Alon USA Energy's (ALJ) CEO Paul Eisman on Q2 2016 Results - Earnings Call Transcript

| About: Alon USA (ALJ)

Alon USA Energy, Inc. (NYSE:ALJ)

Q2 2016 Earnings Conference Call

July 29, 2016 10:30 ET

Executives

Stacey Morris - Investor Relations Manager

Paul Eisman - President and Chief Executive Officer

Shai Even - Chief Financial Officer

Kyle McKeen - Vice President, Wholesale Marketing

Scott Rowe - Senior Vice President, Asphalt Marketing

Analysts

Paul Cheng - Barclays Bank

Chi Chow - Tudor, Pickering, Holt

Phil Gresh - JPMorgan

Johannes Van Der Tuin - Credit Suisse

Jeff Dietert - Simmons & Company

Operator

Greetings and welcome to Alon USA Energy Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Stacey Morris, Investor Relations Manager. Thank you. You may begin.

Stacey Morris

Thank you, Rob. Good morning, everyone and welcome to Alon USA Energy second quarter 2016 earnings conference call. With me are Paul Eisman, President and Chief Executive Officer; Shai Even, Chief Financial Officer, along with other members of our senior management team.

During the course of this call, we may make forward-looking statements based on our current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties and our actual results may differ materially. For a discussion of factors that could affect our future financial results and businesses, please refer to the disclosure and risk factors disclosed by the company from time-to-time in its filings with the SEC. Furthermore, please also refer to the statement regarding forward-looking statements incorporated in our news release issued yesterday and note that the contents of our conference call today are covered by these statements.

On this call, we will discuss non-GAAP financial measures. You can find the reconciliation of these non-GAAP financial measures to GAAP in our financial release, which is posted on our website. Finally, please be aware that all our statements are made as of today, July 29, 2016 based on information available to us as of today. And as except as required by law, we assume no obligation to update any such statements.

With that, I will turn the call over to Paul.

Paul Eisman

Thank you, Stacey and good morning everyone. Refining margins in the second quarter continued to be under pressure as a result of relatively high domestic product inventories and higher RINs prices. In addition to a challenging margin environment, our results in the quarter were also negatively impacted by operational issues at both Big Spring and Krotz Springs. As previously discussed in our press release dated June 3, a storm-related power failure at the Big Spring refinery resulted in damage to one of our flares, which led to an extended outage in our FCC and alkylation units.

Also in our first quarter call, we mentioned that the Krotz Springs FCC was shutdown on March 28 as a result of catalyst circulation issues. Repairs were completed and the unit was returned to service in mid-April. We are disappointed with our operations in the quarter and the impact that these outages had on our financial results. We are working hard and will return to the operating reliability levels that we expect to achieve. As a result of market conditions and these operating issues, we reported a net loss of $0.21 per share for the second quarter after excluding special items.

The power failure at Big Spring occurred on May 30 during a severe thunderstorm when both external electrical feeders supplying the refinery experienced power dips from the lightning strikes. Our operators were able to bring the refinery down safely, but upon inspection, we noted that our south side player would serve several process units, including the FCC and the alkylation unit failed during the event. This required extensive repairs and resulted in approximately 2 weeks of downtime for the affected units. As a result, our total throughput at the refinery averaged 71,200 barrels per day for the quarter.

Our estimate of the lost opportunity and increased cost resulting from the power failure and repairs is $10 million in the quarter. This includes approximately $1.2 million in repair costs and the remainder is composed of both lost throughput and lower gross margin. The refinery operating margin for the quarter was $8.53 per barrel, which was negatively impacted by approximately $1.30 per barrel due to the unplanned outage. Other than this event, the refinery ran relatively well during the quarter. As I mentioned, operating costs were impacted by the repair cost, but despite this we have reported fairly good direct operating expense of $3.59 on a per barrel basis for the quarter.

