CHICAGO --The overall merger-and-acquisition market for convenience stores and gasoline stations is remarkably strong! The acquisition teams of the acquirers get larger, while asset divestitures, even for weak assets at large corporations, remain on the back burner.
If an asset gets sold, worry develops about how to replace it. Whatever happened to the old retail rules, such as “automatically sell your 10% lowest return sites and replace them with newer and better sites”? Maybe persistently low rates left over from the last recession and a free rein on consolidation have caused a change in strategy for some time to come. That raises the question: Are we now experiencing a “new normal”?
A Feeding Frenzy
Master limited partnerships (MLPs) have certainly added to the feeding frenzy. Considering they are relatively new to the retail and wholesale side of our world, there are quite a number of existing and potential MLPs looking at every deal. They frequently beat out longstanding traditional growth companies in our industry.
For those unfamiliar with MLPs, the U.S. Tax Code and subsequent interpretations allow MLP shareholders a tax deferral on income earned and dividends paid from qualified, usually energy-related activities. Most popular have been companies with steady, predictable earnings streams, such as pipelines, since they can pay out most of those earnings as tax-deferred dividends. Shareholders counting on income from dividends are particularly keen on the predictability. Wholesale mark-ups to dealers or operators are counted as qualified income, and these mark-ups have been improving along with overall retail margins the last few years, creating more interest in dealer buyouts and multiples. The remaining “retail” portion is non-qualified income, but still of interest to many retail-oriented companies, such as CST Brands Inc.
The end result is that MLPs have an inherent advantage competing in the acquisition world with a lower overall cost of capital, as reflected in the fact that the EBITDA multiples of their equities typically far exceed those of their parent companies. A good example is downstream Marathon Petroleum Corporation and its related midstream pipeline company, MPLX LP, whose multiple has consistently been much higher than its highly successful parent company.
The MLP equity world is going through its own shake up at this time, as reflected in its stock-market index called the Alerian MLP Index Trust (NYSE: AMZX). It has declined 26% from its 2014 high. Clearly, many of the declining issues are tied to more volatile and sensitive commodity prices, such as oil, natural gas and coal. Some of the coal MLPs may be on the path to bankruptcy. Current serious pressure on oil and natural gas prices, while long-term price hedges expire, bring no comfort to Wall Street. Since the U.S. economy seems on the mend, there may be anticipation of higher interest rates to come, which often helps the U.S. dollar, but usually depresses commodity prices.
Why the Soft Stocks?
All that being said, it is somewhat surprising that the wholesale-related MLP stock prices are soft, despite decent margins and overall stable fuel demand and strong profitability. For example, CrossAmerica Partners LP (linked with CST) is down 29% from last year's high, strong Global Partners LP is down 26%, and Sunoco LP is down 38%.
Granted, equity supply continues, as indicated by the initial public offerings of GPM Investments and Empire Petroleum Partners. However, these are relatively small equity offerings of $100 million apiece, not normally enough to kill the overall equity side, unless the demand for these equities has tapered off considerably. What might be wrong with this seemingly good picture for downstream MLPs? Let me offer some possibilities:
- Oil prices. Should oil prices drop much further than now assumed by the marketplace, all downstream petroleum margins could suffer over time. Most vulnerable might be U.S. refiner margins, which are currently “to the moon,” because of the wide WTI-Brent crude-oil spread and the lunacy that U.S. producers cannot export their crude oil, yet U.S. refiners can export products at world-market prices--ah, heaven! Lower oil prices could impact margins in general as working capital requirements decline, and, more importantly, the 1% discount for prompt pay offered by branded refiners becomes worth less to middleman distributors. Perhaps Wall Street simply feels the “bloom is off the rose” for anything oil related for now.
- Are purchase multiples too high? There has been spirited competition for M&A deals from MLPs, but equally from refiner-marketers such as Marathon/Speedway and Shell, as well as from many solid retail oriented players who want to use their strong cash flows and credit lines to expand, yet find organic growth too slow. Thus, there is a huge urge to merge by many players, as on Wall Street in general these days. MLPs have the absolute need to grow their dividends but, depending on their complicated structures, have quantifiable EBITDA multiple limits as to what they can pay and still have the acquisitions be accretive to earnings. And, as we all know, not all acquisitions work as planned, so the need can increase to acquire more to stay ahead of earnings. Many are fortunate because the interesting web of MLPs, general partners, sponsors, long-term financing vs. short-term financing, and lines of credit give them a smorgasbord of financing options while most interest rates are at historic lows. It’s a chief financial officer's best dream--or nightmare.
- Interest rates. For whatever reason, unforeseen right now, might interest rates go higher than anticipated?
It's a hot stock market, for sure. The U.S. has already booked $2 trillion (that’s with a “t”) of merger deals this year, and it is only July.
In our industry, it is hard to tell what is going on in the minds of Wall Street. Are they throwing out the baby with the bath water? Arbitrage from hedge funds can easily affect relatively thinly traded stocks like the MLPs, while the larger company sponsors' stocks perform well. But we have all seen cycles come and go in our industry and can't help but wonder if we are close to another peak. Unfortunately, the last time the Alerian Index was getting clobbered this badly was before and during the 2008 recession. Surely, much has changed for the better for the whole economy since that ugly period. And the really good news is that petroleum marketing came through the Great Recession with flying colors, helped by good fuel margins and strong convenience-store sales.
Jeff Kramer is managing director at NRC Realty & Capital Advisors LLC, Chicago. NRC will headline the Financial Outlook session at the 2015 Outlook Leadership Conference, Nov. 14-16 in Scottsdale, Ariz.