Western Refining's Management Present at Credit Suisse Energy Summit Conference (Transcript)

Feb.24.12 | About: Western Refining, (WNR)

Western Refining Inc. (NYSE:WNR)

Credit Suisse Energy Summit Conference Transcript

February 9, 2012 10:00 AM ET


Jeff Beyersdorfer – Senior Vice President, Treasurer

Mark Smith – President, Refining and Marketing


Edward Westlake – Credit Suisse

Edward Westlake – Credit Suisse

Okay. Well, thanks everyone for attending on a snowy third day at Vail. So, I’m surprised that a few people gone up skiing. We’re very happy to have Jeff Beyersdorfer from Western Refining; and Mark Smith, who heads up Refining and Marketing at the company.

Clearly, you have seen some of my research on a decade of free cash and some of the advantages that the U.S. refiners have over their global peers. And now that, Jeff, has done such a good job of pulling down debt at Western, it would be interesting to hear what the next steps are. Thanks very much.

Jeff Beyersdorfer

Okay. Thanks for attending this morning. I’m going to spend about 20 minutes talking about three different topics, three different areas. One, a quick overview of our asset base and with the asset divestiture of Yorktown, we are now fully concentrated in the Southwest, say for a small marketing business, wholesale marketing business on the East Coast. I want to give you a brief overview of our asset base.

The second thing I’d like to do is talk about the accomplishments we had in 2011, but more importantly how they set us up to do further things in 2012. And then the third thing is a little detail about our revised capital budget, we’ve increased it recently by about $30 million to $35 million. We’ve got a couple of projects that I’ll share with you to further increase EBITDA and earnings.

So the first slide is a quick overview of the asset base, as I said, we are concentrate in the Southwest, for those of you that don’t know, there is two refinery, one is El Paso, Texas, one in Gallup, New Mexico, about a 150,000 barrels a day of crude.

And we also have two businesses that basically serve as an outlet for the refine product. One is a wholesale business, that’s in the Southwest. And our wholesale business is a bit different than most others and that we sell all the way through to the end customer.

We've got the little landscaper in Tucson as a customer all the way up to the big mining companies and railroad companies in the Southwest. Whereas most of our competition sells their product at the rack, they don't necessarily have a -- on the pulse of end markets. So our wholesale business is a little bit different.

And the other outlet that we have are 210 retail stores throughout the Southwest, mostly concentrated in the Four Corners area, we’ve just added some retail sites about 60 retail sites over the last six to nine months and I’ll get into that in some of the later slides.

A little hard to see up here, but if you got a presentation in front of you, this is a map of the Southwest product distribution network. So these are all product pipelines in the Southwest. And we content that size and complexity of refiners no longer matters as much as it once did, but logistics and location matter more.

And if you look at the pipeline logistics, El Paso which sits right there, sits at this hub of this spoken hub system and all the product that goes west from El Paso into Tucson and Phoenix has to pass through El Paso, they comes from here, comes from here, comes from here, passes through EL Paso.

Why that’s important is there are unique gasoline specs particularly in Phoenix, they are done state by state gasoline specification. But as an example, Phoenix runs a different grade of gasoline in summer versus the winter, and for somebody that is geographically close to Phoenix can satisfy that demand more on a just in time basis than those refiners on Gulf Coast or even on the West Coast.

So logistics matter and how you get product in, sorry, product out or product in to market, crude into a market matters more now than complexity or size. This is shown in a graph again pretty hard to read up here, but it’s in the presentation that shows and this is all publically available, that shows a ranking of gross margin minus direct OpEx, so operating margin by refinery or by region of the various independent refiners. This isn’t the integrated just the independent. The yellow obviously is our, the grey are others.

But the common theme for those at the top are they sit on top of their crude sources. They are not complex refineries. They are simple refineries. They are small and they serve pretty unique areas. That’s what results in better gross margin we content these days versus the old paradigm of you got to be on the water, you got to be a big complex refinery in order to run a lot of different groups.

Quick summary of our third quarter results. I will remind you, we are going to report on February 28th, the Tuesday, where we’ll talk about fourth quarter results and we’ll give some more detail around our capital budget and some of our insights into the market and why this Brent-TI spread is widening back out again.

