, and we still threw up a very good quarter in the second quarter. When it comes to the price volume optimization that we went through, I think a good way for the street to think about this is when we provided guidance in late 2017, as you noticed in 2019 guidance, a year later, it went up about $0.01.
A portion of that, I think this way to think about it is, minus any tailwinds or headwinds when it comes to RBOB drop, we're saying that through our price optimization, along with acquisitions that we've added, where the margins of the acquisition is higher than our base layer, in combination, it's given us a higher CPG on a going forward guidance basis.
Got it. That makes a lot of sense. Just bigger picture, can you talk about your portfolio management process as you consolidate the fragmented fuel sector? Do you have a formalized program in place for not only the growth side, but also the portfolio pruning side for any assets that you deem may be better off under another owner?
Yeah, this is Karl again. I'd say yes, we have a formal process that we're always going to look at a given site that we control which channel is the best, and that's an ongoing process. We go through that process as we acquire things at times. We've exited the retail channel, but at times we've made acquisitions where they had retail properties with them, and then we switch those over to one of our channels of wholesale business. The Speedway acquisition that we announced is an example of that. Yes, we go through that process even in our base business on a regular basis.
Okay, great. Lastly, just to clarify the 2019 OPEX guidance. That's inclusive of both announced M&A as well as incremental M&A at your normal cadence, or would the latter cause the OPEX to drift higher?
Everything that's been announced is included in our operating cost estimates. We obviously don't know what would be acquired in the future, so therefore that's not included.
Okay, great. Thank you very much.
Our next question comes from the line of Shneur Gershuni with UBS. Please proceed with your question.
Hi, good morning, guys. I just wanted to go back to the margin optimization discussion that you've had with several prior questioners. You sort of make the point about regardless of higher or lower gasoline prices throughout the quarter, that overall your trend seems to be up in terms of guidance. How much further can we go on the optimization? Has it been rolled out to the entire footprint? Is there a next level of optimization that you're looking at more on the volume side versus pricing side? Just kind of wondering if you can expand on it a little bit and how much you're keeping back in terms of calling it a trend versus your guidance.
This is Karl again. I would say that I would not expect a material upward trend going forward. As Joe mentioned, we factored in a lot of our acquisitions and our strategy around gross profit optimization into our guidance for 2019. I'd refer back, we're comfortable with both the EBITDA and the margin guidance we gave for 2019. At this point, remember on the gross profit optimization overall, that's trended our margin up and all things being equal, maybe the volume down, there's some pockets of our business where the opposite is true, where to optimize gross profit, we might take less margin, we might take more volume. I'd say it's more about the operational, making that process consistent over time versus a material upward trend on our margin.
Shneur, the one other area that we do have some opportunities is on our base business, as Karl mentioned. I think the team has done a really good job of optimizing and growing our gross profit. Where the opportunities lie for us is if we do an acquisition and we buy a set of assets. That's where, as part of our synergies, Karl's talked about renegotiating deals to get better cost of goods. On the revenue side, we have that same opportunity that when we applied to Sunoco over the last year, we can apply that same profit optimization to our acquired assets.
To clarify, you're using data analytics as part of your optimization process?
That's correct.
Okay, maybe just to transition, you brought up synergies with acquisitions and so forth. I was wondering if you can expand on the pipeline a little bit of where you see opportunities and more importantly, where you expect to focus. Do you see more opportunity in smaller bite-sized acquisitions, where the economic profit seems to be a much larger spread, given where you trade versus what you would pay, versus larger packages where maybe that cost of capital advantage is a little bit smaller?
Shneur, this is Joe. I think there's a couple of ways to look at it. First of all, I'll reiterate what I said earlier. Our goal is to become a larger, more diversified MLP that has an increasingly more stable income profile. That said, whenever you talk about bite-sized acquisition, I think we demonstrated pretty well last year that we did five acquisitions in a post-7-Eleven environment. The pipeline is full. The opportunities are good. The financial attractiveness is high. We're also balancing that with our overall goal for us to become a more diversified MLP. Even though there might be X amount of ample deals on the fuel distribution side, we're managing the overall portfolio. I think that's where the American Midstream two terminal acquisitions plays into that, where it's at a higher multiple, but also helps their income portfolio.
As far as larger deals, smaller deals, of the five acquisitions that we did last year, four of them were off-market. This is through our relationships and us knocking on doors and establishing relationships. The fifth one, the American Midstream, we were in the process. We hit a limit. We stepped away from it. We saw an opportunity to come back in at the backside at a better value. We'll participate in every public process, but a lot of the stuff that we're working on is really more of one-on-one relationship type of deals.
In the knocking on doors approach, is that where you see the most depth in the pipeline right now?
You broke up. One more time on that, as far as the knock on doors?
On the knocking on doors approach to acquisitions, is that where you see the most depth in your pipeline right now?
I would probably say so, yeah. As far as announced auction processes, I guess over the last year, those have probably slowed down a little bit from our end, as far as the visibility that we had. Most of the pipeline we have are really non-auction process opportunities.
Perfect. Thank you very much, guys. Really appreciate the color today.
Thank you.
Our next question comes from the line of Jeremy Tonet with J.P. Morgan. Please proceed with your question.
Good morning. Thanks for fitting me in here. I'll keep it short. Just wanted to touch on the ethanol facility, the best share that you guys have done, and just wondering if there's kind of other smaller assets within your portfolio that could be divestiture candidates and could be recycled into businesses kind of more core to what you're looking to do.
Hey, Jeremy. It's Joe. First of all, our path is growth, not contracting. The ethanol plant was a one-off opportunity that we took advantage of. The ethanol plant didn't meet two very important criterias, growth and stable income. It was by far our most, on the whole spectrum of stability, that was the worst one we had. This is a one-off opportunity. We had an opportunity to divest a non-core asset, we took advantage of it.
