Delek US - Earnings Call - Q2 2017

Transcript

Speaker 0

Good morning. My name is Pasha and I will be your conference operator today. At this time, I would like to welcome everyone to the Vale U. S. Holdings Q2 twenty seventeen Earnings Call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. I would now like to turn the conference over to Mr. Keith Johnson.

Please go ahead, sir.

Speaker 1

Thank you, Pasha. Good morning. I would like to thank everyone for joining us on today's conference call and the webcast to discuss Delek U. S. Holdings second quarter twenty seventeen financial results.

Joining me on today's call is Uzi Amin, our Chairman, President and CEO Kevin Kremke, CFO and other members of our management team. As a reminder, this conference call may contain forward looking statements as that term is defined under federal securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward looking statements. You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release.

As a result, actual operations or results may differ materially from results discussed in the forward looking statements. We undertake no obligation to publicly update any forward looking statements whether as a result of new information, future events or otherwise. On today's call, Kevin will begin with a review of the financial performance for the quarter, then I'll turn it over to Uzi for a few closing strategic comments. With that, I'll turn the call over to Kevin.

Speaker 2

Thanks, Keith. For the 2017, Delek U. S. Reported a net loss of $37,900,000 or $0.61 per basic share compared to a net loss of $7,000,000 or $0.11 per basic share in the second quarter of last year. On an adjusted basis for the 2017, Delek U.

S. Reported an adjusted net loss of $25,000,000 or $0.40 per share compared to an adjusted net loss of $5,100,000 or $08 per basic share in the prior year period. A reconciliation of reported results to adjusted results is included in the financial tables of our press release. Both reported and adjusted results in the 2017 included a hedging loss of $31,700,000 or $0.31 per share after tax related to a realized loss on a crude oil inventory hedging strategy associated with the J. A.

Aaron supply and offtake agreement at El Dorado. The hedges were entered into in late twenty fourteen in anticipation of the expiration of the supply and offtake agreement in the second quarter of this year. However, we elected to extend the maturity of that agreement until April 2020. The primary driver of the change on a year over year basis was reduced performance in our Refining segment, which I will discuss in more detail in a few minutes. We completed the acquisition of the remaining outstanding common stock of Elan that we did not already own in an all stock transaction on July 1.

For the 2017, our 47% investment in Elan USA resulted in a pretax income of $400,000 compared to a loss of $10,400,000 in the prior year period. Delek's equity investment income from Elan was reduced by approximately $1,100,000 for transaction costs that Elan incurred during the 2017. Due to the timing of the completion of the acquisition on July 1, Alon will not file a quarterly report on Form 10 Q or issue a press release to announce quarterly results. I would like to point out that Delek U. S.

Provided supplemental financial data for Alon's second quarter performance on a Form eight ks filed 08/02/2017. Our operating expenses increased by $4,300,000 compared to the second quarter of last year, driven primarily by increased outside and contract services. General and administrative expenses increased 3,900,000 on a year over year basis, mostly due to transaction related costs. Finally, our income tax rate excluding the non controlling interest income associated with Delek Logistics of $5,700,000 was 41.6% in the 2017. Turning now to capital spending.

Our CapEx during the period was approximately $15,000,000 compared to $7,100,000 in the the second quarter last year. During this second quarter, we spent $11,200,000 on our Refining segment, 2,100,000.0 in our Logistics segment and $1,700,000 at Corporate. Our 2017 capital expenditures are forecast to be $95,000,000 which compares to $46,300,000 in 2016. This amount includes $63,000,000 in our refining segment, 21,100,000.0 in our logistics segment and $10,900,000 at the corporate level. This compares to our previous estimate of $89,200,000 for Delek U.

S. Prior to the Elan transaction. In addition, during the 2017, we expect to spend approximately $75,000,000 related to the Elan operations acquired on July 1. This equates to a 2017 forecast capital spending of approximately $170,000,000 total. We ended the second quarter with approximately $572,000,000 of cash on a consolidated basis and $250,200,000 of net debt.

