Greetings, and welcome to the Sonoco Third Quarter 2018 Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Scott Grishow, Senior Director, Investor Relations and Treasury.
Please go ahead.
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, November 8, 2018, so 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 Carl Sales, Chief Commercial Officer and other members of the management team. Before I turn the call over to Tom, I would like to review some of the partnership's accomplishments and activities that took place during this very strong Q3. First, we completed the Stanford Oil acquisition on August 1, which included a 115,000,000 gallon a year field distribution business to exploration, drilling and oil field service customers, primarily in Texas and Oklahoma. Then on October 16, we completed the acquisition of Brenco Marketing Corporation's fuel distribution business, which distributes approximately 95,000,000 gallons of fuel per year across the network of dealer, commission agent and commercial account locations in Central and East Texas. Both acquisitions bring commercial and G and A synergies resulting in post synergy multiples in the mid single digits.
We funded both of these acquisitions with cash on hand and amounts available on our credit facility. We expect both acquisitions to be accretive to our unitholders in the 1st year. These acquisitions along with the Superior acquisition in the second quarter are examples of the types of opportunities we continue to see in a fragmented industry. We maintain a robust pipeline of potential acquisition targets and we'll only pursue the most attractive opportunities that allow us to capitalize on our scale and to meet our financial goals. Moving on to an update on the tax impact of the divestiture of our retail operations to 7.11 earlier this year.
Through the end of the Q3, Sunoco LP made a total of approximately $370,000,000 in tax payments related to the 711 sale. Our estimate for the total 2018 tax impact remains at $480,000,000 with the final payment due in mid December. Finally, I would like to wrap up my comments by addressing a new story that came out last week regarding the Federal Circuit Court of Appeals ruling about Sunoco Inc. The Sunoco Inc. Entity is a wholly owned subsidiary of Energy Transfer Operating LP.
As such, the court ruling is unrelated to and has no impact on Sunoco LP. I will now turn the call over to Tom.
Good morning, everyone. As Scott mentioned, last night we reported strong third quarter results building on a solid second quarter. In the 2 quarters since our exit from operating 1200 retail site, we delivered financial and operational results demonstrating our ability to execute our strategy. We've controlled costs, made 3 roll up acquisitions, captured strong margins and surpassed our leverage and coverage target. For the quarter, the partnership recorded net income of $112,000,000 and adjusted EBITDA of $208,000,000 which includes $2,000,000 of transaction related expenses and a one time cash benefit of $25,000,000 from a settlement with the fuel supplier.
Even without this one time cash benefit, the business performed extremely well this quarter with strong fundamentals, including healthy fuel margins and flat sequential operating expenses. These results drove leverage as defined by our credit agreement down to 4.27 times. This is down from last year's Q3 result of 5.59 times. Distributable cash flow as adjusted was $149,000,000 yielding a 3rd quarter coverage ratio of 1.73x and 1.24x on a trailing 12 month basis. Last year at this time, our trailing 12 month coverage ratio was 1.04.
If you remove the one time cash benefit of $25,000,000 our coverage for the quarter would have been 1.44 times and leverage would have been 4.44 times, an outstanding quarter no matter how you look at it. On October 26, we declared an $0.825 per unit distribution, the same as last quarter. We are confident in the sustainability of our distribution at this level. Over time, we will manage leverage within the target range of 4.5 times to 4.75 times and a distribution coverage ratio of at least 1.1 times. Our liquidity continues to be robust with $1,000,000,000 available on our 5 year revolving credit facility, which we extended in July.
Looking at our operational performance, total fuel in the 3rd quarter was a little over 2,000,000,000 gallons, a 1.4 percent increase over the Q2. For the Q3, fuel margin includes above the $25,000,000 adjustment was $0.127 per gallon. Removing the one time $25,000,000 our margin would have been approximately $0.114 per gallon, which is a very solid margin on its own. I would like to provide some context for how we view and manage fuel margin. First, as we have mentioned in the past, we manage the business for long term gross profit dollars, not margin and volume separately.
