How Messed Up Is Calumet Specialty Products?

| About: Calumet Specialty (CLMT)


After market close on Friday, Calumet Specialty Products announced it was suspending its quarterly distribution. The MLP was paying a high 20% plus yield.

Calumet has serious cash flow problems which may not be solved by just suspending distribution payments. This is a company that needs serious restructuring.

It's curious how the CLMT unit value dropped by 25% in the two trading days before the announcement. Expect a 50% or more drop on Monday.

Like bad news out of a Federal agency, Calumet Specialty Products Partners (NASDAQ:CLMT) dropped a bomb at 5:30 PM Eastern time on Friday, April 15. The biggest piece of news is that the company has suspended the payment of distributions to limited partner unit holders. While a distribution cut should not be a big surprise, as I discussed in an article in February, the complete suspension will be hard on investors who own CLMT units. However, it appears the company waited too long to reduce the unsupported distribution rate, and now is in the scramble to cover interest payments and expenses mode, while trying to straighten some of Calumet's money losing business sectors. I expect the CLMT unit value to drop below $5 on Monday, and the question now is whether the company has a viable future for investors or will be forced into a reorganization.

Before I crunch a few numbers, here is a recap of the reasons why Calumet has landed in its current situations:

  • The company insisted on maintaining its status as a fixed distribution rate MLP, even though the fuels products production and sales half of the business generates highly variable profits, or even quarterly losses.
  • Management insisted in growing the distributions even though distributable cash flow was well short of the cash needed to pay distributions. In 2013, the quarterly distribution was increased twice, even though DCF for the year only covered 10% (0.10 times) the distributions paid.
  • $750 million of organic growth products over the last several years have been mostly a bust and have not generated the forecast $200 million plus of added annual EBITDA.
  • The first three quarters of 2015 were very profitable for crude oil refiners. The Calumet business plan looked like it was working with 1.33 times DCF coverage for those three quarters. Then refining margins collapsed in 2015 Q4 and 2016 Q1, resulting in close zero DCF for Q4 and a big loss for Q1.

New management under new CEO Tim Go took over February this year. He has a big job to turn around this foundering company.

Cash Flow Numbers

The press release that announced the distribution suspension also gave preliminary Q1 financial results. Adjusted EBITDA excluding special items (all the listed EBITDA and DCF numbers will be thusly double adjusted) is expected to be between a loss of $17 million and a positive $3 million. Let's use the midpoint of a $10 million EBITDA loss for the 2016 first quarter. The "I" in EBITDA is a real cash number, and Calumet has a quarterly interest expense bill of $25 million, so free cash flow for the quarter was negative $30 to $40 million. Paying the quarterly distribution would have required another $55 million of cash outflow.

For comparison, in the 2015 first quarter, the company reported adjusted EBITDA of $125 million, and distributable cash flow of $94 million. Assuming the specialty products profits remained relatively stable, the fuels and oil field services division's EBITDA declined by about $130 million for Q1 on a year-over-year basis.

For the 2015 fourth quarter, Calumet reported DCF of $4.0 million and paid the $55 million in distributions. So between Q4 and the soon to be announced Q1, the company has bled almost $100 million in negative real cash flow. That's a serious number for a company that reported $600 million in gross profit before any expenses for all of 2015.

Can Calumet Dig Out of Cash Flow Hole?

The company has three divisions. The core specialty products division has been the source of steady profits and the press release indicated that it remains so. The division generates about $50 million per quarter or $200 million per year in adjusted EBITDA. The fuel products division suffers from the basic economics of the refining business and is not very efficient compared to the companies that make refining their primary businesses. In the 2016 fourth quarter, the fuels division reported a negative $22 million of adjusted EBITDA. I don't think the oilfield services division has ever made money for Calumet, and in Q4 it lost $5 million as measured by adjusted EBITDA. With the adjusted EBITDA dropping from a positive $22 million in Q4 to a projected $10 million loss in Q1, it appears that the combined losses from fuels products and oilfield services doubled in the first quarter.

To save itself, Calumet is selling $400 million of 5-year senior secured notes at an 11.5% yield. The new debt increases the company's quarterly interest bill from $25 million up to $36 million. With all of the cash flow bleeding over the last two quarters, and also from earlier years when distributions were paid using debt rather than earned DCF, the company has reached a position where 75% of the EBITDA from its one stable business line -specialty products- must go to cover the quarterly interest bill. Cash flow available for distributions, or to pay down debt, will come from the other two divisions, which are not consistently profitable and have been losing a lot of money over the last two quarters. CEO Go faces a very difficult challenge to just keep Calumet out of a reorganization.

If history repeats, the second and third quarters should allow the fuels segment to return to some level of positive EBITDA generation. However, gross refining margins are not yet close to the levels that produced the big profits of the first half of 2015. Investors and the company cannot count on the summer driving season to generate big DCF numbers. I expect something like $10 to $30 million of DCF per quarter. Big changes need to be made at Calumet and in my February article I covered the new CEO's plan to improve results:

"CEO Go has launched his "Roadmap for Growth" to become a premium petroleum specialty products company and to grow revenues and cash flows. There are three parts to the roadmap. The first is to optimize and improve the efficiency of the current assets.

Second, the company will no longer be spending capital on expensive, long lead time growth projects. The company will now pace spending on a few conservative projects at a time that can be quickly completed and will generate capex paybacks in one to two years. Third, Acquisitions will be refocused on the niche, specialty product sector.

Finally, Go expressed a pretty strong willingness to sell assets when those assets have a higher value for a potential buyer compared to how they fit into the Calumet business model. This is a big change to the previous administration focus on adding a range of assets that did not fit with the core Calumet business."

After a disastrous Q1, time is short to put some of these plans into action.

Investment Outlook

Two months ago, I stated that Calumet should reduce the distribution to a level supported by the specialty products cash flow and pay special added distributions when the other divisions actually have cash flow positive quarters. Now the company is in a deeper hole, and Calumet must become more efficient to pay down debt and reach a point where the EBITDA minus interest stays above zero quarter in or quarter out. The company currently faces a "can it stay out of bankruptcy?" challenge rather than "can it pay distributions?"

As noted above, I expect the CLMT unit value to drop below $5 when the market opens on Monday. It will still not be a bargain. The potential of a reorganization that wipes out LP unit holders is too high. If you own CLMT sell at whatever price you can get (there may possibly be a dead cat bounce later in the week) and do not buy in on the expectations of a future recovery. I do hope the new CEO can save Calumet Specialty Products, but that is not a bet worth putting money on.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.