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Calumet Specialty Products Partners, L.P (NASDAQ:CLMT)

Barclays High Yield Bond & Syndicated Loan Conference Call

May 13, 2014 6:25 PM ET

Executives

R. Patrick Murray, II – Senior Vice President and Chief Financial Officer

R. Patrick Murray, II

Good afternoon, my name is Pat Murray, I’m the Chief Financial Officer for Calumet, I appreciate your attendance today. I’d like to go through and many of your familiar with our story, I want to hit some highlights, Calumet has been very busy over the last few years really, but especially over the last few months there are lot of developments that we can review. And then certainly try to leave some time at end for some questions.

I’m just going through Calumet is a master limited partnership. We were formed in 2006. We’ve been public for several years. We had our debut senior notes offering in 2011 and have progressed and added several offerings since that time. We are fixed distribution, master limited partnership, it is contrasted with some variable distribution MLPs strictly on the fuels refining side of the business.

We separate our business into two segments; the fuel products side of the business and the specialty products side of the business. And we’ll talk throughout the presentation about the interplay between the two segments of the business.

In terms of competitive advantages for Calumet there are many. We are in vertically integrated producer and distributor of specialty products and fuel products. There is really no one out there that offers the breadth of specialty hydrocarbons that Calumet offers and we’ve seen over time that this offering of products has continued to expand as we enter into new markets and add customers.

We’ve about 6,000 specialty products and just about as many active accounts. So we are selling a lot of products to a lot of different people, there is very little concentration risk in our business. We also, in addition to specialty products, we have niche fuels refining and we do not endeavor to be a large scale fuels refiner in the coastal regions, we concentrated on well positioned niche refining assets, primarily in the Mid-Continent for which the scale is generally smaller. But we think we can add value over time through organic growth and combinations of products and we will cover that.

Very high barriers to entry in the specialty product side of the business, we will talk about – these are technical sales to customers that need our products in their formulation and it’s very expensive to reformulate us out of these products. So very high barriers to entry requires a lot of physical assets, but also these approvals, which can take multiple years to get.

Here is our footprint and this has been expanding over the last few years, Calumet when we at the point we were public. Really had a fairly small footprint but we’ve been very acquisitive over the last several years, primarily starting in 2011 where we bought the fuels refinery in Superior, Wisconsin from Murphy Oil. And since that time, we’ve been very busy, on expanding our footprint, adding to our diversity of assets and increasing our geographic footprint as well, which we think has continued to foster our growth and remains very important.

As I mentioned, we have the two segments of the business, specialty products which are for the fourth quarter represented almost 80% of our gross profit. On that percentage allocation can fluctuate, primarily based on where the cracks spread. But again, highly reliant on the specialty products business for the majority of our gross profit generally speaking. And then you can see the yellow dots indicate where we have fuels refineries. And one of the fuels refineries that we place on this map is a joint venture refinery. We are building the first Greenfield refinery in the United States, since the mid-1970’s we are joint venturing with MDU Resources to build a 20,000 barrel per day diesel refinery in southwestern North Dakota.

We have about 12.5 million barrels of storage across our refining system and facility system that gives us a lot of flexibility for distribution, as we look ahead distribution of various products, a lot of distribution of asphalt, which is important as we managed that part of our business and being able to sell that asphalt in the local retail bases as much as we can versus wholesale.

And then scattered throughout here our most recent acquisition Anchor Drilling Fluids. We bought that business at the end of the first quarter and you can see several locations here, primarily in all the major shale plays. And so that is a new part of our business, across the specialty products business, and we will talk a little bit about that acquisition as well.

I am quickly moving through our footprint as assets on the fuel side of the business, you can see here the identified facilities, the new joint venture refinery which will come on stream in the fourth quarter of this year at Dickinson, North Dakota 20,000 barrel a day diesel refinery. We purchased the Superior Refinery from Murphy Oil in 2011 and really had a lot of success with that refinery.