We have added resources to optimize our gross margin and we are very pleased with the results so far. 2nd, we had an excellent quarter in all our channels. We employ a multi channel strategy that balances highly ratable income such as our 7.11 take or pay and our $140,000,000 per year of rental income with channels and geographies that give us the opportunity to capture robust margins. West Texas, Hawaii and East Coast markets have had strong margins, which we expect to continue. Finally, our acquisitions of Superior and Sanford had a positive contribution to our fuel margin.
Moving on to expenses. Last December, we provided run rate estimates for several key modeling inputs. We have focused on controlling spending throughout the year. We expect to be within our December expense guidance even with the addition of the 3 bolt on acquisitions. During the Q3, G and A expense was $34,000,000 in line with our $140,000,000 annual guidance and flat to the 2nd quarter.
Rent expense totaled $20,000,000 also flat to the 2nd quarter and within our annual guidance at $75,000,000 3rd quarter other operating expense was $86,000,000 annualized this number is above our $325,000,000 run rate discussed last December. The nature and timing of certain expenses within the category will always result in quarter to quarter fluctuation. That said, we are very confident in our annual run rate of $325,000,000 As I mentioned on last quarter's call, in the first half of the year, we revamped our capital allocation process and this resulted in lower capital spend in the 1st two quarters. In the 3rd quarter, we invested $30,000,000 $19,000,000 of growth capital and $11,000,000 of maintenance capital. We expect annual capital spend to be approximately $30,000,000 for maintenance capital and approximately $65,000,000 for growth capital.
In December, we intend to provide updates of the key financial modeling inputs for 2019. I will now turn the call over to Joe for closing thoughts. Joe?
Thanks, Tom. Good morning, everyone. The Q3 has historically been our most profitable time period and our results this quarter reinforced our earnings power. The underlying business is strong and we expect it to continue. Our October results were very encouraging and looking forward, we expect the Q4 to be another solid quarter.
Last year, we outlined a plan and this year we're delivering on that plan. For 2018, we're either meeting or exceeding our guidance for gross profit, expenses and maintenance capital. As a result, our coverage is materially above 1.1 times and our leverage is below 4.5 times. We remain confident in our ability to sustain our distributions, while still having excess cash that can be used for growth opportunities. And most importantly, we expect this to continue into the foreseeable future.
We're also delivering on our growth plan, completing 3 accretive acquisitions since April. Our pipeline remains robust and we will continue to deliver on additional accretive acquisitions. Let me close by stating that we are very optimistic about our future and our ability to deliver on our financial goals. Operator, that concludes our prepared remarks. You may open the line for questions.
Thank you. At this time, we'll be conducting a question and answer Our first question comes from the line of Theresa Chen with Barclays. Please proceed with your question.
Good morning. Great to see the very strong CPG in 3rd quarter even ex the one time effect. And Joe, just following up on your comment about expecting a solid Q4. So when we look at the current period and the precipitous decline in wholesale product prices, can you talk about what you're seeing in terms of margin trends currently? And should we expect the Q4 of CPG to be even stronger than Q3?
Hey Theresa, so good question. First of all, as I mentioned in my prepared remarks, the Q3 has historically been the best quarter for fuel distribution companies and for retail centric companies. With that said, I think the way to look at it is, is look at our business on an annual basis where typically the Q3 is the best, the second quarter is the 2nd best and the 4th quarter is the 3rd best and the 1st quarter is typically the lowest margin period. But if you look at that in totality and you look back at kind of a recast base of our business over the last 4 years, what you'll find is and what I mean by recast is take the 711 agreement and push it back retroactive 4 years. What you'll find is that our annual average over 4 years has been slightly above $0.095 Then if you kind of look back over the last 2 years, our business has actually yielded more towards $0.10 And if you look at 2018, we're actually slightly above 2017 on a margin basis.
And I think the key point is this is partially a very solid industry fundamentals, but there's also some proactive steps that we've taken. We did those 3 bolt on acquisitions. The blended margin of these acquisitions is actually higher than our base business. So you're going to see an uptick on that. Secondly, as Tom mentioned in his prepared remarks, we've gone through this volume margin optimization.
