Delek Logistics Partners, LP (NYSE:DKL)
Q2 2016 Earnings Conference Call
August 4, 2016 8:30 am ET
Keith Johnson - IR
Uzi Yemin - Chairman, CEO
Assi Ginzburg - CFO
Danny Norris - CAO
Mark Smith - EVP
Brian Gamble - Simmons
Lin Chen - Silver Point
Good morning. My name is Keith and I'll be your conference operator today. At this time, I would like to welcome everyone to the Delek Logistics Partners Q2 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you.
I would now turn the call over to Keith Johnson, Investor Relations. Please go ahead, sir.
Thank you, Keith. Good morning. I would like to thank everyone for joining us on this webcast to discuss Delek Logistics Partners' second quarter 2016 financial results. Joining me on today's call will be Uzi Yemin, our General Partners Chairman and CEO; Assi Ginzburg, CFO; Danny Norris, CAO and other members of our management team.
As a reminder, this call may contain forward-looking statements as that term is defined under Federal securities laws. For this purposes, any statements made during this call that are not statements of historical facts may be deemed to be forward-looking statements. Without limiting the foregoing, the words believe, anticipate, plans, expects, and similar expressions are intended to identify forward-looking statements.
You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations and results may differ materially from the results discussed in the forward-looking statements. We undertake no obligations to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise.
On today's call, Assi will begin with a few financial comments and Danny will review our financial performance. Then Uzi will offer a few closing strategic remarks.
With that, I'll turn the call over to Assi.
Thank you, Keith.
Our DCF was approximately $23.7 million in the second quarter of 2016, which is a 13% increase from $20.9 million in the second quarter of 2015. EBITDA includes the $27.1 million for the second quarter of 2016 compared between $25.7 million in the prior year period. The DCF coverage was 1.3x for the second quarter 2016, which is an improvement from 1Q 2016 of 1.2x.
Based on our performance, we're pleased to announce an increase in our quarterly distribution to $0.63 per limited partner units for the quarter ended June 30, 2016. This distribution is payable on August 12, 2016 and is a 3.3% increase from our first quarter 2016 distribution per unit. This is our 14th consecutive increase and is a 14.5% higher than our second quarter 2015 distribution of $0.55 per limited partner unit.
During the second quarter of 2016, DKL continued to maintain a flexible financial position with $330 million of available capacity on our $700 million credit facility and a leverage ratio of 3.5x, which is well within the 4.75x currently allowable under our current facility.
Now, I will turn the call over to Danny to discuss the financial results.
Thank you, Assi.
For the second quarter of 2016, Delek Logistics reported net income attributable to all partners of $18.9 million or $0.66 per diluted common limited partner unit, compared to net income attributable to all partners of $18.3 million or $0.70 per diluted common limited partner unit in the prior year period. Our contribution margin increased to $30 million from $28.8 million in the second quarter of last year. This increase on a year-over-year basis is due to a combination of lower operating and G&A expenses, combined with better results in wholesale marketing and terminaling.
Second quarter 2016 contribution margin in our pipelines and transportation segment was $20.3 million, compared to $20.9 million in the second quarter of 2015. This change was primarily attributable to a decline in volumes in the SALA gathering system, fees associated with other pipelines and lower performance in our trucking operations. Those factors were partially offset by higher crude oil volume in the Lion Pipeline system and lower segment operating expenses.
I want to provide an update on the Paline Pipeline hydro test. As we discussed in our last earnings call, this test is required by PHMSA, the Pipeline and Hazardous Material Safety Administration, every five years. We began the hydro test in July and it's on schedule to be completed at the end of August. We recently filed a FERC tariff for volumes moving from Longview to Nederland and we continue to evaluate options for this pipeline in the future based on market conditions.
Contribution margin in our wholesale, marketing and terminaling segment was $9.7 million in the second quarter of this year, compared to $8 million in the prior year period. On a year-over-year basis, results benefited from improved gross margin performance in West Texas, and higher terminaling and East Texas marketing agreement volumes.