But it’s very fluctuating as you know. It changes day-to-day. What we say here today maybe completely different, what we are going to say on February 28th. But I will remind you that we are going to call that day where we’ll share our results in little bit more and insight into 2012.

Okay. Let step back for 2011, talk about what we did but more importantly how this sets us up for 2012. So in ’11, we did five major things. The first is we implemented our cracks spread hedging program, because of this wide WTI Brent phenomena that we saw in ’11.

And so we were pretty aggressive we think. We got a good 2012, ’13, ’14 program. The market fell back off as you know in the fourth quarter, so we didn’t find an opportunity to hedge as much, but with the market coming back around a little bit again, some of the, particular diesel cracks spreads up pretty attractive. So we still have some room to go on our hedging program. But, again, we’ve got a pretty aggressive hedging program to lock in unprecedented spreads going forward.

Second thing we did is added some retail on wholesale sites, primarily to further find the home for our product, for our refine product. And again, I got a couple of slides on this. I’ll get into this in a second.

Third thing we did at the very end of the year, we monetize Yorktown for $220 million at that East Coast asset and we are targeting that cash for reinvestment in business and some of the capital projects I’ll talk about or debt reduction.

And the final two things is the balance sheet. We are not fixed yet, we are not where we want to be yet, but we made pretty good progress on the balance sheet in terms of upsizing our revolver, lower interest rate, extending maturity and we also paid down some debt, floating rate notes, $275 million at the end of the year. But we are not where we want to be yet and I’ll show you a cap table in a couple of slides and talk to you about where we want to get to longer term.

So these are things we did in 2011, but here is some, it’s going to, we think set us up for 2012. So the first thing I talked about was the crack spread hedging.

Here is our book at the end of the year, at the end of December and the reported results. You can see for the fourth quarter because of the fall off in the margin environment, we actually have an unrealized gain of almost $300 million. So in our reported EBITDA for the fourth quarter that show here us report on February 28th. It’s going to include that $298 million as unrealized gain and then for the full year, it’s a $182 million.

As I said though, there is an opportunity to do some more hedging. We are not complete yet with our hedging program. We have some more to do in ’13 and ’14, and as the market presents itself, we’ll take an opportunity to do some additional hedging.

Here is another way to look at the hedging for gas and diesel cracks. The first I’ll say is, with our hedging we are using Gulf Coast products or Gulf Coast gasoline, Gulf Coast ultra low sulphur diesel. Those are the same products that are tied to our contracts that we are selling to our customers. To set another way we have very little bases risk between the paper market and the physical market.

The other thing is, you could see how we have still above market rates. The green going forward is the futures curve, this was at the end of January, it’s again moving around very rapidly. And the yellow line on out is our hedge book.

For 2012, if you look at the prior page and multiple the strike price times the hedge volume that we have implemented that’s going to cover about half of our 2012 budgeted fixed charges. So OpEx, SG&A, interest expense, CapEx, these hedges for 2012 already cover about half of that fixed charge, so we feel pretty good about where we are in 2012, and as I said, we are going to take an opportunity to do some more for ’13 and ’14.

Okay, turning the acquisitions that we did, the modest acquisitions for wholesale and retail. As you heard me say upfront, we think about these businesses perhaps a little bit differently than others. It’s mainly an outlet for our refine product.

So our wholesale business which year in year out generates around $25 million or so of operating income, as I said, all the way through the end customer. What we picked up in 2011, are about 10 cardlock locations, cardlock is a man-less gasoline or diesel dispenser typically found in an industrial area and it’s more an accounting function or accounting program for again that little landscaper in Tucson, he has card that will can buy, swipe it at our dispenser, get us gas or diesel, we send them a bill, he goes about his way, he doesn’t have to stop at the local Wawa or Quik Trip or anything else.

So we’ve added some of that. We are trying to modestly grow that business that cardlock business. But again, this wholesale business, as I said upfront is a little different. We saw all the way through to the end customer, so we’ve done a finger on a pulse of the end markets.

The other distribution network, you heard me talk about upfront is retail. And again, we think about retail differently. We think about it as an opportunity to place our barrels end markets. We got a home for our refine product every day.

So we picked up about 60 new sites mostly in Tucson and El Paso in 2011 and we are not actively looking to pick up more sites, but what we are finding is a couple of operators of these convenience stores who are up in age, more mature, beside they want to get out healthcare bill, all kinds of expenses coming on board, and we are going in and talking to them about taking over their operations and doing it through a lease structure.