We saw improvements in our wholesale marketing business relative to our results in the first quarter versus the same quarter last year. Wholesale gallons were up 7.6%. This increase is mostly the result of our entry into the Southeast markets along the Colonial pipeline. In the second quarter, sales into our Southeast markets increased to approximately 5,300 barrels per day. This allows us to capture RINs offsetting some of the RINs obligation out of our Krotz Springs refinery. Sales volume into our Big Spring related markets increased by approximately 0.5% versus the same quarter last year.

Our retail marketing business performed decently given the increasingly difficult economic conditions impacting our Permian Basin stores, where we continue to see deteriorating sales. However, we were able to achieve an increase in fuel margin. As compared to the same quarter last year, fuel sales volume on a same-store basis was down 9.6% driven mostly by double-digit reduction in fuel sales in our Permian Basin stores. We have also seen declines in Lubbock and Abilene, two markets adjacent to the Permian. However, as we said last quarter, we more than offset this regional weakness with sales out of our newly acquired or constructed stores.

Total fuel volume sales were up a total of 3% relative to the same quarter last year. It is still too early to tell whether or not we have reached the bottom in these markets, but we are encouraged by increases, albeit small in the regional rig count. From the perspective of fuel margins, we did well averaging a fuel margin in the second quarter of $0.208 per gallon as compared to $0.203 per gallon in the same quarter last year.

We saw similar trends with respect to merchandise sales. Same-store merchandise sales were down 5% relative to the same quarter last year. This is composed of a 12% reduction in merchandise sales in our Permian Basin stores partially offset by a 2% increase in other stores. When adding the impact of the new stores, overall merchandise sales were down 1.4% versus the same quarter last year. Merchandise margin of 31% was lower than the same period last year when we reported 31.8% margin. Much of this was due to compressed margins for beer and cigarettes.

Retail marketing SG&A costs for the second quarter were just over $1 million higher than the same period last year. Much of this is due to higher cost resulting from the acquisition of the 14 stores in Albuquerque. Our Krotz Springs refinery averaged 62,300 barrels per day of total throughput in the second quarter. After resolution of the FCC catalyst circulation issues and the replacement of the naphtha hydrotreater catalyst in April, the refinery ran relatively well in the latter part of the quarter. Our estimate of the lost opportunity associated with these events during the quarter is $5 million.

Also during the quarter, we elected to take some economic run cuts during low margin periods in an attempt to improve product yield and margin capture. That effort is continuing. The Krotz Springs refinery operating margin for the quarter was $3.96. We estimate that the Krotz Springs refinery operating margin was negatively impacted by $0.86 per barrel due to the downtime in the quarter. Operating costs during the quarter were higher than we typically see at $4.10 per barrel primarily as a result of maintenance costs to repair the FCC and the lower throughput.

In California, we reported a small operating loss for the Alterra Renewable Fuels project driven by lower utilization primarily as a result of the 2-week outage during the quarter during which we made revisions designed to improve the reliability of the operation. Profitability was also impacted by higher prices for tallow and by lower renewable fuel deliveries to the Defense Logistics Agency during the quarter. Since the outage, the unit has been operating well. We are adjusting to higher tallow prices by testing other feedstocks and recently completed a successful test on soybean oil. Lastly, we expect purchases by the Defense Logistics Agency to return to prior levels during the third quarter. We remain optimistic about the profitability of and prospects for the operation and continue engineering work to better understand the capital required to expand the unit to 6,000 barrels per day from its current 2,500 barrels per day capacity.

We were very pleased and encouraged by the performance in our asphalt marketing segment. Asphalt sales in the second quarter were 43% higher than the same period last year with a very good gross margin of $107 per ton. I have often said that this is a fixed cost business. Our efforts to reduce operating costs have paid off and our total direct operating expenses in the second quarter of this year were actually 9% lower than they were in the same period last year in spite of the higher sales volume. On a per ton of sales basis, our direct operating expense in the second quarter was $36 per ton as compared to $56 per ton in the second quarter of 2015. We expect this performance to continue in the third quarter as demand remains very strong.