It’s a very well run refinery and creates a lot of benefits for us, we bought that refinery essentially at the right time at the right price, recouped a lot of value right off the bat with that acquisition. It actually allowed us to purchase our Great Falls, Montana Refinery, which is a 10,000 barrel per day fuels refinery for which we are expanding to 20,000 barrels per day that project will be completed by the first quarter of 2016. We were able to buy that refinery with cash, which we up to that point did not done on an acquisition.

Our largest refineries are Shreveport, Louisiana refinery, nameplate capacity is 60,000 barrels per day. That is the one refinery we own that actually makes both fuel, products and specialty products. Our largest refinery that was purchased in 2001 from Pennzoil-Quaker State. And then we purchased the San Antonio refinery from NuStar at the beginning of 2013. We’ve expanded the capacity of that refinery from 14,500 barrels per day up to 17,500 barrels per day. And you can see here we are running, we posted the feedstocks slates here, the production slates, but we like the location of these refineries there. They are all in major shale plays, access to local crudes which we think makes them very important and of course very relevant going into the future.

And a larger footprint on the specialty product side of the business, this covers several product lines, lots of facilities but what you will note on specialty products facility they tend to be smaller and in size. These are making very specialized products, doing a lot of custom blending for our customers.

We own facilities really all over the country, just kind of moving through quickly our Karns City facility in Pennsylvania is where we make white oils and petrolatums, so the Penreco brand of products is produced at this refinery. This refinery takes base oils and unfinished waxes and further processes them to make these high-end specialty products.

Farmingdale, New Jersey that was part of our recent Bel-Ray acquisition that makes primarily synthetic finished lubricants and also high performance greases of an international company that we purchased actually provides a nice export springboard for us to because of its international connections.

Again, at Shreveport we make paraffinic base oils, in that refinery in addition to the fuels. We also have a Calumet Packaging facility in Shreveport where we produce several specialty products, including the engineered fuel for TruFuel, which is the combination of fuel and lubricating oil that’s used in sort of one core applications and things like wheat tremors and blowers and the like for home use.

And then at Princeton, Louisiana we have a paraffinic lub oil refinery that was actually the legacy assets when the company was first formed back in 1990 by the two families which still own our General Partner. We also have the only on purpose full range solvents refinery in the U.S. that’s the Cotton Valley refinery. Royal Purple, the Royal Purple brand in that facility is located in Port of Texas, just south of Houston and we also have a facility close to Houston, Dickinson, Texas where that was also part of the Penreco acquisition where we make our white oils and also make natural petroleum sulfonates. And then we also have esters facility in Missouri. Esters are an important component, a blending component, synthetic lubricants, so you can see there is a lot interplay between these refineries and we’ll talk about that as well, about how important it is that all these assets work together.

This next slide is really meant to illustrate the myriad of applications for our specialty products, as I said before we are not really dependent on any one industry or product line. We enjoy the opportunity to sell products in many different applications and this doesn’t even cover the full spectrum but you can see our products are going into formulations for a lot of key industrial products, consumer products and our desire ultimately is to widen this as much as possible and service as many industries as possible. And of course then we produced the traditional motor fuels and asphalt. Even within those categories, we sell a lot of specialized asphalts on the fuel side we sell a lot of specialized fuels primarily to the U.S. government in terms of specialized jet fuels that are used by the Air Force.

How are we growing for our investors on both the equity side of the capital structure and also on the bond side? Primarily growing through acquisition, but also there is a key focus on organic investment of the company.

We’ve grown as I said fairly dramatically almost doubling in size over the last three years or so through acquisitions, accretive stable growth businesses with unique competitive advantages whether it’s a specialty products business which offers new product offerings, higher margins or if it’s niche fuels refining interesting assets in shale plays that give us feedstock advantages. Those are always the focus as we think about the business in terms of valuation we target about six to eight times multiple on specialty products businesses refining assets are two to four times. We don’t see any shortage of opportunities for future acquisition for the Company.

