CrossAmerica Partners: Don’t Get Tricked By Working Capital, The Distribution Remains Risky (NYSE:CAPL)

CrossAmerica Partners: Don’t Get Tricked By Working Capital, The Distribution Remains Risky (NYSE:CAPL)

Summary

I previously warned that CrossAmerica Partners was at risk of reducing their very high 14% distribution yield, but their cash flows were surprisingly strong following this analysis.

During the first half of 2020, this was largely due to a significant favorable working capital movement, which is only temporary.



Once this is removed, their distribution payments are not covered by free cash flow and thus their coverage is very weak, meaning they continue requiring debt to fund the shortfall.

Their very high leverage and weak liquidity further heighten the risks that they will be forced to reduce their distributions since they have minimal financial flexibility.

On one hand, their very high distribution yield is attractive, but on the other hand, these factors make it seem unsustainable and thus I believe that a neutral rating is appropriate.

Introduction

It was slightly over two months ago that I previously warned that CrossAmerica Partners (CAPL) was at risk of reducing their very high distribution yield of almost 14%. Whilst their earnings performance during the second quarter was surprisingly strong, it does not alleviate the pressure their distributions face and was also significantly boosted by favorable working capital movements.

Executive Summary and Ratings

Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criterion that was assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.

CrossAmerica Partners ratings

Image Source: Author.

*There are significant short-term and medium-term uncertainties for the broader fuel retailing industry; however, in the long term, they will certainly face a decline as the world moves away from fossil fuels.

Detailed Analysis

CrossAmerica Partners cash flows

CrossAmerica Partners notes 1

Image Source: Author.

Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and best captures the true impact to their financial position. The main difference between the two is that the former ignores the capital expenditure that relates to growth projects, which given the very high capital intensity of their industry can create a material difference.

When looking at their cash flow performance during the first half of 2020, it initially appears that they have turned a corner despite this economic downturn. Their distribution coverage increased to a strong 130.86% versus a weak 84.10% from the average of 2017-2019; however, this was actually simply due to a large favorable working capital movement of $27m. If this is removed, their distribution coverage drops to a very weak 59.44% and thus they remain dependent on debt to fund a significant portion of their distribution payments. On a related topic, I must say that I was quite surprised by the stability of their operating cash flow considering the following commentary management made during their first quarter of 2020 results conference call.

The volume declines, both on a year-over-year basis and a week-over-week basis, accelerated through the end of March, but then began to stabilize at the beginning of April. Since early April, we have seen moderate increases in overall same-site week-over-week volume. Currently, our volumes in the most recent weekly are period off around 40% on a same-site year-over-year comparable week basis.”

– CrossAmerica Partners’ Q1 2020 Conference Call.

Their surprising cash flow stability only goes so far when sustaining their distributions and due to their weak distribution coverage, they will continue leaning on their financial position to support the additional debt required to bridge the gap. Given this situation, it seems worthwhile to reanalyze their capital structure, leverage and liquidity to assess for any material changes and assist any new readers.

CrossAmerica Partners capital structure

Image Source: Author.

When looking at their capital structure it can be seen that their net debt has remained essentially unchanged since the end of 2017, which stems from a total of $41m of divestitures helping to counteract the cash shortfall to cover their distribution payments. Whether this has been sufficient to keep their distributions sustainable will still depend on their leverage and liquidity.

CrossAmerica Partners leverage ratios

CrossAmerica Partners notes 2

Image Source: Author.

Upon reviewing these financial metrics it was a simple open and shut case of very high leverage, as primarily evidenced by their net debt-to-EBITDA of 5.12 sitting above 5.00, which I deem as the threshold between high and very high leverage. The situation does not change regardless if an investor prefers reviewing their leverage, with their net debt-to-operating cash flow of 7.52, gearing ratio of 81.41% and interest coverage of only 1.80, all indicating the same findings. Given their earnings have proved surprisingly stable this does not necessarily threaten their ability to remain a going concern; however, it certainly diminishes any margin of safety for sustaining their distributions.

CrossAmerica Partners liquidity ratios

CrossAmerica Partners notes 3

Image Source: Author.

It easily becomes apparent that their liquidity is weak, as current and cash ratios of only 0.45 and 0.01 are seldom a positive sign, especially since their current ratio has deteriorated from 0.74 at the end of 2017. This situation is quite concerning and thus leaves them with only minimal financial flexibility to sustain their distributions, plus leaves them reliant on their credit facility due to their likely continued cash outflows to cover their distributions.

Whilst different investors will have differing opinions regarding the extent that this matters, it should be generally agreed that this is not ideal, especially during periods of heightened uncertainty since credit facilities could be reduced in the future. Presently they have $203m available in their credit facility and thus it should be sufficient to remain a going concern, but given their very high leverage it would be dangerous to burn through this to simply pay distributions. It was rather unusual to see all of their debt being comprised from their credit facility, apart from a small portion relating to finance leases, as the table included below displays.

CrossAmerica Partners debt maturities

Image Source: CrossAmerica Partners’ Q2 2020 10-Q.

Conclusion

Whilst some investors may wish to believe that their surprisingly resilient cash flow performance should save their very high distribution yield, I remain skeptical given their very high leverage and weak liquidity. On one hand, their very high distribution yield is attractive but on the other hand, these factors make it seem unsustainable and thus I believe that a neutral rating is appropriate.

Notes: Unless specified otherwise, all figures in this article were taken from CrossAmerica Partners’ Q2 2020 10-Q (previously linked), 2019 10-K and 2017 10-K SEC Filings, all calculated figures were performed by the author.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


Originally published on Seeking Alpha

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