In the second quarter, our total SG&A costs were $2.5 million in the second quarter last year primarily due to the previously mentioned retail marketing SG&A cost and also due to employee retention cost. Depreciation and amortization costs were $5.7 million higher due primarily to amortization of the Krotz Springs turnaround that’s completed in the fourth quarter of 2015.

The total cost of meeting our RINs obligation in the second quarter was $9.1 million, including $2.1 million for the Big Spring refinery. Our current projection for RINs cost for the year is $10 million at Big Spring and $33 million at Krotz Springs based on RINs pricing as of June 30. While we do have the capability to offset much of our obligation at Big Spring, that is not the case at Krotz Springs. Except for feedstock purchase costs, this is our largest single cost item at the refinery. We agree with those that argue that this is a broken program and one that needs to be fixed. In the interim, we are considering making an application to the EPA for an exemption based on the impact the program has at Krotz Springs.

Looking forward to the third quarter, crack spreads are similar to what we experienced in the second quarter. We will take the Big Spring reformer down for a catalyst regeneration during the third quarter and will operate at reduced rates for 12 days as a result. Other than that, we expect to operate at capacity in average 69,000 barrels per day at total throughput during the third quarter and 70,000 barrels per day for the entire year. Based on the forward curve and the anticipated cost of RINs, we would expect to continue to take economic run cuts at our Krotz Springs refinery and work to improve margin capture. The forward curve for much of the remainder of the year is currently very low. However, margins have been and will continue to be volatile as they react to events and market conditions. We will be responsive to market conditions, but this is difficult to anticipate. Our current expectation of total throughput during the third quarter will be an average of 63,000 barrels per day and 66,000 barrels per day for the year.

Given the relatively weak markets that we have seen so far this year, we are continuing to trend back on capital expenditures. As part of these efforts, our Board has requested that we slowdown in capital expenditures relating to the Krotz Springs alkylation unit. We are not yet ready to announce the new start-up date, but do expect to eventually make this investment. With this delay, our new expectation 2016 capital spending is in the $60 million range. Finally, as noted in our earnings release, our Board has declared the regular quarterly cash dividend of $0.15 per share. Each quarter, our Board evaluates our dividend in the context of our financial position and also in comparison to the shareholder return provided by our peers. The Board’s decision to maintain the dividend reflects our comfort with our financial position and the liquidity available to us.

With that, we are glad to take your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting question-and-answer session. [Operator Instructions] Our first question comes from Paul Cheng with Barclays Bank. Please proceed with your question.

Paul Cheng

Paul, good morning.

Paul Eisman

Hi Paul.

Paul Cheng

On the Krotz Spring wind you touched the ones, does it in any shape or form that impact product yield or so?

Paul Eisman

Yes. I mean that’s what I was talking about when I was talking about trying to improve margin capture. As you run at full rates, typically you can’t do certain things in the refinery that you would like to do to maximize yields, to optimize yields and to increase the value of products. We think there are opportunities to do all three of those when we are running at reduced rates.

Paul Cheng

Okay. Can you tell us that in this particular case that how your yield may look like in the third quarter comparing to the second quarter?

Paul Eisman

It’s too early to tell you that. I just think we will have to see how it runs. But we are working hard and looking for opportunities to improve the yields and margin capture.

Paul Cheng

Alright. And with the [indiscernible] move up this year, you indicated in your prepared remarks, anyway still going to go forward with the alkylation construction, but does it really necessary from this standpoint?

Paul Eisman

Well, I mean we have seen – we look at the economics of the project. And typically, I think what we said is in our remarks earlier that we expect that to generate $45 million of EBITDA based on a mid-cycle sort of numbers and octane value. That obviously varies, it varies – sometimes, it’s higher than that. Sometimes, it’s lower than that. Right now, we see octane values being a little bit lower. And we – I would tell you that I think that number today is maybe $35 million, but that’s still a good project. And so I do expect to eventually complete that project.

