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Alon USA Partners, LP (NYSE:ALDW)

Q4 2013 Results Earnings Conference Call

March 7, 2014 10:00 AM ET

Executives

Stacey Hudson - Investor Relations Manager

Paul Eisman - President and CEO

Shai Even - Chief Financial Officer

Analysts

Mohit Bhardwaj - Citigroup

Jeff Dietert - Simmons & Company International

Paul Cheng - Barclays Capital

Rakesh Advani - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Alon USA Partners’ Fourth Quarter Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions)

This conference is being recorded today, March 7, 2014. I would now like to turn the call over to Stacey Hudson, Investor Relations Manager. Please go ahead.

Stacey Hudson

Thank you, George. Good morning, everyone. And welcome to Alon USA Partners’ fourth quarter 2013 earnings conference call. With me are Paul Eisman, President and Chief Executive Officer; Shai Even, Chief Financial Officer, along with other members of our senior management team.

During the course of this call, we may make forward-looking statements based on our current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially.

For a discussion of factors that could affect our future financial results and businesses, please refer to the disclosure and risk factors disclosed by the company from time-to-time in its filings with the SEC.

Furthermore, please also refer to the statement regarding forward-looking statements incorporated in our news release issued Tuesday and note that the contents of our conference call today are covered by these statements.

On this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP in our financial release which is posted on our website.

Finally, please be aware that all our statements made as of today, March 7, 2014, based on information available to us as of today and expect as required by law we assume no obligation to update any such statements.

With that, I’ll turn the call over to Paul.

Paul Eisman

Thank you, Stacey, and good morning, everyone. We are generally pleased with the results from the first full year of operation of Alon USA Partners. For the year, we generated net income of $136.2 million or $2.18 per unit and distributed a total of $2.37 per unit based on 2013 operations.

For the fourth quarter we recorded net income of $13.5 million or $0.22 per unit. With the cash generated during the fourth quarter, we paid a distribution of $0.18 per unit on March 3rd of this year.

While crude differentials are down from their highs, they are still healthy and we feel they are structural, sustainable and supportive of good profitability at Big Spring refinery going forward.

The Big Spring refinery had an excellent operating fourth quarter setting a record quarterly throughput of 33,600 barrels per day. Direct operating expenses during the quarter were good at $3.98 per barrel.

Crude differentials and the resulting crack spreads were volatile in the fourth quarter, differentials were very narrow early in the quarter, but they widened as a quarter progressed.

For the quarter we averaged the refining operating margin of $9.96 per barrel, as compared to $25.26 in the same quarter last year. The reduction was driven primarily by price weakness for gasoline in the Mid-Continent compared to the Gulf Coast along with lower crude differentials at Cushing and Midland.

We believe that there will continue to be pressure on local crude prices as production continues to grow. Our way of illustration, the increasing Permian Basin crude production is increased -- is resulting in downward pressure on Midland pricing versus Cushing.

As crude oil production in the Permian Basin continues to increase, having a refinery in the middle of all that production provides us a competitive advantage. In this environment we also continue to optimize our crude mix and refinery operations to capitalize on changing crude and product differentials.

As the production of sweet crude in the Permian has grown, we have improved our margins by running more WTI and less WTS, which improves our yield substantially making more gasoline and less asphalt.

In the quarter we ran almost 29,000 barrels per day of WTI, compared to 19,000 barrels per day year ago and did so, while achieving record quarterly throughputs. More to that point, we recently run up to 45,000 barrels per day of WTI Big Spring.

We announced earlier this year, that we were delaying our plan first quarter turnaround at Big Spring into the second quarter. This decision was based on our desire to optimize the turnaround and our vacuum tower revamp project.

This project will allow us to increase disciplined recovery of the plant by 2000 barrels per day while increasing our ability to better utilize the equipment and improve the energy efficiency at Big Spring. The capital cost of this project is $25 million and generates benefit of nearly $20 million per year at expected margins.

The turnaround is now expected to start in early May and finish in the last half of June. Our estimated throughput in the second quarter is 46,000 barrels per day as a result of the turnaround in the vacuum tower revamp project. We expect throughput at Big Spring to average 67,000 barrels per day for the entire year.

In our wholesale marketing business, both branded and unbranded fuel sales during the quarter were very strong versus the same quarter last year branded sales gallons were up over 11% while unbranded sales were up 22%. Our board has approved cash to use for capital expenditures for turnaround chemicals and catalyst for the year 2014 of approximately $57 million.

