Calumet Specialty Products Partners Earnings Analysis - Is The Distribution Safe?

Feb.26.14 | About: Calumet Specialty (CLMT)

Last week I wrote an in-depth analysis of one of my favorite MLPs, Calumet Specialty Product Partners (NASDAQ:CLMT). In that article, I explained the reasons for the disastrous 2013 financial results and why I still believed the partnership to be a good long-term holding for patient investors.

Last Wednesday, Calumet released their 4th quarter 2013 earnings and while the results were far from great, the conference call did shed much light on what 2014 is going to look like financially. What investors most want to know is: will the distribution be cut? Will there be a secondary offering? I will now explain why I believe that the risks of a secondary offering are reduced, and the risks of a distribution cut have almost been eliminated entirely.

First let's review the highlights of the conference call, and then I'll explain what they mean for the company going forward into 2014.

-Net Loss of $15.5 million vs. $45.7 million Net Gain in Q4 2012.

$14.6 million of this loss was due to early debt extinguishment fee from the partnership refinancing higher cost 2019 notes. Adjusted for this onetime expense the loss was $.9 million.

-Adjusted EBITDA down to $53.2 million from $91.3 million last year.

-2013 Adjusted EBITDA was $242 million, down from 2012's $405 million.

-DCF for the quarter was $10.6 million vs. $54.5 million in 2012, representing a coverage ratio of 20.2%.

-DCF for fiscal year 2013 was just $19 million, representing a distribution coverage ratio of 9.05%.

-$350 million in 7.65% notes sold, representing $239 million in net loans.

It is important to note that this loan represents a 200 basis point decline in borrowing costs, indicating that capital markets are gaining faith in Calumet's financial future.

Management indicated $111 million was for refinancing, and the remainder was used for the Bel-Ray acquisition in addition to funding the cap-ex, which would put the cost of that company at less than $239 million.

-Current hedging stands at 50% of fuel production. Management's goal is 75% hedging up to 4 years out, to maximize cash flow predictability.

-2014 cap-ex projected at $340-$385 million

-Total liquidity (cash + increased credit revolver) is $594 million up from $387 million in 2012.

-Crack spread declined to $16 on WTI/Brent spread of $9.42.

-Through half of Q1 2014 management is seeing:

-Crack spread increased to 20

-RIN costs spiking to $.5/barrel

The above graph and recent analyst prediction that WTI/Brent spread will be stable at $11.3-$11.4/barrel through 2015, its current level, is vital to predicting how Calumet will fare in 2014.

Using simple proportionality, we find that if the WTI/Brent spread is $9.4 and 2-1-1 crack spread is $16, then at $11.4 we expect a crack spread of $19-$20. During the conference call, Pat Murray, Calumet's CFO, stated that, through mid February, the partnership was averaging about $20 crack spread, a 20% improvement over Q4.

What's more, according to some analysts, this will be the average crack spread over the next two years. This is disappointing because it is so far beneath the $27 crack spread from several quarters ago, but good in that it gives us something with which to calculate projected Adjusted EBITDA and DCF. With this, we can analyze the safety of the distribution.

So let's run through the math and see how 2014 might look financially.

$53.2 million in Adjusted EBITDA, at today's margins of $16 crack spread, with the lower RIN expenses I predicted, ($.3 actual, I modeled $.29).

According to page 16 of the earnings conference call slide show, 2013 total turnaround cost was $53.5 million. Since no specifics were given for this quarter, I'll assume that the cost was evenly distributed across the 3 quarters that the turnaround was occurring, ($17.8 million/quarter).

Add to the EBITDA $14.6 million in financial non-recurring charge, as well as $17.8 million in the final turnaround expenses for the San Antonio and Montana refineries and you, get adjusted EBITDA from operations of $85.6 million.

This is the figure I am estimating that Calumet's operations, without any investment or growth, with Q4 margins, would produce. However, to model the actual 2014 results we'll need to factor in RIN expenses and margin improvement and stabilization.

On page 6 of the conference call, CFO Pat Murray said that management is projecting $90-$95 million in RIN expenses, which is similar to the $85-90 in 2013. Thus, I must adjust my previous EBITDA model, (from my previous article) which assumed a $43.5 million benefit in 2014. That is now apparently off the table.