And as I stated previously, as Tom stated, the early results have been very encouraging given us the gross profit increase. And finally, you think back to December when we announced like our West Texas deal, we stated that we selectively picked out key markets that we want to have the ability to capture the full margin. And West Texas, Hawaii and in New Jersey Turnpike are 3 very robust margin areas and we proactively strategically pick these out. These are niche markets really strong and we expect that to continue. You put that into totality, I think what you'll see why our margins were so strong in Q3.
I wouldn't get overly caught up into quarter to quarter. What I would really focus on is over the course of the year, we've delivered over the last 4 years over 9.5%. And I think this year's results makes a very compelling case that it's going to be above that number.
Got it. And related to the settlement with the fuel supplier, can you just provide some history and context of how that came about?
Sure, Tricia. This is Carl. The settlement really relates to fuel purchases from one of our major suppliers. As you think about our business, we've told the market that one of our strategic advantages is our scale and the fuel purchasing power that provides us. We do a lot of things day to day to continue to ensure that we capture that purchasing power with our fuel suppliers.
So that settlement is related to this year, we resolved an open issue with 1 of our suppliers on fuel purchasing price and that settlement was finalized in the Q3. So if you retroactively applied that settlement across the last few years on our volumes, that would have increased our average margin by about 0.0 $0.01 per gallon. So last thought I'd say is I'd reiterate again what Tom said in his
can you talk about given just very healthy coverage year to date, can you talk about what your plans are for the excess cash? Are you looking at potentially growing the distribution again? Or do you think the cash would be better spent reinvested in the business?
Chris, this is Joe. If you look at our excess cash, first of all, our solid results are going to give us, I think we targeted 1.1. But if you look at kind of market sentiment, I think the market is more leaning towards higher coverage versus an increase in distribution. And if we did increase our distribution, I don't think it necessarily gives us a lower yield resulting in lower cost of capital. So as of right now, I think the opportunity for us is to take this excess cash and apply it to growth or to our balance sheet.
Great. Thank you very much.
Our next question comes from the line of Jeremy Tonet with JPMorgan. Please proceed with your question.
Hi, good morning. This is Charlie on for Jeremy. One quick one for me is, just thinking about Energy Transfer, family and kind of everything simplified there with no IDRs. Is Sun going to request an IDR elimination? And I understand that you're going to say that that's you talked about energy transfer about that.
I'm trying to understand from your perspective, is that something that you're proactively pursuing?
Hey, Truman. So first of all, I think no effort is being spent by neither Sun or Energy Transfer on IDR elimination. I think the second thing that you have to take into consideration is that we put together an executable strategy to grow the company and to create value for both our LP and for our GP. And I think you look back since the 711 transaction, I think we have definitely had 2 quarters, the second and third quarters showing that we can deliver on that. And as I said in my prepared remarks, I expect another solid 4th quarter and stated I'm very optimistic about the future.
So the fact that we're delivering, we did 3 acquisitions since April, even with a very, I would say, a yield that I think we're justifying should be lower and yet we still did 3 accretive acquisitions. I mentioned that we have a robust pipeline. I think what we're showing is that even with a high yield and with the IDRs, we're growing and delivering on our plan.
Great. Thank you. And then one more from me, on savings, you've done a good job there. Thinking about in contact of the recent acquisitions, is there any foreseeable savings that you could capture maybe looking forward into 2019?
Let me answer that 2 ways. We feel comfortable with the guidance we've given you for the remainder of the calendar year. As for 2019, we're in the process of pulling together our budget and we'll be sharing that with you in December. Just one final point on that is when we make the acquisitions, we would normally expect to be able to have some synergy.
Great. Congrats on the quarter again.
Appreciate it.
The next question comes from the line of Patrick Wiehm with Robert W. Baird. Please proceed with your question.