This is higher than the capital budget over the last several years and the increase is driven primarily by increased spending at Big Spring for the major five-year turnaround. We are looking at a number of potential capital projects with excellent returns to help us grow the distributions going forward.

We have opportunities to improve gross margins, increase our throughput and the profitability of our company and are working to develop these opportunities. As we more completely develop these projects, we will provide additional information on how they will be supportive of increased distributions in the future.

We are very optimistic about the future for Alon USA Partners. As it was mentioned earlier, the Big Spring Refinery is strategically located and as a result, we expect to experience advantage crude oil pricing, that is structural sustainable and supportive of strong profitability of Big Spring going forward.

With that, we are glad to answer any questions that you might have. Hello?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is from Mohit Bhardwaj with Citigroup. Please go ahead.

Mohit Bhardwaj - Citigroup

Hi. Thanks for taking my question. I just had a question on the turnaround. Paul, you’ve mentioned in the past that you’re also looking for increasing the total throughput to the Big Spring’s refinery. Is that going to be completed once the turnaround is done. I think the number of that was mentioned about 3000 barrels per day?

Paul Eisman

Yeah. Just to clarify, we do think that we’ll get an increase. I mentioned in the statement about better utilizing existing equipment that we have. So there is really not investment increase in the throughput but just it eliminates the bottlenecks that prevent us from using that existing equipments. So we do think we’ll get an increase and that will occur after completion of the turnaround in the second quarter.

Mohit Bhardwaj - Citigroup

Thanks. And just on the wholesale volumes, would you mind providing the numbers comparing 2013 with 2012 and also the margins if that’s possible?

Shai Even

Yeah. We can provide the volume. We don’t really report the margins separately. The margins for the wholesales are included in our operating margins. But the reported margins for Big Spring of $9.96 a barrel for the quarter, included in that is the effect of the wholesale, both branded and unbranded. I do have the total volume of branded gallons for the quarter. It was approximately 104 million gallons and for the unbranded, we have approximately 99 million gallons. I do not have here with the 2012 numbers.

Mohit Bhardwaj - Citigroup

Okay. Thank you.

Operator

Thank you. And our next question is from Jeff Dietert with Simmons & Company International. Please go ahead.

Jeff Dietert - Simmons & Company International

Good morning.

Paul Eisman

Hi, Jeff.

Jeff Dietert - Simmons & Company International

I was hoping you could talk a little bit about the evolution of crude quality in the Permian Basin. You’ve seen some lighter almost condensate kind of crudes being produce in the Delaware Basin or other parts. So are you seeing API gravity rise in the Permian? Is that influencing the quality of crude and that you are getting at Big Spring and maybe you can talk in a context as to why West Texas Sour was trading at $1.05 premium to WTI Midland, that’s pretty unusual?

Paul Eisman

Yeah. It is unusual and I will answer that last question first. First of all, I don’t really have an answer but we view that not so much that WTS is expensive as WTI has become discounted and relative to the value. So that’s why we are trying to take advantage of it by maximizing the WTI going to the refinery.

In terms of your question about how light crude has gotten weak, we have seen that the API of the WTI and the WTS has been increasing. Some of that is seasonal. I mean, we’ve always seen a little bit of seasonality summer to winter with that, but we think this goes beyond that but you are seeing increased production of light crudes.

You are not seeing that in the Permian to the same degree we’ve seen it in the Bakken or the Eagle Ford. But we are seeing evidence that we are starting to see lighter crudes. We do have an advantage there and that thing in the area, we pick and chose which crudes we want to charge to our refinery and we’ve seen production increases occur in our local area and our truck barrels has increased significantly.

And we’ve developed a program to track the quality of those barrels and try to only take the barrels that are of higher quality, lower gravity, lower vapor pressure crude. So, yeah, we’ve seen some of that trend but we’ve been able to mitigate some of that because of where we are.

Jeff Dietert - Simmons & Company International

And you’ve kind of shifted from your historical feedstock of 80% sour, 80% WTI. You’ve kind of doubled your WTI consumption there over the last couple of quarters. Is there opportunity to further increase WTI consumption if these economics stay in place?

Paul Eisman

I think there is. I mentioned 40,000 barrels per day in my comments, that’s kind of a limit right now with the existing equipment. We are obviously working with engineers to see how we can get around those limits. But we’ve gotten to that point. We are going to have to do something I think to get significantly higher than that.