We’ve got as I mentioned about 6,000 specialty products customers many of which would serve as good acquisition targets for us. Our acquisition of Royal Purple in 2012, of Bel-Ray company in 2013. Those are just two examples of customers that we then acquired. So we are moving in this strategy of moving through vertical integration further down the chain, and acquiring customers, it’s an important part of the growth strategy.

So there is definitely a focus on both segments of the businesses as we think about growth. Most recently we’ve been more focused on specialty products acquisitions. We also like midstream type assets. We’ve been interested in making acquisitions with those types of assets. They have been pretty expensive. We’ve been focusing on the build-out of sort of organic midstream assets. We purchased some crude oil gathering assets from Murphy last year.

We’ve also focused on long-term pipeline agreement to service our San Antonio refinery which will be on-stream during second quarter. But we do remain focused on growing the business in that way as well. And then in terms of organic investment, one of the things we also focus on in the acquisition is what might we do differently with an acquired asset and we’ve entered the largest capital campaign for organic growth in the Company’s history. We have several projects in process right now.

The total ticket for all the projects is about $500 million to $550 million. We think this will represent a significant uplift ultimately in EBITDA contribution as we say here, we think that we can add $200 million of adjusted EBITDA from these investment, so these are high return projects, we’ll talk about them in specificity, here shortly but primarily capacity expansions, sourcing logistics improvements and really enhancing our optionality on distribution, and also the product offering, and we’ve got a record frankly of evaluating good synergies and finding ways to grow the business.

This graphic, the main takeaway from the graphic, I’m sure it’s kind of tough to read some of these, but basically this company has a lot of different assets and really they are all in a related in terms of these arrows really are indicating products flow whether it’s raw materials or finished goods. There is a lot of interplay between the various entities, product lines that we have, production from one refinery can be a feedstock to another refinery. We’ve got multiple source points of feedstock coming from refineries.

We’ve really operate this portfolio of assets as one unit, even though we’ve got the business separated into a couple of segments for reporting purposes. Fuels refinery supports specialty refineries and vice versa. Really the assets that we own we desire to keep based on their relative importance among and this is something that we always think about as we evaluate, and this more of a constant effort of finding other ways that the refineries and facilities can work together to either in that grows forward to the marketing organization to how come some of these acquisitions we’ve made mostly recently work together to overall on a gross sales on an overall basis.

The next slide shows, some of the key brands of products that we have one of the strategic areas that we are trying to focus on is branded products and we talked a lot about that on our conference calls, because it’s an interesting new part of the business.

We believe that growing branded products in the specialty product segments are very important key in growing the businesses, is a growth area for us. We’ve listed several brands here, some of which we’ve developed in house but the majority of which represent acquisitions that we’ve made.

The Royal Purple brand, Bel-Ray, Quantum those are all recent acquisitions and those are in the high performance specialty products primarily synthetic lubricants, greases. These businesses command profit margins that are higher than let’s say, base oils that we’ve might have originally sold.

So Royal Purple, gross profit margins approach 50%, Bel-Ray’s gross profit margins approach 35%. So these are very important to again increasing value moving closer to the customer selling more to customers that are going into retail applications, high performance.

Some of the other brands the Penreco brand I mentioned earlier we bought that in 2008 from ConocoPhillips and private equity that time was sort of our highest level of specialty product that’s little white oils and petrolatum. We also brought the Orchex brand from Exxon Mobil back in 2003 that again – Orchex is a specialized lubricating oil that is used mainly in pesticide applications for spraying on citrus trees and nut trees and things like that. But this indicates our relationships with the majors are important, we trade with them they serve as a larger supplier to us also competitor and also customer and that’s kind of how this business ends up working.

But it very important for us to maintain these relationships with companies like Exxon because we are often have ability to trade with them on product lines. And then the Anchor Drilling Fluids that’s our most acquisition again another specialty products company, it’s a leading provider of drilling fluids solutions, completion fluids to the E&P business. They’ve got a lot of sites. It’s a relationship driven business, they are growing the business very impressively over the last few years and so we look forward to the continued integration of that business.