Hi, good morning. Great to see these numbers. If we could look broadly at your M and A framework, what type of cost equity do you assume when assessing potential transactions under that, that 50% equity framework? And then at what distribution yield would you believe you could achieve accretive M and A through equity rather than entirely on the revolver?
So first of all, I want to reiterate that we don't see a need for 2018 equity. As we look forward to 2019, we're committed to maintaining the leverage targets of 4.5 to 4 0.75 over a long period of over a long period. As we look at attractive acquisitions, we do look at it on a fifty-fifty capital basis. And given right now where our yield is and we would probably be looking at a preferred to help fund the acquisition. We feel like it's just a better use of capital right now.
Okay. That makes sense. Thanks for that detail. And staying on this topic, is there a certain stock deal, let's say, something larger in the terminals area? Is there anything sizable in pricing that may require some equity or some preferred equity alongside debt, let's say, in 'twenty?
Yes. So, Patrick, it's Joe. I think the way to look at our M and A is that it's kind of 2 parts. One part is the fuel distribution, I think we're starting to build a good resume of delivering on attractive multiples, accretive acquisitions. On the midstream side, we're definitely looking at midstream assets.
And as far as giving specific color on a specific target, I think it's way too early on that one. But I think what you can take away is that we're looking when we find the right assets at the right financial fit, we'll go after those assets.
All right. That's good to hear. Thank you very much.
Thank you. The next question is from the line of Mike Guyer with Janney. Please proceed with your question.
Yes, good morning guys. Can you talk a little bit about, I guess, working capital requirements? And I guess, in general, for your conversion to the full wholesale model, do you think there's any benefits that you can sort of ring out of the working capital within the network or I guess how you feel about the working capital in general?
The good thing about the wholesale side of the business is it has a much more rapid cycle where things are paid quickly. It is an area that we're looking at. We haven't been looking at it in great detail. We'll be advancing that over the next couple of quarters. But it's not real high on the priority list.
Okay. And then on the operating front, can you tell me if you had any, I guess, benefit or headwind from the hurricanes in any of your regions or markets this quarter?
Yes. This is Karl. I would say there's no material impact either positive or negative from the storms this quarter.
Great. Thank you.
The next question comes from the line of George Wang with Citigroup. Please proceed with your question.
Hey, guys. Congrats on the strong quarter.
Thank you.
Just want to hone in on the future roll up acquisitions. So is this post synergy mid single digit to the full multiple still a firm guidance and the target you guys are looking at? Like just I'm sure you guys are looking at different targets. Like are you guys still seeing bench of attractively valued acquisition targets you guys can roll up?
George, this is Joe. Yes. So obviously, if we can continue to find assets that are synergized, mid single digits, obviously those are attractive. And as I said, we've built up a good pipeline of these type of field distribution targets. And what we'll do is we'll pick the best out of the ones that comes presented to us.
But secondly, I think this is a very important point. Our goal long term is to become more diversified and become a larger, stronger MLP. And that means that we're going to also balance that out with some other traditional midstream targets that might trade at a slightly higher multiple. And then the good news is that the same type of synergies that we bring to the table for fuel distribution that's also applicable to some midstream assets such as product terminals. So the goal obviously is to purchase assets at a very low multiple, but depending upon the quality of the assets and how that enhances our overall portfolio, I think we'll be looking at the whole range.
Got you. That makes sense. And are you guys still looking at 4 to 5 deals a year? I don't know if you guys are still speaking to this quantity of guidance. And since you guys have done kind of 3 deals so far, I mean, so do you think start to assume you guys may still announce 1 to 2 deals this year?
I don't think the 4 deals will be I think guidance might not be the right word, but I think the if you put together a good pipeline, you build the capabilities. I think although M and A is not ratable, I think we put together a program where we've really yielded 3 since April, which is I think a strong Our approach is really evolving away from necessarily building up the pipeline. We have a pipeline. Our path forward is making sure we pick the best of our pipeline and also enhance our field distribution business with other businesses that can balance off our portfolio.
Got you. Understood. My last question, so you guys talk about post synergy. I'm not sure if you can give more color just on how soon do you think you guys can achieve this 5 to 6 times multiple after your conclusion?