Paul Cheng

With RIN cost for this year in Krotz Springs about $33 million, historically you don’t really have the capability to export from Krotz Springs, does it make sense to make some investment so that you will be able to export, so that you will be able to in some way to take the destiny on your own hand relying on EPA?

Paul Eisman

Yes. Paul, that’s a good question. I mean we are looking at all kinds of alternatives to generate RINs out of the refinery or to avoid the obligation. Export is one possibility. We did invest in some space in Colonial and we are kind of learning from that at this point. We – I think everybody in the industry is looking to find ways to deal with these high RINs costs. And we are no different than that.

Paul Cheng

With that, let me just ask slightly differently, in Krotz Spring, you need to invest – you have to decide on what the investment is so that you can export to overseas, what type of investment we may be talking about and how quickly can you get there?

Paul Eisman

I don’t know that I have any specific numbers related to how much it would cost us or how quickly we could do that, Paul.

Paul Cheng

Alright, okay. Thank you.

Paul Eisman

Thank you.

Operator

Our next question is from Chi Chow with Tudor, Pickering, Holt. Please proceed with your question.

Chi Chow

Hey. Thanks. Good morning.

Paul Eisman

Hi Chi.

Chi Chow

Hi, Paul. So, I guess on AltAir, I know you made some comments in your prepared remarks, you have a couple of slides in your recent deck in there, but can you just kind of give us an overview on what’s going on, what’s the business there, it’s hard to get any visibility on the P&L, given that is consolidated, so any comments on the nature of the business, the revenue, operating costs and forward strategy will be helpful?

Paul Eisman

Well, I understand – we have been to several assert discussions with several people. We understand it’s a little bit difficult to model. We – and I will just talk qualitatively here. Obviously, we are buying these agricultural products, either tallow or soybean oil so that there is one set of pricing. And then the product pricing is tied to really West Coast distillate values. And then important to the project, we generated three kinds of environmental credits. We get the federal blenders tax credit, the dollar a gallon. We get LCFS credits. And we also generate RINs. And Shai in terms of additional visibility into how to do this...

Shai Even

Other than stating that we already stated before that you mentioned the 2,500 barrels a day is the capacity. I don’t know that we really can say much more than this at this point.

Chi Chow

Okay. I know you started operations in February, is that correct?

Paul Eisman

Right, that’s correct.

Chi Chow

Can you – just for 1Q and 2Q, can you give us again the kind of P&L impact first couple of quarters here?

Shai Even

We have approximately $7.5 million of operating income, which most of that is associated with the first quarter.

Chi Chow

Okay.

Shai Even

So the second quarter was negatively impacted by – as Paul mentioned earlier by the downtime to do some work around the unit and also by increase in tallow prices during the second quarter and as Paul also mentioned earlier, by lower sales of diesel to the government.

Paul Eisman

We – as you said, the units started up in February. We are still on the process of working out the bugs. And so we took this outage. We did some work around a couple of compressors that we have been getting these problems around the reactor and trying to get more hydrogen in the unit. And so far, it looks like those revisions had positively probably impacted the operation. But this is a new unit and you expect to have some bugs. We are working through those.

Chi Chow

Right. Okay, thanks. And then on retail, could you – I think I might have missed it, but could you give us the same-store fuel sales again in Q2? And any view on how things have trended here in July so far?

Paul Eisman

Yes, it was down, same-store fuel sales were down 9.6%, if I remember the numbers and – but overall, after adding the new stores, it was up 3%. It’s really all about the Permian. And I mentioned in my comments that relative to the first quarter, we saw continued deterioration in the second quarter. I don’t know if we have seen the bottom at this point, but they are starting to increase rigs. I know that’s somewhat in doubt with the reduction in crude prices that we have seen over the last week or so, but it appears it’s at least trending towards stabilization. And I will ask Kyle if he has additional comments.