We already selling into drilling fluids as part of our specialty products offering that gives us obviously a former footprint. As I mentioned we have what we are coining a well head to retail strategy and if you look at the graphic here in 2006 when we went public we were primarily a niche specialty products company. And over the last eight years, we’ve really transformed into a much larger company with not only in terms of sales but in terms of our touch on the industry in general.

We’ve dramatically increased the diversity of assets, the geographic footprint, the diversity of earnings and we’ve moved into a lot of new areas which we think combined make us a very unique play in both refining but also importantly in specialty products. And you can see here, you move around a lot of these are through organic growth or through acquisitions, finished lubricants, talked about fluid gathering, niche fuels refining, again expanding our scope and scale has been very important. And our goal of course, is to become the most integrated and one of the most successful independent specialty.

Hydrocarbon businesses in North America and with the most diversified and specialty product solutions and we really are executing on that strategy and you can see here moving all the way from the wellhead to retail applications, ultimately is the goal and we are executing on all those through either organic growth or through acquisitions.

What are the investment catalysts for Calumet and why do people focus on us? It’s not easiest story to understand, admirably there are a lot of pieces, there are a lot of moving parts, but we think that once people sort of focus on sort of the core investment attributes of the company they tend to like what they see, they like the diversity of the assets. They really like the specialty products business. On the equity side of the capital structure right now, people are attracted by the relatively high dividend of about 9%.

We had many consecutive quarters of cash distributions, our current distribution is at $2.74 per unit. We’ve seen increasingly a number of bond investors that could have the flexibility also focus on the equity. And as I mentioned, we think that the company is undergoing a period of step change in terms of its earning potential as we round out these capital projects. We believe that the company moves from – to a new level of earnings capacity, we think we’re going to add about $200 million of incremental EBITDA once the projects are completed.

From a risk mitigation standpoint, we have a very active hedging program that’s a very important part of our strategy in order to mitigate volatility of cash flows and that’s important for everyone in the capital structure and it’s important as we look ahead. And it’s a way we differentiate ourselves from – let’s say a variable distribution MLP that might not employ a hedging strategy. We know that on the commodity side of the business, we don’t have the types of pricing flexibility and sticky pricing that we would have on the specialty product side of the business where we are able to move pricing quickly to customers and – study even an commodity price is fall.

So far us it’s important to be hedged, we’ve got more than 50% of our current year production on the fuel side hedged. We don’t hedge on the specialty product side of the business because we feel like we are able to move product pricing quickly to customer. So we don’t see that as a risk that needs to be hedged. We have a strong balance sheet in terms of liquidity we are in the strongest position we’ve ever been in. At the end of the first quarter, we have more than $700 million in liquidity combined between cash on the balance sheet, and availability under our revolver and high level of management ownership not only in our units but in sort of vested interest in the day-to-day operations of the business.

As I said the two families are two original sponsors you joined together to form the company and take it public are still actively engaged in the business. They own 100% of the GP and 26% of the limited partner units and remain very active at the Chairman of the Board, at the CEO level and also at our President level. All those families remain very engaged in the business. It’s still run primarily as a family company. Even though, we’ve continued to grow two different – we’ll be named as a Fortune 500 this year. But it still feels like the same family business.

From a strategic standpoint, we do have a successful record of acquisition integration and earnings accretion in the projects, leading portfolio of inland refining assets again that serves us well especially on the fuel side of the business, access to cost against feedstocks, regardless of what ultimately happens as infrastructure is built, these assets especially in the north even when we may see some day when basically differentials are more about transportation differentials only, we’re still going to be very well positioned with these assets that we have in the north.

Then we have a balanced sales mix across stable to growing GDP type growth business in specialty products side, but upside provided by new products as we move and continue to grow this branded and packaged business. We see ability for the product mix to improve even further, move to even a new level of specialty products gross profit. And of course, we have fuel products which again we think provide a lot of uplift and stability through hedging.

