Sell Sunoco And Expect Dividend Cut, Says Jefferies

“To remain in compliance with credit covenants & restore its financial health,” Jefferies’ Christopher Sighinolfi expects Sunoco LP SUN to implement a dividend cut by the year end.

Sighinolfi downgraded the rating on the company from Hold to Underperform, while lowering the price target from $35 to $23.

It’s A Leverage Issue

“Despite solid 1Q results & a 2 percent q/q distribution raise, we are more cautious on SUN & see escalating leverage prompting a distribution cut by YE,” the analyst mentioned.

Sighinolfi noted that in the absence of $40 million in margins from opportunistic supply and trading, which management does not expect to persist, the normalized 1Q DCF would have been $70 million, which implies coverage of only 0.7x, rather than the 1.18x reported for the quarter.

Related Link: Jefferies Downgrades Sunoco LP To Underperform

Dividend Cut Could Help

“With stronger vols expected in 2Q–3Q as the US enters peak driving season, partially offset by higher int expense following SUN's $800 million Apr note placement, we see flat distributions producing avg DCF coverage of ~1.1x over the remainder of the yr,” the analyst stated.

However, leverage was expected to quickly approach Sunoco’s credit covenant of 6.25x, which was likely to tighten to 5.5x in 2017.

“Given ETP needs, SUN condensed an initial 27-month dropdown schedule into just 18 by relying heavily on debt to fund its ~$5.7B of purchases. The process left its leverage stretched & liquidity tight,” the Jefferies’ report went on to say.

Sighinolfi believes a distribution cut to the MQD would help Sunoco lower leverage to 4x by 2020.