Holly Corp.'s Peer Advantage: Increased Production in Domestic Shale Oil

| About: HollyFrontier Corp. (HFC)

Holly Corp. (HOC) is an independent refiner in the United States that produces high value products such as gasoline, diesel and jet fuel. Holly is a pure play refiner, with 250000 bpd capacity. It operates three refineries. Its refineries are complex and able to provide multiple sources of crude supply. This company also has flexibility to change supply with demand. It provides service to the Rocky Mountains, MidContinent and Southwest. Holly has a balanced product mix and can provide specialty lubricants.

In recent years, Holly has reinvested over $500 million to increase growth and feedstock flexibility. It recently purchased a Tulsa refinery which blends well into current business. Holly has consistently led return on invested capital, and return on assets with respect to peers. Historically it has also had low debt and conservative management. Holly has a track record of profitability, and the flexibility to change with the market. It has stable cash flow from HEP through regular incentive distributions.

Holly's refineries have good locations and an average complexity over 12. These refineries are connected to Canadian and domestic crude trading hubs. Owns 100% of GP and 7.3 LP units of Holly Energy Partners (NYSE:HEP). Holly Energy Partners' pipeline easily integrates in its current system.

Holly Energy Partners has over 2500 miles of refined product and crude pipelines. It has 11 terminals and 8 loading rack facilities in 7 western and MidContinent states. Over 6 million barrels of refined product and crude oil storage. This company has 25% interest in Salt Lake Pipeline, a joint venture with Plains, delivering crude oil into Salt Lake Valley.

The Navajo refinery in Artesia New Mexico, with capacity of 100000 bpsd, which was expanded in 2009. It has the ability to process heavy and sour crude into high value light products. Distributes to high end markets in Arizona, New Mexico and West Texas. Navajo's complexity rating is 11.8. Annual capital expenditures on this facility is $10 million. Its product mix is 58% gasoline, 32% diesel, 3% fuel oil, 3% asphalt, 2% jet fuel, and 2% other. The Navajo refinery is seeing improvements in crude charge, refinery production, refinery utilization (82%), and gross margins from 2009 to the third quarter of 2010. Operating expenses were up $.20 per barrel. This refinery has a large percentage of sour crude and that has increased 1% over the past year.

The Woods Cross refinery is located in Utah. It has crude oil capacity of 31000 barrels per day. This locations processes regional sweet, lower cost black wax crude and Canadian sour crude. Distributes to markets in Utah, Idaho, Nevada, Wyoming, and eastern Washington. Its Nelson complexity rating is 12.5. The annual maintenance for this facility is $5 million in capital expenditures. This refinery produces 6% gasoline, diesel 28%, 5% fuel oil, 3% asphalt and 2% other. From the 2009 to the third quarter of 2010, this refinery has seen improvements in crude charge (BPD), refinery production (BPD), sales of refined products (BPD), and a 7% increase of refinery utilization. Refinery gross margins are over $8 better per barrel. This refinery still has the majority of the crude it converts as sweet, but other such as sour and black wax crude are up 1% of the product mix.

The Tulsa refinery was previously two facilities owned by Sunoco (NYSE:SUN) and Sinclair. These facilities will be interconnected, due to their proximity of 2 miles. It is estimated by Holly that these two facilities will be capable of 125000 BPD. The proposed interconnection should take place sometime this year. This has a Nelson rating of over 14. Full year capital expenditures on interconnecting and maintaining the facilities is estimated at $25 million. Product mix should be 44% gasoline, 39% diesel, 10% lubricants and 7% other. Once interconnected this facility should be mainly a sweet crude facility. By adding the facility gross margins have almost doubled.

Through three quarters last year, Holly looked to have been able to increase EBITDA to 2006 levels. Holly should be monitored as to its capacity. In 2008, its capacity was 111 bpsd, which is much lower than 2009's 256 pbsd. Navajo and Woods legacy refineries were producing 131 bpsd. The addition of the Tulsa Sunoco refinery added +85 bpsd, and the Sinclair refinery another +40 bpsd. Through the first nine months of 2010 gross margins improved from $7.21 to $9.10.

The first three months of 2010 have shown a gradual increase in gross margins for Holly. It is important to realize the Tulsa refinery will realize gross margin gains as the two locations are combined. Also, the Woods cross facility has seen very large gains. Holly Corp. has consistently outperformed Gulf Coast gasoline crack spreads. Although demand was only up slightly (.3%), the increased crack spreads from recessionary levels in 2008 has improved the refinery sector. Holly Corp. has also been an outperformer with respect to Gulf Coast crack spreads, and diesel demand was up 4% year over year from 2009 to 2010. Diesel cracks have rebounded from the lows of 2009, and seem to be outperforming gasoline.

Returns on invested capital from 2005-2009 show Holly has the highest ROIC among its peers.

Holly has a strong balance sheet and liquidity with conservative debt levels going forward. It has a cash balance of $272 million, a $400 million credit facility, $300 million of Holly senior unsecured notes.

Holly's growth has been good as of late, the improvement in margins and production is also optimistic. It has made significant investments and acquisitions. In 2008 it increased capacity by 111 bpd. Investments were also made in legacy refineries Woods and Navajo which increased capacity by 20 bpd. The Tulsa acquisitions increased capacity by 125 bpd. All together, refining capacity from 2008 to 2010 created 256 bpd. $500 million was used over this time to increase feedstock flexibility and growth. The synergies created in Tulsa were done at very low cost. This extra capacity could be at a perfect time as oil usage increases.

Holly's legacy refineries have had several modifications over the past couple of years. The improvements are:

Navajo Refinery

  • increased capacity 17% (total 100000 bpd
  • allows 100% sour crude processing
  • increased USLD production percentage
  • increased intermediates processing
  • provides access to Cushing crude oil hub and other cost advantaged crudes
  • can now shift up ti 40% if crude slate to lower priced heavy crudes

Woods Cross Refinery

  • capacity increase of 19%
  • increased capacity of lower cost black wax and Canadian crude from 20-50%
  • increased USLD production percentage
  • enhanced black wax and heavy crude receiving capabilities

Holly has also made a strategic addition through Tulsa refineries. When integrated they would produce 125000 bpd. This integration could take up to 18 months. Pipeline connection of the facilities will increase yield, optimize blending and reduce operating expenses. This integration creates synergies and savings of $125 million. Holly's estimates of all-in cost of BPD of capacity has this Tulsa refinery of $824 per bpd and all-cost per complexity $59 CBPD. When looking at the cost of refinery acquisitions over the past five years we see Tulsa's value. The average of $11325 and high of $18000 per barrel capacity and the average $1186 and high of $2000 show why the synergies of the two facilities were so important, and inexpensive when compared to industry averages.

Holly also has 75% interest (Sinclair 25%) in a 400 mile refined products pipeline from Salt Lake City to Las Vegas. Benefits from this pipeline as Las Vegas gasoline trades at a premium to Salt Lake. This lowers the impact of Salt Lake seasonal demand reduction. It also provides access to Rocky Mountain refiners. The upside is on completion HEP will have option to buy Holly's interest in the pipeline for 180 days after completion. The purchase price is estimated at $225 million plus 7% per annum carrying cost.

In summary Holly Corp looks good and has definite advantages over it competitors. It has refining assets in attractive markets. Holly has reinvested in legacy refineries for cost reductions and increased production. The Tulsa complex increased capacity at a very low cost. Although many of the names in this sector have run up quite a bit, it is possible they could have a ways to go. Buy on pullbacks.

Disclosure: I am long FTO. Information on publicly traded companies (FTO, TSO, VLO, SUN) was taken from public financial statements.

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