Excluding net debt at Delek Logistics of $392,000,000 we had net cash of approximately $142,000,000 at June 3037. And Elan had approximately $250,000,000 of cash and $564,800,000 of total debt. On a combined basis at June 30, the company would have had a projected capitalization of approximately $790,000,000 of cash and a net debt position of approximately $600,000,000 If the net debt at DKL is excluded from the combined capitalization, the net debt position would be $2.00 $8,000,000 Now I would like to discuss our results by segment. In our Refining segment, we reported a contribution margin of negative $14,000,000 compared to a contribution margin of $40,000,000 in the second quarter of last year. Market conditions improved on a year over year basis as the Gulf Coast five-three-two crack spread increased to $10.86 per barrel for the 2017 compared to $9.8 per barrel for the same period last year.

Also RINs expenses declined to $5,500,000 in the Refining segment from $12,300,000 a year ago. These improvements were offset by a combination of factors. First, there was an inventory charge of $14,000,000 in the second quarter of this year compared to a benefit of $12,900,000 in the prior year period. Second, this quarter included a net hedging loss of $29,500,000 compared to a $17,400,000 hedging loss in the prior year period. As I described earlier, this hedging loss includes the approximately $31,700,000 realized loss on hedges associated with the J.

Aaron agreement that reduced performance at the El Dorado refinery. Third, lower margins on residual products including asphalt contributed to reduced margins at El Dorado. The combined contango and Midland Cushing differential benefit declined by approximately $0.24 per barrel on a year over year basis. This consists of a favorable differential between Midland and Cushing that averaged $0.83 per barrel discount in the 2017 compared to a discount of $0.18 per barrel in the prior year period. And contango in the crude oil futures market that was $0.54 per barrel in the 2017 compared to contango of $1.43 per barrel last year.

Now I'd like to review our Logistics segment, which is comprised of the results from Delek Logistics Partners. Our Logistics segment contribution margin was $31,700,000 in the second quarter of this year compared to $30,000,000 in the prior year period. On a year over year basis, improved performance in the West Texas wholesale business offset lower performance from the Paline Pipeline and Salic Gathering System. I will now turn the call over to Uzi for his closing remarks.

Speaker 3

Thank you, Kevin. First, I would like to thank the employees of both Delek and Alon for their efforts to close the transaction on July 1. We are very excited about the future of the combined company and look forward to working with both organizations as we integrate the operations. We are on track to create approximately $95,000,000 of synergies in 2018 and integration is moving forward with the efforts underway to apply best practices of both companies to the combined organization. In addition, our teams are focused on unlocking the value of approximately $78,000,000 of logistics EBITDA through future potential dropdowns to DKA.

We believe that our company is well positioned in the Permian Basin with approximately 200,000 barrels per day of access or approximately 75,000,000 barrels a year. By partnering with DKL, we can utilize our logistics system system to support this larger operation through crude oil and light product initiatives in the future. Based on June 30, the combined DELEC and Alon cash balance was approximately $790,000,000 This financial flexibility should support our efforts as we move forward with the integration and evaluation of potential growth opportunities, while remaining focused on creating long term value for our shareholders. With that, Parsha, would you please open the call for questions?

Speaker 0

And your first question is from the line of Roger Read.

Speaker 4

Sorry, had to get the mute off there. Guess I'd like to get into what exactly we should think about the performance of El Dorado. Kind of a tough quarter here. I know you called out the non clean products, but would have expected a light crude refinery to have done a little bit better in that region this quarter. Just curious if there was anything else that went on there?

Speaker 3

That's a great question, Roger. Good morning. We didn't want to go on the press release with the noise that we had in El Dorado this quarter. But all over in El Dorado, we had $12,000,000 if you will, of charges and stuff that usually doesn't happen. So let me call these three components.