So the predominant number of stores we purchase through an operating lease structure to limit the capital upfront and they still get an income stream, we are paying them income stream for rent, but we get the operations and get the EBITDA.

So we’ll continue employ that model going forward. Again, we are not actively looking to grow retail, but if somebody approaches us, we look at a lease structure and again, if it makes sense, we can find a home for our barrels will probably grow some additional retail sites.

The asset sale I mentioned at Yorktown, we are very happy to have that behind us. So we sold the terminal and the refinery to playing just we announced in late December, gross proceeds of about $220 million. We do have some tax leakage on the proceeds, tax leakage is going to be around the $20 million, $25 million range. And so we are going to use the net proceeds for reinvesting in our business or for debt reduction.

We still have a presence on the East Coast. We still have a wholesale business there. We had customers there when the refinery was running, since we shut it down, we kept intact that wholesale business and today we are running about 25 or 30,000 barrels a day in the Mid-Atlantic. We suspect at some point in time because we’ve got no other asset base on the East Coast that will most likely monetize that wholesale business and fully concentrate on the Southwest.

Okay, turning to the capital structure. This is pro forma for the two items I mentioned where I talked about 2011 initiatives. One is the repayment of the floating rate notes, $275 million, and the sale of Yorktown.

So pro forma for third quarter were at about 1.3 times debt-to-EBITDA and where we like to take the balance sheet is metrics associated with a BB credit, today we are B credit. The metrics associated with a BB credit are about 1 to 1.5 times EBITDA through mid-cycle conditions.

For us, mid-cycle conditions are $9 or $10 Gulf Coast 3 to 1, the results of about $350 million of EBITDA for this company. So we take 1.5 times $350 million resulted about $500 million of debt. You can see we’ve got about $800 million of debt. So we’ve got about $2 or $300 million more work to do on the balance sheet.

How do we get there? What do we do? We’ve got a couple of opportunities, one is the term loan, term loan is our only pre-payable debt on the balance sheet is actually $200 -- $325 million outstanding. It’s pre-payable at any time. It’s a 7.5%. We rather not pre-pay that because its lowest coupon debt on balance sheet, but because of some constraints I’m getting ready to tell about, we are probably going to ship away at that term loan as the year progresses.

What we rather take out are the 11.25 that are due in 2017 but aren’t callable until June of 2013 and the convertible notes that don’t mature until 2014. But unfortunately those are very expensive to take right now. We have to tender for the 11.25 or for the convert and again, even though the high yield market has come back and seems to be very robust right now, it’s still very expensive to tender for those coupon or for those two notes.

So it will give most likely, say, if we don’t refinance 11.25 and it converts ship away at the term loan this year. But over in the next 18 months or so, we strive to be a BB credit and to get down to that $500 million level in debt and we think that balance sheet will help manage us through good times and bad in the refining space.

Turning 2012 couple of initiatives that we announced earlier this year and I’ll talk about some CapEx. We got a new Board member former CFO of Conoco, Sig Cornelius, he joined us early this year, bring some good industry experience to the Board. We announced the modest dividend of $0.04 a quarter to about $14, $15 million a year, that will be paid out next week and we’ve got a CapEx budget of $162 million for 2012.

All refiners are facing pretty good outlook over the next couple of years in terms of regulatory capital including us. So the last five, six years refiners has spent ton money on regulatory capital. We’ve got window here where there is nothing on the horizon until 2016, 2017 in terms of regulatory capital.

So our regulatory capital is going to go down and our discretionary capital is going to go up, and you can see the chart on right shows that. Here are some of the projects that we are doing with the discretionary capital.

So everybody heard about the Permian Basin and the shale plays in Permian Basin. In our neck of words I’ll set the metrics here, here is El Paso refinery, over here, this is New Mexico, here is Texas obviously. This is Kinder Morgan crude that runs from Link, Texas to our refinery.

In this area is called two plays of Bone Spring and Avalon Shale. And there just being now productions being ramped up for those plays more liquids then gas and we are finding that crude to be a super suite crude, it’s better than the crude we are running today.