Yes. This is Karl. I'd say, obviously, it depends a little bit on the individual acquisition. But in general, a good rule of thumb is that in year 1, we'll capture 50% of the synergy and by year 2, we'll be at run rate. You think about the deals we've done so far this year, Superior has been in our portfolio about 6 months and I'd say we're tracking maybe even a little ahead of that on our synergy.
And then Sanford and Brenco are both pretty recent. So I'd say it's too early, but those integrations are on plan. And the other thing I'd add is, as we do these, we get better at them as well. So I'd expect, if anything, that our ability to capture those synergies and integrate them will accelerate.
Cool. Sounds good. Thanks a lot.
The next question comes from the line of Ben Brownlow with Raymond James. Please proceed with your question.
Hi, good morning. Thanks for thanks. I appreciate all the color around you provided a lot of detail around the drivers on the fuel margin. And you made one comment around one element of that driver was the added resources to optimize fuel margin. Can you give any specifics of that driver or what that entails?
Sure. Yes, this is Karl. I can provide a little more guidance. The basic idea behind our price optimization, the resources we've put on it is,
you look
at both margin and volume impacts when you set price, not just one of those 2. So I'll give you an example. So in a lot of our locations in our where we set prices at an individual site, we've developed individual location by location elasticity curves. So that when we set a price on a daily basis, we're taking into account what the anticipated volume impact of that is and so we can look at the overall gross profit. So I guess the other color I'd say is we're adding more data analytics around choosing competitors and how we make that choice in local markets.
So the underlying principle is really putting more data, more analytics with real business responses to drive those decisions.
Great. That's very helpful. And just one more for me, a minor modeling question. Within the wholesale segment, can you give some color on the other category? There was around $7,000,000 gross profit.
So it's a small contributor relative to the fuel category, but it still fell off relative to sequentially from the 2nd quarter. So just trying to understand some of the movement there.
Right. The Q2, well,
first of
all, what's in other income?
Yes, the other income.
Yes, the other income that tends to be credit card, merchandise, food service, lotteries, things like that, things from running the stores. And we think that you probably should use this quarter as a run rate going forward as opposed to last quarter, which had some adjustments.
Okay, great. Thank you.
The next question comes from the line of Sharon Lee with Wells Fargo. Please proceed with your question.
Hi, good morning. I was just wondering if you could maybe provide some color on volume trends. Q3 was up about 1% sequentially, volumes this quarter and where you see volumes trending next quarter?
Sure. Hi, Sharon. This is Karl. You pointed out, right, our Q3 volumes did rise seasonally from Q2 and from our acquisitions. I'd say that's in the area of our expectation.
So a few points to give color on that. One, remember that our volumes with 7.11 really that's protected by our take or pay on an annual gross profit arrangement with them. We've also stated in prepared remarks and even in our Q and A this gross profit optimization strategy where there are some trade offs between margin volume. So you should think about that. And then the last point I'd make is really our strategy is to continue to grow gross profit and to get a bigger piece of the pie, right, whether that pie is shrinking, growing, whether it's staying the same.
And so I think really our gross profit delivery is really the focus and that's what we did this quarter and that's what you should look at going forward.
Okay. And then just housekeeping item, the income tax expense was a little higher this quarter, I think because of discontinued ops. What is a good run rate number for cash taxes going forward?
Right. We've talked about $12,000,000 in the past. We think that's a good run rate. If you recall last quarter, it was negative taxes. A couple of things this quarter, when you make money from your in your C Corp, which we did and we had a good quarter there, you pay more tax and we also sold one of our where we had a gain, we sold one of our non core assets.
Great. Thank you.
All that. Thank you. Ladies and gentlemen, we've reached the end of the question and answer session. And I would like to turn the call back to Scott Grishow for closing remarks.
Well, thanks everyone for joining us this morning. Please feel free to reach out to me if you have any follow-up questions. This concludes today's call.
Thank you. Today's conference has concluded. You may now disconnect your lines at this time. Thank you for your participation.