Our West Texas wholesale gross margin was $2.13 per barrel in the second quarter of this year compared to $1.31 per barrel in the second quarter of last year. Throughput in West Texas during the second quarter of 2016 was 12,600-barrels per day compared to 17,490-barrels per day in the prior year period. An outage in a third party pipeline in late May and early June that serves the West Texas market from the Gulf Coast had a positive effect on gross margin per barrel, but played a role in lowering volume on a year-over-year basis.
Looking forward, we expect that gross margin per barrel should be in a range of $1.25 to $2 during the remainder of 2016, but will vary based on product supply and demand changes in the region through the year.
Capital expenditures were approximately $800,000 in the second quarter of 2016. For 2016, our total capital expenditures forecast remains $14.3 million, which includes $3.5 million of discretionary and $10.8 million of maintenance. We have invested approximately $74.2 million as of June 30 in our joint venture pipeline projects and the estimated total investment for the RIO and Caddo Pipelines is expected to be approximately $99 million.
With that, I will turn the call over to Uzi for his closing comments.
Thank you, Danny.
Our production has improved on a year-over-year basis, in which the second highest DCF on record during a challenging environment in the energy market. Our team has been focused on cost controls and reliability to our system and this was a factor in the expenses reduction year-over-year. We're nearing completion of our RIO joint venture crude oil Pipeline project in West Texas with operation expected to begin later this month. We should begin to benefit in the second half for this project as pipeline utilization ramps up in September. Our second joint venture project, the Caddo pipeline is expected to be completed and operational by January 2017.
We continue to maintain financial flexibility at DKL and our financial position should support our growth initiatives, which include our joint venture pipeline project investment, partnering with our sponsor on potential asset dropdown, and evaluating third party acquisitions. We believe that this growth initiative and financial position should continue to support our target to increase the annual distribution per limited partner unit by 15% for the remaining of the year.
With that, Keith, would you please open call for questions?
[Operator Instructions] Our first question comes from the line of Brian Gamble with Simmons. Your line is open.
Good morning, guys. Great quarter.
Thank you, Brian. Thanks for the compliment.
No problem at all. Uzi, wondering you could give your thoughts on the retail drop? No mention of it in your release. Obviously, it is in the DK release, this kind of kicking the ball down the road, still working on it. But can you give updated results, given market conditions, given you had such a strong quarter? We got some balance sheets moving around on both entities. I just wanted to get your feelings on how that was going.
Yes. Absolutely. I would like to say one more thing just to give some color behind that. As you know, we invested these two pipelines or these two projects over the last two years. Obviously, there's no EBITDA associated with these two projects as we stand and one of them will start generating revenues later this month, the other one will start generating -- we are expecting to start generating income -- revenues and income early next year. So while we are leveraged of 3.5x, if actually we take these two projects and start ramping up, that leverage should come down.
So that gives us and the long answer for this or the long background answer, that gives us more comfort around the leverage of DKL. And Assi and his team have been doing a lot of work in the last two months as we committed to the market that we could do around taxes and around the idea of dropping down the entire retail, partially retail and Assi, do you want to give some thoughts about the tax work?
Sure. As we mentioned in our prior call, we did some preliminary work initially to see the availability of the drop down with the minimum tax impacts, both to DK and DKL. And I will say we have completed majority of that work and based on our initial thoughts, we can do the drop down as either partial, all of the retail business through the MLP with basically limited impact on taxes, if any, on both DK and DKL, which is something that will allow us to do this transaction, the multiples that we've seen in the market because there's no tax impact on the EBITDA. Anything else that you would like to know about the potential drop down?
Let me just make sure I heard you. You're saying at this point you concluded that the tax implications regardless, if it's a partial or a complete drop down is, you're agnostic either way, both entities there are minimal taxes regardless of whether you choose a portion of it or whether you choose the whole thing?
Correct. From a DK perspective, as we mentioned in the DK call, it's a deferred of taxes so we will pay over the next 15, 20 years. At the DK level, the DKL level with the current structure, we will be able to distribute the majority of the cash flow without tax impact or the DKL unit holders or in the DKL company. So from a DKL perspective, it will be like most of the other assets that we own, most of the income will be qualified. If it won't be qualified, it would be shielded and even the income that would be shielded, we don't expect to have any material taxes related to it.