Kyle McKeen

Yes. I mean, I think that again as Paul outlined, we are not calling the bottom, but we are cautiously optimistic in what we are seeing today out in the Permian.

Chi Chow

Okay, great. Any view so far in 3Q on how that’s trending?

Kyle McKeen

It’s pretty early in the quarter to tell. But again, I mean, we had a good July 4 and we are optimistic that we will continue to see some improvement in the Permian going forward.

Chi Chow

Okay, great. Thanks, guys. Appreciate it.

Paul Eisman

Yes, thank you, Chi.

Operator

Our next question comes from Phil Gresh with JPMorgan. Please proceed with your question.

Phil Gresh

Yes, good morning. Couple of quick questions. First one is on the throughput guidance at Krotz Springs. If I have my numbers right, it looks like it’s 63 in the third quarter and 66 for the year, so implying that you would be ramping back up maybe to the high 60s in the fourth quarter. Are you assuming the macro environment will get better or is there something maybe company specific there?

Paul Eisman

It’s just hard to tell. We are planning – you look at the forward curve and the forward curve doesn’t look particularly good. I would tell you that the forward curve is not necessarily good reflection of where we will actually be. I mean, we don’t know that it’s a good reflection. You have a lot of liquidity in the market on the crude side, but very little liquidity on the product side. So, we will just have to see what happens. So, we pick the number and then we optimize around that. But as I said in my comments, we will be responsive to the crack spreads that we actually see. We have got planned 30 days out, 30 to 45 days out. And as we get closer, I think there is more credibility around the crack spread numbers and that’s how we will plan our business. And if it’s worse, then it maybe lower than that. If it’s better, it may be higher than that. We just basically picked the number at this point.

Phil Gresh

Okay. On the CapEx, the $60 million guide for the year, I assume that, that is excluding the turnaround capital spending – catalyst capital spending, is that accurate? Is it that might be like another $30 million as well?

Shai Even

The $60 million that Paul mentioned, that includes capital expenditures and turnaround and chemical catalysts. So, it’s all in.

Phil Gresh

Okay. Because it looks like the first half was $60 million already.

Shai Even

The $60 million, that’s what we mentioned, I think that’s on during the first quarter call. $60 million is the budget for the entire year. The spend this year already includes in the number about $20 million of capital expenditure that are associated with the turnaround of costs we have incurred in fourth quarter of 2015, which as the cash was paid during the first quarter of 2016.

Phil Gresh

Okay, got it. And then is the $60 million guide, is that basically your sustaining capital spend and would you be able to continue that into 2017?

Shai Even

I think that it’s too early to tell about our plan for 2017. We are just now working the plan for 2017, but the $60 million is basically, most of that is sustaining regulatory. We don’t have much of the growth. So, the expectation is that will be a benchmark for us for next year, but we don’t have yet the plan for next year.

Phil Gresh

Okay, it’s alright. Thanks. And then my last question would be you mentioned a comment about potentially asking the EPA for an exemption for RINs at Krotz Springs, how would that work? I am not familiar with that process.

Paul Eisman

The statute provides for the ability for small refiners that are disproportionately impacted to apply for exemptions. And it’s our feeling that the Krotz Springs meets that criteria and could potentially be awarded in exemption. We received one in...

Shai Even

2013, we received an exemption for the Krotz Springs refinery.

Phil Gresh

Okay, got it. Thanks a lot.

Paul Eisman

Thank you.

Operator

Our next question comes from Ed Westlake with Credit Suisse. Please proceed with your question.

Johannes Van Der Tuin

Hi, it’s Johannes here again. Thanks for taking my call. So, very quickly, on AltAir, you had mentioned that it generates RINs, do you have a dollar value for the amount of RINs generated in the second quarter?

Shai Even

No, we don’t have total value generated, but we do generate default through the AltAir operations.

Johannes Van Der Tuin

Okay. Is the number that you are presenting in terms of the estimated RINs cost at Krotz Springs or for ALJ as a whole net for the AltAir, it’s not?