But there are things we think we can do. I mean, basically you are getting rid of bottlenecks in the light ends of the refinery, which tend to be less costly than getting around bottlenecks in the heavy end of the refinery. So, things like our pre-flash tower, which is pretty inexpensive way to get around the bottlenecks in the crude tower and then we are looking at capacity in some of our light ends fractionation and also in the reformer because we produce more naphtha with WTI than we do with WTS. So yes, we can get around that. We’re actively looking at those projects. I mentioned, we’re looking at projects to improve the profitability and those are among the projects that we’re looking at.

Jeff Dietert - Simmons & Company International

Good. And they are lower cost, and I would guess they are shorter lead time projects as well, was that trim?

Paul Eisman

I think that’s generally correct. I mean, if you’re dealing with conversion equipment, those tend to be much more significant. You only do it during turnarounds, and so there are a lot more -- there are a lot tougher to do.

Jeff Dietert - Simmons & Company International

All right. Thanks, Paul.

Paul Eisman

You bet. Thank you.

Operator

(Operator Instructions) And our next question is from Paul Cheng with Barclays. Please go ahead.

Paul Cheng - Barclays Capital

Hey, guys.

Paul Eisman

Hi, Paul.

Paul Cheng - Barclays Capital

Good morning. Paul, if you’re going to 100% WTI Midland today, what is the volumetric reduction that may have applied and how is that yield is going to shift also?

Paul Eisman

So if we would run a 100% WTI right now, we’ve got some estimates from our engineers that that could de-rate the refinery by 6,000 or 7,000 barrels per day. We believe that. You look at margins, I mean your big driver for profitability at Big Spring, given the margins that we got is maximize throughput. So that’s part of our optimization and the differentials got wide enough that we might take that approach. But given the margins we got out there and the throughput being such a big driver, I don’t think that’s really going to occur.

Paul Cheng - Barclays Capital

So I fully understand. Just trying to get a better idea that, I mean what is under the most extreme case that if you do see the economics to do that, you say it’s 6,000 to 7,000 barrel per day of reduction. And in terms of the light product yield, if you run 100% of WTI, I presume the 6 to 7 reduction it would be primarily a reduction in the asphalt, should that be a reasonable assumption say at least that 5 would be a reduction in asphalt than 1 or 2 will be in the other products?

Paul Eisman

Yes. The throughput reduction is really based on our inability to deal with the light ends and the crude tower today.

Paul Cheng - Barclays Capital

Right.

Paul Eisman

But in terms of the yield structure between WTI and WTS, it looks like us that most of that is a reduction in asphalt production and it seems like most of that lose the gasoline. And I don’t have the actual numbers in terms of the percentage, but their crude is probably a reduction in asphalt from 7% to 4% WTI versus WTS and most all that moving to gasoline.

Paul Cheng - Barclays Capital

And maybe a follow-up to Jeff’s question, I know it’s still early time, do you have a rough estimate what may be the CapEx requirement to the bottleneck on the light end so that you have the flexibility to go up to 100%?

Paul Eisman

We’ve got the engineers working hard on that, so they have not given me a number.

Paul Cheng - Barclays Capital

And when that you think you have a little bit better data to share?

Paul Eisman

Hopefully soon, but we are working hard. So, I don’t know when -- I can’t promise you a date on that, but that’s one of our top projects and we’re working that hard.

Paul Cheng - Barclays Capital

And I think in the past that there is always discussion saying that you can really get your crude unit up to about say 75,000 barrel per day and beyond that would be pretty expensive in terms of CapEx. Have you done any study in terms of, if you want to go beyond 75,000 barrel per day? How expense is this going to be?

Paul Eisman

We are also doing those studies and I don’t have numbers for that. It’s not just the crude unit; you look at reform, look at some other unit capacity.

Paul Cheng - Barclays Capital

Yeah. And I think that will be essentially that the all compression unit…

Paul Eisman

Yeah.

Paul Cheng - Barclays Capital

… everything need to be expand.

Paul Eisman

So as you can imagine, when you do these studies, you are pushing a little bit and see what your limits are then you figure out what cost you would get that through that limit then you push it to the next limit and so those -- these studies take a while and we are in the middle of doing those.

Paul Cheng - Barclays Capital

And final one, I mean, when I am looking at from the third to the fourth quarter, I thought the Gulf Coast margin actually improved somewhat better and what you see the corresponding improvement in your result, is there any somewhat one-off item that we should be aware that billing in your number or that is a pretty trim margin realization that we can use it as a base case?