However, there is very good news on the distribution coverage front.

year adjusted ebitda DCF DCF yield
2009 151 99 0.66
2010 138 76 0.55
2011 211 127 0.60
2012 405 281 0.69
2013 242 19 0.08
Avg 09-12 0.63
standardized 0.60
Click to enlarge

Here is a table created using the conference call slide show presentation. It measures the DCF yield of Adjusted EBITDA. It shows that, on average, excluding the best and worst years, (standardizing to eliminate extremes) 60% of Adjusted EBITDA is converted into DC to pay distributions.

This past quarter, with just $10.6 million in DCF had a yield of 19.9%, which is still better than the horrible 8% seen in 2013. If we factor out the non-recurring charges and turnaround expenses then we see a vast improvement in the DCF and its yield on Adjusted EBITDA.

It also means that, had it not been for the refinery turnaround and the financial cost of gaining the large loan, DCF would have been $43 million, and the distribution coverage ratio would have been .82. While still not sustainable, it is far from disastrous and gives rise to the idea that perhaps the distribution, even at its high annual cost of $210 million, is safe. To see if this is true, we must first estimate 2014 Adjusted EBITDA, to determine the DCF and how close to the $210 million cost it comes to covering.

As I've shown above, the AEBITDA from operations in Q4 was $85.6 million. This is our starting off point for Q1 2014. To that $85.6 million we need to add the $3.75 million in AEBITDA that the completion of the San Antonio refinery expansion and gasoline mixing facility will provide ($12.5 million/year).

This brings us to $89.5 in AEBITDA from which we must deduct the 60% increased RIN expense mentioned during the conference call by Calumet's CFO. He stated that the cost in Q4 was $7.5 million in RIN expenses. This totals $30 million annually. However, Mr. Murray stated that management is estimating $90-$95 million in annual RIN costs. This means that they are anticipating a $60-$65 million increase in RIN (renewable energy mixing credits) expenses or $17.5 million/quarter.

When the increased RIN expenses are deducted my Q1 2014 estimated Adjusted EBITDA comes to $72 million; however, this is based on last quarter's margins. As explained previously, management has stated that they are seeing 20% margin improvement thus far in 2014. This improvement is based on the projected stabilization of the WTI/Brent spread and its effects on the 2-1-1 gulf coast crack spread.

So to model Q1's predicted AEBITDA we need to take the operating Adjusted EBITDA, which is based on 20% weaker margins and account for a crack spread of $20. This brings us to $107.4 million, from which we subtract the $17.5 million in added RIN expenses to reach an estimated $89.9 million in Adjusted EBITDA for Q1 2014.

If we model a return to the historical 60% DCF yield, this gives us $53.94 million in DCF and brings the coverage ratio to 1.03 and making the distribution sustainable and safe.

If we model a return to the historical 60% DCF yield, this gives us $53.94 million in DCF and brings the coverage ratio to 1.03 and making the distribution sustainable and safe.

However, there is an even stronger reason to feel confident in the safety of the distribution. That reason is Calumet's $594 million liquidity position, which the partnership can use to pay for the $340-$385 million in 2014 cap-ex, $210 million in annual distribution cost, interest expenses and future acquisitions.

How much is Calumet's annual interest on its debt? Well for the trailing 12 months Calumet had $98 million in interest expense. The new loan is for a net of $239 million. Based on its 7.65% interest and last year's interest, we get an approximate $116 million in projected 2014 interest payments.

So using the $594 million liquidity and backing out $116 million for interest and $340-$385 million in cap-ex, we get a remainder of $93-$138 million to either pay the distribution or for new acquisitions.

If Calumet had to pay out the entire distribution from the existing liquidity stake then we can see that the partnership falls $72-$117 million short. Does that mean that the distribution has to be cut? Should investors sell or stay away? No, and here's why.

That $72-$117 million shortfall is assuming that management wanted to use the existing borrowing and cash (total liquidity position) to pay for everything in 2014. It assumes no incoming Adjusted EBITDA and no DCF to pay for distributions.

As shown above, I am modeling $89.9 million in Adjusted EBITDA in Q1. Given that there are no projects scheduled to come online in 2014 other than the San Antonio Refinery expansion, which I have already included in my model, we can estimate full-year Adjusted EBITDA at $360 million for 2014.

A new pipeline is scheduled to begin supplying the San Antonio refinery with cheaper Eagle Ford Shale oil starting in July of 2014. This will improve the margins out of that refinery but in order to be conservative I'll model no additional AEBITDA from this event.

To determine the DCF for 2014, we take the current AEBITDA yield of 50%, as well as the historical yield of 60% to get an expected $180-$216 million in 2014 DCF. That gives a projected distribution coverage ratio of .86-1.03.