So we are building some infrastructure out here, hard to see, we are building a pipeline that runs into an area called Mason station and we are building a truck rack for about $15 million to facilitate the delivery of this crude into El Paso. So with that construction that will be later this year, done later this year, will be able to run up to about 20,000 barrels a day of this super suite crude at El Paso.

It’s got a better yield. It generates more gasoline and diesel from a barrel of oil from what we are running today. So the economics are not only is it cheaper than the WTI that we are running today, but it’s got a better yield. So the IRR is pretty attractive at around 60%.

Later this year and next year, we are going build an additional pipeline running east to west further into these fields at a cost of around $10 million, that’s part of the capital budget that will facilitate an additional or incremental 20,000 barrels a day. So we will be able to run about 40,000 barrels a day of this crude at El Paso, again, cheaper crude, better yield.

Ultimately we are also going to spend some money on expanding El Paso’s crude rate. So El Paso today is a 125,000 barrels a day. We are going to expand El Paso fairly modestly put it by about 25,000 barrels a day to bring it up to a 150,000 barrels. I don’t have a slide on this and we’ll give more details on our call and it’s a couple year project, but again very, very good returns for that project.

One other area we are spending discretionary capital is at Gallup, Gallup today is a 23,000 barrel day refinery. We are expanding it by 2000 barrels a day. The reason you say why 2000, why not more, it’s in an area where the market demand really isn’t growing all that much in the Four Corners area. We think if you expanded too much, we’ll swap the market with product but 2,000 barrels a day makes sense and we will be able to run again some of this new shale crude that’s happening in New Mexico and Utah through Gallup. So it cost about $6 million in IRRs a pretty compelling also.

So quick summary then, for 2012, number one, we’ve got this capital projects last couple of years, we’ve haven’t had much discretionary capital this been. We’ve got some projects on board, particularly in El Paso and it help drive margins, help drive EBITDA, drive EPS.

Number two, we are going to work on the balance sheet. You heard me talk about how much more we want to do? How we’ll get there, most likely. And we’re going to continue to maximize liquidity, we’ll for opportunity to continue to maximize liquidity and secure that BB credit.

Any questions. That’s it. Any questions.

Question-and-Answer Session

Edward Westlake – Credit Suisse

Great. Hey, Jeff. Thanks very much for that.

Jeff Beyersdorfer


Edward Westlake – Credit Suisse

It's nice to see someone walking around the room, getting some energy here, yeah. VP should have done that this morning. So just a quick question, so you’ve got some gathering assets and some logistics assets, I mean, obviously, MLPs were involve, you have spoke about that in the past, where are we on that process?

Jeff Beyersdorfer

Yeah. So, the MLP assets we have, we’ve got some pipelines, we’ve got some product terminals, asphalt terminals, some gathering systems all in the Southwest. There is a level that probably doesn’t warrant a standalone MLP, in terms of EBITDA generation and in terms of dropdown strategy. We have to pull all of our assets in there, no, nothing left for dropdown and probably don’t generate EBITDA to warrant standalone MLP.

Having said that, we are out exploring alternatives for how do we maximize these assets. There is an entity that’s trading at 2 or 3 times, where there could be an entity trading at 9 or 10 time, so we know there are some multiple arbitrage to be have there.

So we are talking to other companies that are kind of in our situation that have a modest asset base in our neck of the woods. Can we combine it two and take it public. Can we gather or talk to a financial sponsor, yeah, to maybe help us develop some of these additional projects that are going to come on and build out, and maybe that sponsor wants to help facilitate an MLP. We might consider selling those assets to an existing MLP and using the cash to pay down debt. So we are looking at all those different alternatives, Ed, for the logistics assets.

Edward Westlake – Credit Suisse

You’ve been quite clear in terms of the next step that’s El Paso, Gallup and some of this sort of quick hit high payback CapEx. But obviously longer term you still want to grow the company. So can you talk a little bit about the options to do that beyond these smaller projects?

Jeff Beyersdorfer

Yeah. So there are two platforms for growth. One is a logistics that I just talked about and then the things we are doing there. And the other is obviously the refining, the refining platform. We’d like to find assets once we fixed the balance sheet that have characteristics similar to El Paso and Gallup probably west of the Rockies, east doesn't make sense to us, Gulf Coast doesn’t make sense, sorry, west of the Mississippi, excuse me.