The first one, we had a true up of some benzene credit that we bought three years ago or a couple of years ago, we the market on benzene credit went down and we bought two years ago with much higher price. We still have the credit, but we marked it down. That's a non cash event. That's around $4,000,000 Also, had colonial impacting us and the netback along the colonial, which since then improved by $4,000,000 And we did say the asphalt impact, we could quantify for you guys, it's around $5,000,000 So altogether, we are talking about 12,000,030 million dollars We rounded down to $12,000,000 So if you take that $12,000,000 and you apply it by barrel, you'll get the difference and why there was so much noise in this quarter that shouldn't exist in other quarters.

Speaker 4

Okay. So yes, it looks transitory for the most part.

Speaker 3

That is correct. And when Keith will talk to you guys and other investors, he will explain that we didn't want to go into much detail in the press release or in the conference around that, but that $12,000,000 are certainly missing in El Dorado for the quarter. Obviously, don't expect them to continue in the future. For sure, the markdown of benzene credit shouldn't happen anymore. Actually, it's a benefit of these credits and they went down.

Speaker 4

Okay, great. And I know you're probably a little early in the integration process to give us a whole lot to think about different than what's been laid out with the Elan acquisition. But from a cash standpoint, like you called out Kevin earlier on the call, really strong balance sheet here. Uzi, where do you think you are in terms of changes to shareholder returns, whether it's a higher dividend, share repurchase? What's kind of the way to think about that process?

Speaker 3

Obviously, we're early Roger, and you know that we are early in this process. We said very strongly in our comments our prepared comments that the synergies that we see, we don't feel that we're coming short of these synergies. Actually, we are very encouraged with what we see and we expect to start seeing some benefit in the near future. With that being said, the third quarter started pretty nicely. Cracks are good.

The synergies are going our way. Fourth quarter is doing fine with Midland being 150 under. So if this continues, then we will need to consider very carefully if we want to start being more aggressive via our buyback program, which we have. We need to be a little more patient with that, but we are pretty optimistic about it.

Speaker 4

Okay, great. Thank you.

Speaker 0

Your next question comes from the line of Theo Grish.

Speaker 5

Yes, hi, good morning.

Speaker 3

Good morning.

Speaker 5

First question, I just want to clarify the capital spending numbers that you gave. I think you said 75,000,000 for the ALJ assets in the second half. Is that correct?

Speaker 3

That is correct.

Speaker 5

And I think obviously things change. Standalone ALJ was $80,000,000 for the full year previously. So maybe you could just elaborate on what types of things you're spending money on in the second half of the year for ALJ.

Speaker 3

Well, as you probably saw, the Big Spring refinery is about to sign a consent decree. So that will require some projects in Big Spring. Also, as we are looking forward on the and that's more important, on the growth situation, we know it needs attention. So haven't decided to do everything, but we're looking at it very carefully. We have a program that will try to improve costs significantly.

And we wanted to come to the market and say that there is a possibility that we'll start spending money on this facility.

Speaker 2

Sure. Okay.

Speaker 5

The second question is just with the potential drop down through the second half of the year. Is your expectation at the DK level that it would be 100% cash proceeds? And how are thinking about debt equity mix? And is there any circumstance where you would take units?

Speaker 3

SDK? We see it today, probably not.

Speaker 5

Okay. A 100% cash. Okay.

Speaker 3

Now everything can change. The market can go up or down, but as we see it today, probably not.

Speaker 5

Okay. So I guess, I know Roger kind of asked this, but maybe a slightly different way to ask it would be, how do you think about leverage, pro form a leverage moving forward and where you'd be comfortable having it? I know there's some balls in the air here, ALDW and maybe additional

Speaker 3

spend Yes, that's across and other a great question. Excluding DKL, we never want to be more than one time.

Speaker 2

Okay. Got it.

Speaker 5

Okay. That's it for me. Thanks.

Speaker 3

Thank you.

Speaker 0

Your next question comes from the line of Paul Cheng.