Got you. It sounds like there isn't anything else like that in your portfolio.
Nothing we see in the foreseeable future.
Great. That's it for me. Have a good day.
All right. Thank you.
Our next question comes from the line of Chris Sighinolfi with Jefferies. Please proceed with your question.
Hey, guys. Good morning. Thanks a lot for the added color. Two cleanup questions if I could. Appreciate the walk you provide from GAAP net income to Adjusted EBITDA. I'm just curious, if I want to reflect the income statement as an adjusted income statement, just kind of two nitpicking questions about where some line items exist. It looks like the inventory adjustments you guys see show up in the motor fuel gross profit. Wanted to confirm that. Then second, where does the mark-to-market fluctuations reside? Is that in other operating costs?
Chris, this is Scott. Yeah. The lower of cost or market or inventory adjustments do show up in fuel, the mark-to-market adjustments. Let me take that one offline with you.
Okay.
I need to make sure I'm 100% accurate on that, but I'll follow up with you after this call.
Okay. Then second, Tom, maybe this is for you. Just curious, you've been active on the acquisition front, that's been funded with cash on hand and revolver borrowings. You see about $700 million drawn on the $1.5 billion facility. Just curious how we should think about how you think about terming that out, both time and nature of it. What are you comfortable sort of carrying drawn on that over time?
I would think that once you get to halfway, and you see that for a long period of time, you start looking for opportunities to take out a good portion of it. I wouldn't say all of it, but a good portion.
Okay.
It's something we constantly monitor.
Obviously you're closer to it than I am, but with the improvements you guys have made in the business post the retail divestiture, with the margin improvement and the margin pickup you're getting from the acquisitions, just, I guess, how do you think the credit market views Sunoco at this point? If you were to term out, let's say, $500 under 10 years, what sort of rate might we expect to see from you if you did that today?
We issued that 10-year last year at five and seven-eighth. Last I checked, that bond at nine years now was trading at 99. Let's just put it at a little bit over 6%. I would hope that we would be able to be in that range if we chose to go out to a 10-year. We certainly have other holes in our maturity profile.
Sure. Great. Okay. Thanks a lot.
As a reminder, ladies and gentlemen, it is star one to ask a question. Our next question comes from the line of Spiro Dounis with Credit Suisse. Please proceed with your question.
Hey, good morning, guys. Joe, you mentioned diversification a few times. Can you just maybe give us a sense of what else would be interesting to you outside of fuels, distribution, and terminals? I think in the past, it was suggested that maybe you could get into longer-haul pipelines. Is that a strategic goal of yours, too?
Yeah. I think, on the overriding strategy of more fee-based, traditional midstream assets. Pipelines obviously fit into that criteria. We just have to make sure that it is something that fits into our overall portfolio, and it's not an incredible one-off in some region that we have nothing else associated with it.
Got it. That is helpful. Maybe two on gasoline. I know you are a little more detached now from the retail side, but could you just give us a sense of how you see overall gasoline demand shaping up so far this year? I ask in the context of, I guess, what we are seeing in weaker refining cracks. The second part is, do you see any risks or opportunities related to IMO, as it relates to maybe that second derivative impact on gasoline supply later this year?
This is Karl. I will hit the fuel demand first. If you look at 2018, despite the falling prices in Q4 for the full year, gasoline retail prices were up about 11% over 2017, and demand was still flat. If you look at diesel was up. It looks like it is going to end the year up nearly 7% over 2017. Obviously those numbers vary by geography and how that translates to various channels can vary. Overall, still a supportive environment in the United States. Talking about IMO, we have diesel business, obviously we care about how the impact of IMO to the diesel markets will follow through. From a market view, there clearly will be increased demand for lower sulfur distillate fuels and less demand for the higher sulfur fuel oils.
Whether that has been fully priced into the markets or not, it kind of depends on your perspective, right? The refiners are talking about how there is going to be upward movement on the cracks, the ship owners and shippers are hoping that it is already priced in. We are monitoring those and seeing how that impacts your point on whether pushing refinery utilization higher, and you will have an excess of gasoline as a result of that. To the extent that happens, that definitely is supportive of our strategy and is one of the reasons we like our ratable, consistent short in the United States. Where there is excess gasoline, we benefit from that.
Perfect. Appreciate that color. Thanks, guys.
Our next question comes from the line of Dennis Coleman from Bank of America Merrill Lynch. Please proceed with your question.
Yes, thanks. Good morning, and thanks for getting me in. There's a lot of good color here on the M&A pipeline. I wonder if we can talk a little bit about CapEx. Pretty good percentage-wise increment on the growth CapEx budget of $90 million that you gave. Any color you can give on sort of how that falls across the channels? Is it pretty even, or does it direct towards one channel or another?
Yeah, this is Karl again. On the growth side, as you think about the $90 million and what we call our organic growth, we've really spent time and effort. I think Joe's talked about in the past how we were focused primarily, pre 7-Eleven divestiture, our capital and a lot of our time on our company-operated retail stores. Now, over the last year, we've built up this pipeline of being able to grow our wholesale businesses through the various channels. I don't know that it's specific to one of our channels over another. Most of that organic, that $90 million of growth capital, I would say is focused on signing up new customers or investing in sites that we control or operate and growing that business.
Okay. Thanks for that.
If there are no further questions in queue, I'd like to hand the call back to Scott Grischow for closing remarks.
Well, thanks everyone for joining us on the call today. Please feel free to reach out to me with any follow-up questions. This concludes today's call.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.