Should the actual ratio prove on the lower end of the estimate there is $93-$118 million in 2014 liquidity to cover any DCF shortfalls when it comes to maintaining the current distribution.

So from my model we see that the largest amount of DCF shortfall the excess liquidity might need to cover is $29.4 million, (14% of $210 million distribution cost). That would leave $63.6-88.6 million left over with which to make acquisitions.

That last point is important. The 2 issues that have hung over Calumet's unit price the last few quarters have been:

1. Will there be a secondary offering that dilutes unit holders and causes the price to drop?

2. Will there be a distribution drop that causes the price to collapse?

In my previous article I showed how management would likely require a large secondary offering in 2014 to fund its acquisitions, planned cap-ex, make interest payments and fund a distribution that might have to be cut by 34%. I made the argument that this was the worst case scenario and that by 2016, when all the expansion projects were completed, Adjusted EBITDA would be at record levels and the distribution would rise to commensurate levels. This would fuel unit price appreciation and an amazing total return.

I believe that this quarter's results show that things are much better than I modeled. First there is the $360 million in Adjusted EBITDA that estimate for 2014. This doesn't even take into account two large factors that could greatly improve Calumet's 2014 financial position.

Starting in April, Royal Purple, which Calumet acquired last year, will start selling its products in 2400 Walmarts. This will surely bring in cash flow though I can't begin to guess at how much.

Next is the fact that this past quarter Calumet closed on its latest acquisition, Bel-Ray, the international seller of 1,000 specialty products. Given that Bel-Ray had 2013 revenues of $32 million and that Royal Purple had 2013 sales of $432 million, we can see big growth in Adjusted EBITDA possible.

On page 4 of the earnings call, management says that Asphalt made up 19% of their 2013 sales. This means just over $1 billion in sales annually, and the partnership is making a big push into expanding this aspect of the business.

For a total 2014 Adjusted EBITDA, we should include these growth prospects. Royal Purple's sales were included in Calumet's 2013 figures, but the Walmart expansion means that a 5% growth in sales is reasonable. The Blue-Ray acquisitions will add at least $32 million in sales, and I'll model a 5% increase in asphalt revenue, for an additional $51.3 million in revenue.

Now, that's a total revenue increase of $104.9 million. To convert that to Adjusted EBITDA we can look at the 5-year revenues for Calumet and their Adjusted EBITDA. From Morningstar.com, we see that 2008-2013 Adjusted EBITDA was $1.277 billion while total revenues were $19.718 billion. This tells us that 6.47% of sales, over the last 5 years, have been converted into Adjusted EBITDA.

Thus, we can assume that the combined effects of the Royal Purple expansion, Bel-Ray acquisition and Asphalt initiatives, results in an additional $6.8 million, in Adjusted EBITDA.

That puts our final 2014 Adjusted EBITDA estimated at $366.7 million. From this, I project $183.4-$220 million in DCF for a total 2014 distribution coverage ratio of .87-1.05.

So the bottom line is this: Calumet has ample liquidity to pay for its massive cap-ex organic investment products, debt service and to cover any potential DCF shortfall to keep the current distribution safe.

Unless management wishes to make any large acquisitions in 2014, greater than $64-$88 million, then there should also be no need for a secondary offering and no distribution cuts.

Of course, during the conference call the Partnership's CEO did mention that the company is always on the lookout for potential acquisitions, and is examining several candidates, but this should not be of a concern for long-term unit holders. The reason is that management only makes acquisitions that are immediately accretive to Adjusted EBITDA, DCF and thus automatically improve the distribution coverage ratio. Therefore, should management make a large acquisition in 2014 and require a secondary offering to do so, the coverage ratio would not suffer, and the risks to the distribution would only decrease further. The unit price would surely decline in the event of a secondary offering, but that would only give long-term unit holders a chance to buy an excellently managed MLP for an even higher yield.

In summary, 2013 marked a very challenging year for Calumet Specialty Partners. Soaring Renewable Energy credit expenses, collapsing margins and quadrennial turnarounds at 3 of its refineries, created a perfect storm of collapsing DCF and a plunging distribution coverage ratio. This called into question the safety of the distribution and perhaps the need for further secondary offerings, both of which would produce short term price drops. The combined threat of these negatives caused the unit price to drop to today's massively undervalued levels. In my opinion, for the reasons given above, 2014 will prove to be a wonderful year for Calumet, and an even better year for investors who have the courage to wait out the current rough patch.

Disclosure: I 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.