Speaker 6

Hey guys, good morning.

Speaker 3

Hey, Cheng, good morning.

Speaker 6

You see that curious that maybe it's way too early. Is there a timeline that you will put for the resolution for ALDW?

Speaker 3

It's too early to discuss it. We're obviously looking at that. We said all along, it doesn't make sense to have three public companies or actually it used to be four, now it's three. But also it depends on the returns. And if the ALDW price doesn't make sense, we already proved the market that we can be patient and it makes sense obviously to consolidate things, but it needs to make sense also from economic standpoint.

Speaker 6

Sure. That why at this moment that you do not have any definitive timeline that you will be able to share?

Speaker 3

Well, we are doing the work that we can pull the trigger, but the trigger is it depends on the market condition. So it's not that we are sitting on our bus and doing nothing. We are doing the work, but we are obviously not going to overpay for LDW. So we need to be patient.

Speaker 6

And somewhat similar question that in terms of the timeline for your evaluation for CoralSpring, there has always been probably the weakest asset. You are talking about that you may want to spend some money, but what kind of matrix you're going to measure them against and how much time you're going to give that facility before you may decide that whether that should be a continued operation?

Speaker 3

That's a great question, Paul. We told the market and I told you privately in the past, there are three components to cross. First, the cost to bring the barrels to cross, not the barrels themselves, because some of them are actually Midland. The problem is the cost to bring it over. Second is the operation itself, which requires capital, as you know.

And third, sale of the products that needs attention as well. We have a full team already sitting and thinking about these three components. We meet on a regular basis and we need to see if we can come to a resolution that we can find a way to improve it. Right now, we are I am more optimistic about it than I was in the past, but I don't want to declare any victory or to be ahead of myself in that area.

Speaker 6

Because I think you're probably well aware that the IMO 2020 is probably going to make it very challenging for a facility with the current configuration of Coral Springs. So it's either that you're going to make the investment there to trying to reach the high sulfur product or that maybe that you should really consider shutting that down?

Speaker 3

Well, I wouldn't jump into conclusion that we need to do a high sulfur or low sulfur diesel in cost. If you remember, or maybe let me refresh your memory, we have access capacity both in Tyler and El Dorado. And we already have a project that is working, we just now started, that we are selling in Tyler also a lot of additional barrels to Mexico. So and the netbacks are pretty healthy over there. So I wouldn't jump into conclusion that we need to put that investment in place.

I'm very well aware of the 2020.

Speaker 6

And on retail, is that going to be viewed as internally a core part of your long term portfolio or that you will be looking at to monetize it given the continued very strong valuation on the market for us at BingQingChen. So how should we look at the retail inside your portfolio?

Speaker 3

Well, as you know, we weren't afraid to monetize Delix retail few months ago, but the Alon retail will need attention. Again, it will need some capital with mega stores, building mega stores. That's our plan today. We'll start building mega stores and then prove to ourselves because the market over there is very, very strong because of the premium activity. And then down the road, maybe we'll look at it, but it's not on the table, not for sale for the next year or two.

Speaker 6

Okay. Two final quick ones. One is a simple accounting question. Given for the full year, your air fish ownership for ALJ will be way over 50%. Is that at some point you need to restate the first half result to combine to the fully consolidate operation in self parcel consolidation using equity accounting in the first half?

And final one, as the company become bigger, will you we look at your hedging strategy and whether that you should continue to do hedging? I mean, I think we have seen many of your peers, especially the bigger one they have tried and have been quite unsuccessful in their hedging strategy and ultimately that they just abandoned and not doing hedging.

Speaker 3

Let me take the first one the second one, because it's a business question and not an accounting and then Daniel or Kevin will take the first one. The hedging program was very successful for us. I realized that we have a charge here of $0.31 because of our protection of inventory with J. ON. But let's be clear, if we want to get out of these agreements, we really don't want prices to go up because then we will need to pay tremendous amount of money for that inventory.

