As in all of the recent transactions in the oil refining group, there deserves to be a little analysis as to why the refinery sale between Murphy Oil (NYSE:MUR) and Calumet Specialty Products (NASDAQ:CLMT) happened and what the pros and cons are to both parties. The transaction was announced on Monday but was foreshadowed in February when CLMT's management raised $500M in the marketplace by the issuance of $94M in stock and long term debt, a move which caused the analysts to turn negative on the stock.
[Click to enlarge]
1. Murphy Oil's Motivation
Murphy Oil's management has openly stated their desire to leave the refining business, and concentrate on their E and P activities, and this is just a step in the process. Like their bigger rivals Marathon Oil Corporation (NYSE:MRO) and ConocoPhillips (NYSE:COP) who have also recently announced the spinoff of their respective refining groups, they obviously see this as the ideal time to unload these assets, which were a net drain on the company during the 2009 and 2010 time frame when the refining margins were so bad.
MUR was trading yesterday at about 14 times earnings, which is already better than the typical 8 or 9 times earnings seen in the refining group, and management's motivation is to convince the marketplace to value the company more like Occidental Petroleum Corporation (NYSE:OXY) which is trading at 16 times earnings. Only about 10% of the company's first quarter income was due to their refining segment so if the stock starts to trade at OXY's multiple, their stockholders will be better off, and not have to deal with the potential downside of the refining segment at the bottom part of the cycle.
2. The Selling Price favors Calumet
My followers and I have been tracking the most recent refinery transactions and strictly on the basis of the cost of refining capacity, this transaction has been one of the most favorable so far this year, at least for CLMT:
With the transaction cost for just the refining assets of $215M (not including the $260M of inventory), CLMT is getting the capacity at just over $4000 per BPD capacity, which is lower than the MRO/MPC spinoff, much lower than the FTO/HFC merger, and at about half of the current market capitalization of Tesoro and Valero.
So, strictly on the basis of the numbers, CLMT appears to have received a friendly price, keeping in mind that there is an untold amount of money that may need to be spent to modernize/update/retrofit the Superior location to suit the needs of CLMT.
3. The Short Term Effect on CLMT
This transaction increases the capacity of CLMT by nearly 50% from 94K BPD to 139K BPD and follows another trend we noticed some time ago, which was consolidation in the refining business.
|1Q NOI (millions)||$ 46||$ 5||$ 51|
|Annualized||$ 184||$ 18||$ 202|
|Shares Outstanding (mm)||39||39|
|NOI/share||$ 4.72||$ 5.18|
|Stock Price Effect||10%|
The Superior refinery was about 15% of MUR's refining segment operating capacity and given a friendly assumption that it was roughly as efficient as the rest of their system, the plant should be able to contribute another $5M per quarter or $18M per year to the bottom line of CLMT, thus demonstrating the age old oil industry proverb: "bigger is better". The resulting 10% or so of increased income should result in an approximately 10% increase in the stock price, so there are still a couple of dollars to be made for the shareholders of CLMT depending on how the overall market is doing on a given day.
4. Strategic Fit
Here is the biggest question mark: About half of CLMT's business, and much more than half of their NOI has been in the area of process oils, additives, lubricants and specialty oils of one type or another that command a much higher margin than the normal fuel products. In fact, the company was not hesitant to shut down the fuel-making portion of their business when the market turned down in 2009. The plant in Superior WI was supplying mainly unleaded gas to SPUR stations in that part of the country, so there are two questions: Does it make sense for CLMT to increase their participation in the fuel business, thus putting them into competition with Exxon Mobil Corporation (XOM) and Chevron Corporation (CVX)? Secondly, do the economies of scale and/or purchasing economies that they will get by being 50% bigger actually help their efficiency and allow them to make more money in the long run for their stockholders?
The jury is still out on this question, there are a lot of what-ifs, and it will all come down to the refining margin for fuel, which we all know is the key driver of profits in this segment.
There will be plenty of time to follow the outcome of the transaction, keeping in mind that the world is chaotic and there are no guarantees on anything, but there are upsides for both parties in the transaction, at least as long as the refining margins stay at their current historically high levels.
Disclosure: I have been long CLMT since back in February and was rather annoyed that they diluted my stock by the issuance of the additional shares, and the subsequent downgrading of the stock by the analysts, but I feel a lot better about it today, since I also get a nice 8% dividend.