Shai Even

The $30 million – the number that we have presented there for the quarter of combined $10 million for Big Spring, Krotz Springs that’s just based on the obligation generated to the Big Spring operations and Krotz Springs operations offset by RINs generated through the operation of the two refineries, but exclude the AltAir. The RINs that we generated in AltAir is excluded from this number.

Johannes Van Der Tuin

Okay. And then going to the asphalt market, which I had kind of asked about over on the ALDW call, what are you seeing in the asphalt markets? Clearly, volumes are up quite strongly and in fact better than our expectations. But in terms of margins and pricing, is there any dynamic you are seeing there? What’s the effective oil price fluctuations, etcetera?

Paul Eisman

Yes, I want to ask Scott Rowe who runs that business to answer that question.

Scott Rowe

We are continuing to see very strong market in the third quarter. Margins have held. There is a lot of work out there and just struggling to keep up has been a key strategy for this year.

Johannes Van Der Tuin

Do you get the sense that there is going to be a backlog of work that won’t be finished this paving season it’s going to go into the next year?

Scott Rowe

We are seeing significant increases in private markets. Texas business obviously very strong and I think we will have a more significant backlog going into 2017 than we have had in previous years.

Johannes Van Der Tuin

Okay, great. Thank you very much.

Paul Eisman

Thank you.

Operator

Our next question comes from Jeff Dietert with Simmons & Company. Please proceed with your question.

Jeff Dietert

Good morning.

Paul Eisman

Hi, Jeff.

Jeff Dietert

I was hoping to follow-up on Paul’s question on runs and I know you guys run a detailed LP model that with margins down would disincentivize aggressive runs, but could you talk a little bit about – are there – do you use discretion to further reduce runs? Are you pretty much running through what the LP would suggest you should?

Paul Eisman

Well, I mean, we do use LPs and we think they are relatively accurate. We work hard on those LPs to determine how we are going to run at both refineries. The uncertainty is more about pricing more than it is yields or sort of the technical side of the business. And what I was trying to convey earlier in the discussion is that we picked a set of numbers that may not reflect what the current forward curve is, but thinking what could happen and that’s what set the numbers that I reflected in the earlier comments. I also mentioned I will reiterate that we are working hard to see what we can do at lower rates to improve margin capture. And we will after assuming we are successful in that, we will have to make sure that data is added to our LP models. So, we have got a number of ideas associated with that. Obviously, as you run lower rates, you have got more flexibility in towers. You have got more flexibility and you are not selling that marginal barrel. So, we will see – you are not generating the marginal RIN as well. So, there is a lot of reasons, I think that we are hopeful that we can improve margin capture, but we used a set of pricing and we found our models to be typically pretty accurate. And I also said in my prepared remarks that well, we don’t know what our margins are going to be, but we will be responsive to those margins and that’s the big unknown at this point.

Jeff Dietert

And your thoughts influenced by your variable cash operating cost versus your fixed cash operating cost and you mentioned you are factoring in RINs cost as well kind of all incorporating these things into your run decisions?

Paul Eisman

That’s exactly right.

Jeff Dietert

Got it. And secondly, could you talk about your sales into the Arizona and New Mexico market during the quarter? I think we have seen things prices go back up above L.A. prices. Just maybe talk about that in 2Q and your thoughts early in 3Q?

Kyle McKeen

Yes, this is Kyle. We moved about 5,000 barrels per day into the Phoenix market and about 1,600 barrels per day into the Tucson market during the quarter. It’s been a good market. It’s under a little bit of pressure right now with California pricing and that’s been reflected as of late, but it’s been a very good market for us.

Jeff Dietert

Thanks for your comments.

Paul Eisman

Thank you.

Operator

There are no further questions at this time. At this point, I would like to turn the call back to management for any closing comments.

Paul Eisman

Okay. Thanks to everybody for your time and we will talk to you next quarter. Thank you.

Operator

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.

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