That was the idea behind that. Do I like to lose $0.31 Absolutely not. But at the same time, do I want crude oil to go back to $80 and need to pay somebody $200,000,000 against that, that's probably extra. That's probably something I don't want to do either. So let let's just put that in context.

It it from a from a big picture standpoint, yes, there are quarrels that there's noise against, and there are quarrels that against that goes with you. In the last few quarters, because of all the general situation, it went against us. But at the same time, it was very successful for us and we will need to evaluate that every quarter, but that's another tool in our toolbox. In regard to the accounting question, Danny, I don't know if you want to take that one.

Speaker 7

Sure, Paul. It's Danny. So as you're aware, the investment that we had in Elan prior to July 1 was treated for accounting purposes as an equity investment. July 1 forward, we will be consolidating those Alon assets into Delek US and be fair valuing that balance sheet and bringing that into the consolidated Delek US. Did that answer your question?

Do you have a further When question based on

Speaker 6

you report the 10 ks on a full year basis, since you have more than way more than 50% equity ownership, half age for the year, do you need to, in the 10 ks, report it as a fully consolidated operation?

Speaker 7

We are still looking at that, Paul. But right now, thought is that we'll just report the last six months of the year under fully consolidated. And then the 47% we had prior to that stay in equity income. But that's still under review, not fully decided, but that's where we're at

Speaker 6

at the moment. Thank you.

Speaker 0

Your next question comes from the line of Neil Mehta.

Speaker 8

Hey, good morning team.

Speaker 3

Hey, Neil. Good morning, Neil.

Speaker 0

I'm sorry, Neil's question was for John. We do have Chi Chow on line.

Speaker 3

I'm sorry?

Speaker 1

Chi, are you on?

Speaker 9

Yes, yes, am. Okay.

Speaker 3

I'm sorry, Chi. Good morning.

Speaker 9

Good morning. Not quite sure what happened there. Okay. Yes, just a couple of questions here. On the upcoming midstream drop, do have you the EBITDA associated with the asphalt terminal?

Speaker 3

We didn't disclose that just yet. We do have the EBITDA, but let us work on that a little more and then start thinking about dropping it down.

Speaker 9

Okay. Any thoughts on the pace of the remaining drops going forward?

Speaker 3

I'm sorry, what is the question?

Speaker 9

The pace of the remaining midstream drops?

Speaker 3

Yes, eighteen to twenty four months. Okay.

Speaker 9

Okay, great. Then I guess another question back on El Dorado. The benzene credits,

Speaker 3

Chi, just one thing, let me have a correction here. We have it public, so let me give you the asphalt terminals, it's 11,000,000 to $13,000,000 My apologies. Yes.

Speaker 9

Okay. Thanks for that. And then back on El Dorado, the spending credit mark to market issue, is that truly one time or is this going to float around every quarter?

Speaker 3

I need to explain it again because and again, it's a little technical. We Eldorado short benzene credit, so we went ahead two years ago and bought a bunch of them. Then price of Benzene credit went down. So we took the hit this quarter for all of that Benzene credit inventory. It's a non cash event and it will now if the mark it used to be $1 now it's $0.20 If the market goes to $0.10 then you'll have another charge, but nothing to this magnitude.

Speaker 9

Okay. But technically, does it's going float every quarter?

Speaker 3

Maybe $200,000 but not $4,000,000

Speaker 9

Okay. And then you mentioned I think it came up this IMO bunker fuel spec change. How are you thinking about that impact longer term on the asphalt market? Do you have a high yield of asphalt at El Dorado? You've got the asphalt terminals.

Any concerns on that part of the business?

Speaker 3

Well, first let's talk about the high yield of it, it's roughly 10%. We out of tall production of oil company and we have in Big Spring 3,000 or 4,000. So we're talking about 10,000 barrels out of 300,000. We're looking at that. We think this is an opportunity because the demand for asphalt is growing.