Great. That gives you lots of options, that's good to hear. And then, from a timing standpoint, did DK want to conclude or figure out what the conclusion to the DK [lawn] [ph] situation going to be before the retail drop happens or are those, I guess concurrent paths? Kind of give me some color on how we should expect those two different things to work their way through.
I think those are separate items at least to happen. Of course, we're thinking about both of them. With that being said, as we told the market, at the DK level again, shading out the value of the retail is something that is important for the mother company as we believe the mother company is undervalued right now compared to the market value and therefore, we think that that's a step that we need to do, regardless of the lawn transaction.
Great. And then last one for me, on the ramp up, you've got RIO coming on, potentially shortly. How should I think about the utilization ramp as we go through the back half of this year for that pipe and then maybe you could also touch on the early 2017 ramp at Caddo and how quickly would be rammed up as well?
Brian, this is Mark Smith. We over --I think over the past -- first rest of this year, we have minimum volume commitments on RIO that will obviously take effect starting September 1 is the plan, as long as the pipeline begins operation here in August. And we expect to see some ramp up of third party volumes for the rest of the year. But as our predictions with our joint venture partner have it, we see more ramp up come up in 2017 as crude prices recover. And on Caddo, that pipeline is actually replacing another third party pipeline that Plains has right now into Shreveport, so we expect that ramp up to be a little bit different than the RIO joint venture because the RIO joint venture is more of a gathering system and this is more of a delivery system. So once that pipeline starts up, we should see a decent revenue and income from that pipeline pretty quickly.
Great. Appreciate it, guys.
[Operator Instructions] Your next question comes from the line of Lin Chen. Your line is open.
Hi, good morning. Thanks for taking my questions. Congratulations on a good quarter.
I just wanted to follow-up, first question following the drop down for the retail to DKL. How should we think about DKL real finance value? Will DK take some units if the market is not good or how should we think about that?
I'll let Assi take it. I just want to say that it depends on the strategy. We're doing partial dropdowns or entire retail dropdowns. And we're still thinking about these two options. And I want to be clear and honest. We look at DKL as fee and fee-based stable vehicle, so far outside of the West Texas thing. So we need to think if -- how to mitigate the volatility of the retail and at the same time, we want to get as much value for our shareholders, both companies, so that's what we are talking internally. But I'll let Assi answer the structure.
First, I would say that if you read the parent press release, they have not committed yet to sell us the asset. So let's just make sure that if they decide those assets are available for us, it depends on the route we'll take. If we just move on the wholesale business, we can do it probably with debt only. If there's any equity needed, DK would probably take it and we won't be in the market for any equity. That is probably where our head is going into, which means in this case there's will be no equity issuance for DKL at all.
If we will have to drop the whole business, there may be a need for some equity. With that being said, subject to market, Delek will be able to absorb that equity and at this level of the stock, I don't see us going out to the market and raising any equity, so it depends on market. Since Delek at the top has a lot of liquidity, we don't have a need for that unit so that cash coming out of that unit tomorrow.
So I will make it clear. I don't see at this level any equity issuance at DKL. There shouldn't be any fear from investors that something will come to the market that they didn't expect. If we need debt, we have a very large revolver and with the reduction in interest rate across the board for the MLPs, it makes more, more sense to go towards the debt.
Great. And also, a follow-up. You just committed to growth, distribution of 15% for the rest of this year. Compared with other refineries, response MLP, some of them commit to multiple years distribution grows, these are more visibility. How should we think about DKLs next year or the year after if distribution grows?
That's a great question. We debated that yesterday as we prepared ourselves for the call, if we want to commit ourselves to 2017. And as we get clear visibility on the two pipelines and if they ramp up the way we expect, then obviously our target all along is 15%. But we are a little hesitant to answer that question yes -- I'm sorry -- before we see a little visibility of these two pipelines. But if we get what we think we can get, then there's no reason to believe that we won't continue with the path that we had in the last three, four years.