Just moving through some of the recent developments to bring everyone up to speed on what's being going on recently at Calumet. We’ve reported record first quarter adjusted EBITDA of $82.7 million in the first quarter and that’s compared to $80 million at same quarter last year and sequentially, a big improvement over the fourth quarter. We had a significant amount of debt extinguishment costs in the first quarter related to our very successful bond offering that we just closed at the end of March.

2013 was a challenging year for us. We had a lot of turnaround at various of our major refineries, it did have an impact on our earnings. So as we look ahead, and we investors think about 2014 versus 2013, that's a very important distinction to understand in order to bridge expectations in 2014 compared to where we were in 2013.

We also had a significant improvement in our distributable cash flow which is a primary measure for our equity unitholders, but I mean it’s important for everyone to think about the ratio of what we’re earning that we can distribute relative to actual distribution levels. That number was also challenged in 2013, primarily driven by the turnaround activity, but as we look ahead, we think that we are getting closer and closer, our distribution coverage was close to one times in the first quarter. Our goal is to be at the 1.2 times to 1.5 times level on an ongoing basis. We think that's prudent for the partnership given the fact that we’re not generating all of our earnings from fee-based predictable pipeline revenues if business is more complex than that.

We’ve had a successful start as I mentioned improved distribution coverage ratio. We had a successful $900 million bond offering in March. That was our largest bond offering to date at our lowest coupon. I think we’ve made a lot of progress with the investor base on the note side. It’s our highly subscribed deal, upsized and gives us additional flexibility as we complete our capital expenditure program.

As I mentioned, improved liquidity position even from compared to the end of last year. We acquired Anchor Drilling Fluids. That business estimated 2013 results were over $30 million of adjusted EBITDA. So that’s another uplift in 2014 as we bring on nine months of those earnings into the Calumet situation for the full year. We made the acquisition of United Petroleum and other specialty products branded business.

Our San Antonio Refinery operated at record levels during the first quarter. We completed an expansion of that refinery in December of 2013. We’re also producing finished gasoline at that refinery. That was something that they could not do when we first acquired them. That refinery, we believe, will provide significant uplift in earnings in 2014.

We talked a lot about the Royal Purple expansion into Wal-Mart nationally. That’s an important step in our goal to increase the awareness of those brands. We’re selling 12 different products, I believe, into 2,400 different Wal-Mart locations and that will be very important as we think about brand awareness.

Royal Purple is a high-end brand, but brand recognition for those who choose to buy their own products and sort of the do-it-yourself first, very important for Wal-Mart customers who are expecting big things out of that relationship. And interestingly, our margin goals were preserved there. I think sometimes you will assume that if you’re selling to Wal-Mart, you’re selling at different type of margin compression, but that really is not our case. And we continue to make progress on our multi-year organic growth projects. Everything remains on schedule and on budget.

This just kind of highlights kind of where we were the last few quarters, and I think if you want think about looking at 2014 versus 2013, it’s important to think about as quarters roll off and new quarters are posted how this LTM number should get better given the lack of turnaround activity, the addition of the acquisitions and the earnings from those and improvements and things like San Antonio and operational reliability in general.

As you can see, we’re rolling off some quarters last year that we would certainly expect results for the reasons I just gave to be much better than in the third quarter and fourth quarter. So last year our adjusted EBITDA was in the $240 million range. The year before that it was closer to the $400 million. We like people to think about with the addition of the acquisitions, lack of turnaround activity and other performance enhancement that the $400 million is certainly not out of question and it’s certainly not relying on just wide crack spreads.

Specialty Products have a very high gross profit per barrel and this is illustrated on this graph as you can see, much higher than on the fuel side of the business. And we think with the addition of growth in branded and package that gross profit levels in excess of $40 per barrel are certainly – have been achieved and are sustainable. So this, again, gives a flavor. Sometimes people think about relative crack spreads and this is somewhat of an analog to a crack spread. Although I note that within the Specialty Products segment there are certainly products that sell much at higher spread than this, but all in average you can see we’re over $40 a barrel.