Edward Westlake – Credit Suisse

Before you going to California that’s a bit, that was…

Jeff Beyersdorfer

No. Sorry, west of the Mississippi. But at appropriate time, we will take a look at assets and see if they make sense. We don’t have to do anything. We like our asset base today. We think we are in great markets. We think we could generate a significant amount of cash flow perhaps return some of that cash to investors or redeploy in the business. So we don’t have to do anything. But yeah, if the company finds an opportunity to grow at pretty compelling valuations we might have to take a look at.

Edward Westlake – Credit Suisse

And you mentioned perhaps in that statement just before you took return of cash to shareholders. Clearly, one of the reasons in my mind why the refining stock trade as cheap as they do apart from economic uncertainty is perhaps the strategy around return cash to shareholder. Can you take us through your thoughts around that?

Jeff Beyersdorfer

Yeah. We introduced or reinstituted the dividend, again, it was fairly modest, so there might be some opportunity to overtime as cash flow warrants perhaps increasing that dividend. But all of our peer, most of our peer groups, most of our peer group pays a dividend, so we thought, it probably made sense to pay a dividend.

We have currently too many uses for free cash flow in terms of capital with compelling IRRs to do things like stock buybacks. So I don’t think a stock buyback might be in cards anytime soon, just because of the compelling projects that we have to do.

Remember we haven’t spend a lot of discretionary capital over the last couple of years because we come to some difficult times and all these really high return capital projects have come to the forefront that have kind of been have strong the last couple of year. We’ve got a lot of opportunities to go spend capital there. Any other questions.

Edward Westlake – Credit Suisse

I have one more.

Jeff Beyersdorfer


Edward Westlake – Credit Suisse

I can talk all day. Demand, what’s a like in your region, because the DOE stats have been pretty ugly? So any insights on what’s going on?

Jeff Beyersdorfer

Mark, you want to take the demand question?

Mark Smith

Okay. I guess, I would say that, demand refineries will pull out in the Southwest, we never really have a demand issues. I mean, we’re on our refineries at full rate and we have limited by, internal issues, mechanical players that sort of things. So while you read a lot in the press about where the demand is in Southwest we are able to move all the products.

And as Jeff had mentioned, we do have alternate channels relative to our competitors. We have our wholesale division, our retail division, interesting to note out of our Gallup refinery, 70% of the gasoline that we product since our retail station that we own. So we’ve got a pretty secure demand there. So we feel good about Southwest.

Jeff Beyersdorfer

Ed, I suspect a number of our other refining peers have stated that there is probably some distortion in the DOE gas numbers that have come out. We probably say the same thing. We are just not seeing that fall off in our markets that the DOE says its happening.

Edward Westlake – Credit Suisse

And final one for me, if you give, I was a refining engineer and if you give me, well, give refining engineers $1 billion they will come up with $2 billion worth of projects. So, I mean, you talked about small debottlenecking, but it’s there anything that you’re thinking about that could perhaps change yield structure in El Paso, which client high CapEx?

Jeff Beyersdorfer

Yeah. Well, this project we are spend a money on to increase the capacity by 25,000 barrels a day is leveraged to diesels. So it’s going to be about 70%, the increments is going to be 70% diesel, 30% gas and we can find the home for the diesel, no problem. So I don’t make it look more like a true 211 refinery than it does today. Yeah. Oh! Okay. Sorry.

Unidentified Analyst

There’s been a lot of chatter in the last week or two about differentials in Bakken and heavy Canadian crude really flowing out to WTI. Just curious what you’re seeing at your refineries, are you seeing differential, big differential to WTI, can you comment a little bit on that?

Jeff Beyersdorfer

Yeah. At our two refineries we don’t run any Canadian, Canadian can’t get down to our refineries. We’re running WTI, WTS. I think, Mark, the closest it can get is Artesia at Holly's Refinery, Canadian can get.

Mark Smith

(Inaudible) discount relative to Cushing, today it's trading at about $3, so we are seeing some impact but certainly nothing like the Bakken which was 20 of the odd, so.

Edward Westlake – Credit Suisse

Okay. I guess there are no other questions there.

Jeff Beyersdorfer

Okay. Good.

Edward Westlake – Credit Suisse

Thank you.

Jeff Beyersdorfer

Thank you very much for time. I appreciate it. Thanks.

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