Following their significant acquisition of 7-Eleven at the end of 2021, CrossAmerica Partners (NYSE: CAPL) was having some extraordinary times in early 2022, but alas, a reduction in distribution was still likely due to significant risk lurking beneath the surface, like my previous article Explain. Even though the second quarter saw even stronger operating conditions, unfortunately, they were still insufficient to mitigate this risk and so their distributions are now skating on very thin ice with a critical deadline approaching in as little as 30 days which could scuttle their very high 10% yield.
Executive summary and ratings
Since many readers are likely short on time, the table below provides a very brief summary and ratings for the main criteria assessed. This Google document provides a list of all my equivalent grades as well as more information regarding my grading system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial position.
Their cash flow performance saw a very significant year-over-year increase in the first quarter of 2022 thanks to their acquisition of 7-Eleven and booming operating conditions, margins and wholesale fuel volumes hitting near-record levels. Fortunately, this continued into the second quarter with their operating cash flow for the first half of 2022 now reaching $54.7 million and therefore a very impressive increase of 33.27% year over year. compared to their previous result of $41 million in the first half of 2021. .
Despite this improvement in financial performance which increased their free cash flow to $38.2 million in the first half of 2022, their payout coverage was still low at 96.04% and therefore meant that they were still dependent on debt and divestitures to fund a small portion of their distribution. payments totaling $39.8 million. Admittedly, if their working capital build of $4.4 million from the first half of 2022 is removed, that brings their underlying free cash flow to $42.6 million and is therefore now slightly higher than their distribution payments. While that would normally be enough to deem their distribution coverage adequate, in my view that would be shortsighted since their relatively high free cash flow has been significantly aided by record high wholesale fuel margins, as the chart shows. below.
It can be seen that the second quarter of 2022 saw a wholesale fuel margin of $0.118 per gallon, which followed their already very high level of $0.102 per gallon during the first quarter. Historically speaking, there’s a lot more downside than upside from this point, which means their financial performance is much more likely to soften than strengthen in the coming quarters. This situation is not unique to their partnership or the result of superior management, as their counterpart, Sunoco (SUN) also benefited from this same boost, as my other article discussed. The prospect of a recession or economic slowdown on the horizon as the Federal Reserve raises interest rates makes it likely that their fuel volumes or margins will shrink, hampering their financial performance. . Due to their minimal capital expenditures, unitholders cannot expect future fundamental growth to effectively offset lower wholesale fuel margins.
Due to their improved financial performance during the second quarter of 2022, their net debt remained stable, with its latest level of $790.2 million being virtually identical to its level of $790.7 million during the completion of the previous analysis after the first quarter, as intangible disposals filled the gap. between free cash flow and distributions. Looking ahead, the direction their net debt takes obviously hinges on whether they continue to have relatively strong free cash flow, although given that it’s taken record wholesale fuel margins to simply stay flat , this indicates that an upward direction is much more likely than a downward direction.
In addition to helping their payout coverage, their improved financial performance has also helped reduce their leverage slightly after the second quarter of 2022. This now sees their respective net debt to EBITDA and net debt to cash flow trading drops to 5.54 and 6.69. , while their respective results were 6.54 and 7.91 when performing the previous analysis following the first quarter. Even if any improvement is positive, these still remain significantly above the 5.01 threshold for the very high territory, which is obviously anything but ideal for unitholders and given the outlook for their financial performance and of their net debt, their leverage margin is much larger. increase than decrease in the future.
Regarding their liquidity, the second quarter of 2022 saw their current ratio climb to 0.73 from its result of 0.70 when the previous analysis was carried out after the first quarter, thus essentially offsetting their ratio of cash which fell to 0.02 against 0.07 on these same two points. on time. While that sounds correct, their story goes much deeper because, as readers may recall from my previously linked article, their leverage ratio was above the soon to be imposed limit of their credit facility covenant. This removed their liquidity, keeping it low as they faced a potential funding crisis later in 2022 and sadly this remains the case despite a slight decline, per the management commentary included below.
“…our combined global leverage ratio would be approximately 4.85x versus approximately 5.1x at the end of Q4 2021.”
– CrossAmerica Partners Q2 2022 conference call.
As a reminder, after the 30e As of September 2022, the leverage ratio limit for their credit facility covenant reverts to just 4.75, as was discussed in detail in my previous article when this risk first surfaced. Upon reading their most recent Q2 2022 SEC 10-Q filing and associated previously linked conference call, there was no mention of this clause being amended. This means that they only have the third quarter of 2022 to reduce their leverage ratio by at least 0.11 to stay below its limit, which does not seem like an easy task given that their financial performance is more likely to weaken than to strengthen. When it comes to investing, covenants are a very serious financial obligation that the partnership must meet, otherwise a reduction or suspension of distribution is the best case scenario as a breach could trigger bankruptcy and therefore with this critical deadline fast approaching, it now leaves their liquidity very low.
Granted, they could eventually issue more preferred stock to help, as they did in the first quarter of 2022, although given that it features a 9% payout yield, that’s hardly a desirable prospect for ordinary unitholders who would see even less free cash flow to cover their already hefty distributions. Another possible route would be divestitures, although in my view it is doubtful that they can create value for unitholders in the medium to long term, since fewer assets equal less profit.
They’re skating on very thin ice late in the third quarter, with their leverage ratio hovering above its soon-to-be-enforced limit. Unless they find a way to drastically reduce their leverage ratio very quickly or receive reification from their lenders, they appear only 30 days away from a significant reduction or suspension of distribution with the end of September which is fast approaching. While they may find a way to maintain their distributions, I still believe downgrading to a sell rating is appropriate, as there is much more opportunity for disappointment and therefore loss than the other way around.
Notes: Unless otherwise stated, all figures in this article are taken from CrossAmerica Partners’ SEC Filingsall calculated figures were performed by the author.