The growth projects that we’ve announced and that we are getting updates on each quarter are: our Montana refinery expansion, $400 million project. In the first quarter 2016 this is our largest uplift project, projected EBITDA between $130 million and $140 million. Dakota Prairie, our joint venture refinery. We think that will provide about $35 million to $45 million of uplift for us, sort of at our share of those proceeds, which is a 50/50 joint venture.

And then our Missouri esters plant expansion. It’s a smaller project, but, yes, you can see here at a $40 million cost with a return uplift of $10 million. It’s still a significant project and esters are going to be very important due to development of lubricating oils requirements, continue to increase in terms of quality. And this is, again, over 2013 to 2015 we’ve already spend about $100 million through the end of 2013 on the program, a significant uplift.

Just quickly touching on a few of the financial highlights. Obviously, leverage has ticked higher at the end of last year, based primarily on results and as we look ahead, you could see at 3/31, our leverage is about 5.5 times. That’s giving us some credit at least for the annual impact of the Anchor acquisition. But as we continue to roll quarters off and roll new quarters on we certainly would expect based on all the indicators and the things that I’ve mentioned that we make a lot of progress in leverage by the end of year and we’ll continue to keep everyone posted on that.

And I think importantly though during that period we’ve stilled maintained ample liquidity in the business. We’ve got more than $500 million available under the revolver as of the end of March. So the leverage, we would expect to make a lot of progress. Our goal is to leverage it to be below four times.

Capital structure, again, we continue to make progress with success of notes offering. As you can see here, no successful offering with the one we just completed, $900 million, 6.5%. You could see we had some nine handle notes. We actually pulled our 9.375% notes that was part of the use of $900 million in proceeds. So to take those out and that created more flexibility for the company and of course results in an annualized interest savings as well.

In terms of capital markets funding, mentioned the recent debt offering. We’ve also announced an ATM equity program, which is commonly employed by MLPs to fund growth projects and the like. That’s very efficient way to raise capital, can be raised over successive quarters. It’s opportunistic. It’s lot cheaper than an overnight market at offering. We have not executed any sales under that program. We just put in place at the end of the first quarter, but that will be something to keep your eye on as go through successive quarters. That’s an efficient way to raise capital and maintain leverage where it’s today. And we have a traditional ABL revolver, $850 million revolver, matures in 2016 and we’re assessing opportunities there because that market has improved as well.

Touched on the liquidity, as I said, certainly improved liquidity. It’s very important for us to continue to focus on that. We have more than enough liquidity in the business and that really – between that and the bond offering that we just did, we feel we have solved sort of our immediate funding needs on the CapEx program as well as cash from operations, which we expect to enjoy primarily as we think about 2015 forward.

Our hedge program, as I said it’s kind of a cornerstone of risk mitigation for us. We’ve got a lot of barrels hedged at very attractive prices. You can see here the average strikes on the gasoline $14.5 of barrels, diesel upper to mid 20’s and same on the jet fuel. This is a very representative schedule if you look at our history, we’ve always waiting into new positions on hedging, it’s very important to us. We have a collateral trust agreement in place, it gives a first clean on our fixed assets to this hedging counter parties and that allows them to be comfortable wetting of hedge, lots of volume, many years out and so we’ll continue to execute on that program as we go forward.

And then here is our CapEx historical and projected for this year, it’s a big CapEx here with the growth projects, I might highlight our turnaround spending from 2013 to 2014 is much diminished based on a very heavy turnaround schedule last year. We wouldn’t anticipate a lot of turnaround expenditures until 2018 in terms of the cycle program. And then same business CapEx is about $50 million to $60 million.

Okay, we’re about out of time but certainly would welcome any questions that you have. Okay, thank you very much, I appreciate your attendance.

Question-and-Answer Session

[No Q&A session for this event]

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