Great. Thank you very much. Appreciate it.
Appreciate you. Thank you.
And we have another question from the line of Brian Gamble with Simmons. Your line is open.
Hey, guys, hopped back in for a second. Wanted to chat wholesale -- some moving pieces in that one before the quarter benefited margin, hurt the volumes as you said. Could you maybe describe what happened and how that influences Q3 and potentially moving forward?
Yes. So in the month of June, the Magellan pipeline which feeds West Texas from the Gulf Coast had -- we had all of that rain in Houston and the flooding that happened caused the pipeline to shut down for probably close to three weeks, so that obviously volumes stopped moving out to West Texas.
So we were actually able to sell all the volume that we had in inventory and we actually ran out of inventory at most of our terminals, as today the pipeline restarted up. So that caused obviously supply/demand dislocation and therefore margins were higher. Obviously, the pipeline started back up so as we said in our release, we're still -- today and going forward, we still see it being in that $1.25 to $2 range for the rest of the year and our volumes have picked up, obviously, a little bit more now that the pipeline is open.
Brian, just for give you some more color. What we see for the month of July, at least internally, we see roughly 10% increase in volume and around $1.75 on margin. We have may have some write-off of inventory because prices came down, but I don't know what the price will be at the end of the quarter. We actually see them coming up very large and nicely yesterday. So higher volume, slightly lower margin, but please remember when RIN prices are reaching to a record of $1 per RIN and with our blending activity, we're seeing more favorable impact on our margins from RIN going into Q3. RIN came up during Q2 from roughly $0.60, $0.70, finished at roughly $1 dollar, and right now we started the quarter with $1 value of RIN, so that's very supporting.
Great. That helps a lot. And then on the Paline hydro test, remind us the volume impact of that and where that's going to end up flowing through for Q3, just to make sure we catch how that should be modeled?
Yes. So you know that our contract rolled over starting in July to 10,000 barrels a day for the rest of the year with our counter-party. We expect -- the hydro test is done in stages and so we're able to move even though we started the hydro test in July, we were able to move volume in July to Nederland because we started at the front of the pipeline. So injections were still allowed to happen. So we're trying to minimize that number. I don't think we've said what the minimization is, but we'll be very close to the 10,000 a day that is committed for the month of the hydro test.
Great. And then, post the test, as far as you guys reworking and getting some additional volumes on that pipe, any updates there as far as how that's going or how that could theoretically go as the year progresses?
Yes. So in July, we actually filed the first tariff movements from Longview to Nederland and we're working with potential shippers out there to see what it will take to get them by ship. We're kind of in a midpoint location where folks can move barrels from Cushing to Nederland on the big pipes, but there is -- you have to kind of start in Midland if you really want to move barrels into the Gulf Coast.
So this is a pipe that will allow people to move barrels midpoint into Nederland, and we're working with those potential shippers to see what it would take to get them to ship those barrels.
Great. And then, maybe one more for you, Uzi. Third party acquisitions, you mentioned it in the prepared remarks as something that you're obviously always looking at. Any developments or I guess any recent changes in the way that you view the market as far as your opportunity set outside of the DK drops and other things like that?
Well, obviously, it depends on the sponsor's decision alone, but outside these two things, we see the market being ripe for third party activities. We saw an announcement coming from Blueknight with Ergon, I believe a couple of weeks ago. As people starting to absorb new reality for the market, we remain very interested in these areas and we're looking very carefully in areas that are of interest to us. We feel that we as a company turned the corner here with our initiatives. As we said, we had a decent quarter and obviously you know that and the outlook looks not so bad or pretty good, so that gives us confidence to look for acquisitions.
Appreciate the color, guys. Have a good one.
Thank you, Brian.
There are no further questions at this time. I'll turn the call back over to Uzi for closing comments.
Thank you, Keith. Again, I would like to thank each one of our great employees, my colleagues around the table. I'd like to thank you investors for the trust you've given us, managing your money, and we'll talk to you soon. Thanks and have a great day.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!