Paul Eisman

Yeah. I think the big issue in terms of margin realization in the quarter was the discount for gasoline in the group versus the Gulf in the quarter. We -- I don’t think you saw that in the fourth quarter of last year but we had a significant discount group versus Gulf in the fourth quarter this year. And the way we do ours, we don’t breakout the margins for wholesale and so that all ends up shown up in our refining operating margins.

Paul Cheng - Barclays Capital

So you are saying that in the fourth quarter, you see the wholesale margin come down versus the year ago level?

Shai Even

Yeah.

Paul Cheng - Barclays Capital

That’s what you are referring to, Paul?

Paul Eisman

Yeah. That's correct.

Paul Cheng - Barclays Capital

Perfect. Okay. And can you tell us that so for in the first quarter, how is the wholesale margin then versus the fourth quarter, is it better or worse?

Paul Eisman

We have seen improvement in the Mid-Continent pricing versus the Gulf. I don’t think there has been a tremendously big issue in the first quarter.

Paul Cheng - Barclays Capital

Okay. Very good. Thank you.

Operator

(Operator Instructions) Our next question is from the line of Ed Westlake with Credit Suisse. Please go ahead.

Rakesh Advani - Credit Suisse

Hi. This is actually Rakesh Advani. Just to clarify the $57 million CapEx that you gave that excludes the $23 million growth opportunity CapEx, right?

Shai Even

Yeah. We are looking at right now at approximately $25 million for that project.

Rakesh Advani - Credit Suisse

Okay. But that's not included in the $57, right?

Shai Even

That's correct. Yeah. The $57, so we have a project the, as Paul discussed that it's going to generate approximately $20 million pay with the $25 million of total investment and we are looking at this project and other projects, we are looking for way that will not affect to implement these kind of projects without really affecting distributions to the full extent by actually looking for ways to make those payment over period of approximately five years. So that projects and for the future projects, as Paul discussed earlier, we are looking to make those arrangement through help with the parent company or third-party.

Rakesh Advani - Credit Suisse

Okay. And you guys have obviously highlighted the, try to do the different production increase, et cetera and unlocking 3,000 barrels a day a true throughput. But is there any projects being assessed on the logistics side, maybe try to improve gathering or try to build-up that kind of infrastructure.

Paul Eisman

We are looking at those that to this point we’ve been able to use third party to extract. We think most of the value of those, kind of, investments by letting third parties do that although we’re evaluating that. So that’s not been our highest priority to this point.

Rakesh Advani - Credit Suisse

Okay. Thank you.

Operator

Thank you. And our next question is from Mohit Bhardwaj. Please go ahead.

Mohit Bhardwaj - Citigroup

Yeah. Just a follow-up here Paul, just looking at strategic options, you’ve had little over a year running as a variable rate distribution MLP. Just wanted to hear your thoughts on the experiment or a good experience as a variable rate distribution MLP and also if you’re looking at strategic options just for the Big Spring Refinery in terms of additional acquisitions or letting somebody else take a look at Big Spring and see if they can find a better value out of it?

Paul Eisman

In terms of strategic options, I mean, we like everybody look at alternatives and options and evaluate those as they become available. But there’s really nothing of significance to report that we can talk about. I mean, I do think that having the MLP out there provide us some advantages and some opportunities. It’s a good tool. We could potentially drop other things down as a bad asset or into that structure if we chose to do so. We’re not even close to trying to do anything like that but certainly having the optionality to do something like that has been good.

We think it’s been good for the unitholders. This is a good way that we guarantee that the money we make in the business is distributed to the unitholders and we commit to do that. So at the end of the day, we think that that’s a good structure to deliver value to the owners of the company.

In terms of valuation, looking at refining, the value of the assets and MLP to see -- I think that whole analysis is still out there. And I think different people have different views about that. But we’ve been pleased with our first year in Alon Partners. We feel like that it provides the flexibility and optionality that we wouldn’t have if we capture the previous structure.

Mohit Bhardwaj - Citigroup

Thank you.

Shai Even

Just wanted to add going back to Paul, earlier question about unusual item in our margins, so for the fourth quarter we had about $0.85 of the effect of RIN cost included in our reported margins for Big Spring for the fourth quarter of $9.96 and that’s higher than, otherwise we would expect in an environment of the less than $0.30 per gallon for RIN.

Operator

Thank you. And I am showing no further questions, I’ll turn the call back to Paul Eisman for closing comments.

Paul Eisman

Thank you again for taking the time for sitting in on the call and your interest in the company. We look forward to talking to you next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes our conference. Thank you for your participation. You may now disconnect.

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