Hopefully, the bill will pass finally. But that's of course an area that we're looking at.

Speaker 0

Your next question comes from the line of Neil Mehta.

Speaker 8

Hey, good morning team. Can you hear me? Hey, Neil. Good morning. Good morning.

Uday, want to start off and just talk a little bit about the $95,000,000 of synergies. I know it's early. We're going get a little bit more color later this year. Anything that you're seeing that would lead you to think that you can achieve the $95,000,000 of synergies run rate or that there could be potential areas for upside? And can you talk about where those potential value drivers can be?

Speaker 3

It's too early to talk about upside, but we see no reason to believe that 95,000,000 won't be achieved.

Speaker 8

Okay. Got it. All right. And then ALDW, I know there's an element of not wanting to broadcast the strategy here, but can you just talk about how you think about ultimately bringing that into the fold?

Speaker 3

Absolutely. As I said, it doesn't make sense to have ALDW as a different public company. At the same time, needs to make sense financially. And we're doing the work. We'll be ready if the market is right.

And if not, we'll wait, similar to what happened with ALJ.

Speaker 8

Got it. All right. And then on WTI Midland, we haven't talked about it a lot on this call. There have been some pipes that have been announced. Now a lot of them have been contracted out.

But what are your thoughts in terms of the differential from here? And let's break it up into two parts kind of more of a near term look and then a longer term look for the spread.

Speaker 3

Near term, I think that $1 to $150,000,000, we actually see the forward curve at $150,000,000 for the fourth quarter. Next year, I would say anywhere between or let's call it over the next two years, dollars to $2 and after that, I think it's around about 50

Speaker 8

Perfect. Okay. Last one, Uzi, is just we've talked a lot about the Mid Con and the need for consolidation. You're doing a good job of starting that process. Obviously, Tesoro is as well with Western, but there's still a lot of little players out there.

How do you think about the role of Delek in terms of consolidation and incremental M and A in the Mid Con area?

Speaker 3

Well, I didn't change my mind, Neil, that consolidation needs to continue. And our the not only in the big continent, several small companies, us included, will as the time goes by, consolidate with each other. Do I know of anything specific for Delek? Absolutely not. But Delek will be a player.

Delek is not afraid to be active in the M and A market. And we believe with the synergies of Alon and again, it's early to say, but we are very optimistic with the things that we see. Now, that needs to still be laid out in order to see how it is being translated to the M and A market.

Speaker 8

All right, great. Thanks, Uzi. Appreciate the time.

Speaker 3

Appreciate you, Neil. Thanks.

Speaker 0

And your next question comes from the line of Kaley

Speaker 2

Hey guys, good morning.

Speaker 3

Good morning. Good morning.

Speaker 2

Hey, just a couple of housekeeping questions for me on the dropdowns. So as it relates to AODW, does the entity need to be consolidated into DK or you can execute on those plan dropdowns of the Big Spring assets into DKL?

Speaker 3

Prefer that. Hey, guys, I hear myself wise. So we do prefer that, but it's not it's not a must. We can work around it, and we're doing the work both ways.

Speaker 2

Got it. I understand. Separately, AOJ currently reports asphalt as a stand alone segment. You guys are talking about stripping out the terminals in dropdowns. This essentially exasperates those already pretty volatile earnings.

Are you going to continue to report this segment as a standalone going forward?

Speaker 3

We haven't decided that, but probably not.

Speaker 2

All right. Thanks for the answers.

Speaker 1

Thank you.

Speaker 0

At this time, there are no further questions.

Speaker 3

Thank you, Parsha. First, I'd like to thank my colleagues around the table for the hard work that they're putting into this company. I'd like to thank you guys on the phone and other investors and analysts for your interest in our company. And lastly, I'd like to thank our employees for the great work that they are doing for this company. Thanks and we'll talk to you soon.

Speaker 0

Thank you, ladies and gentlemen. This concludes today's teleconference.