Western Refining, Inc. (NYSE:WNR)
Bank of America Merrill Lynch Leveraged Finance Conference Call
November 30, 2011 14:40 ET
Jeff Beyersdorfer – Senior Vice President and Treasurer
Alright. I think we are ready to get started again. So, next up we have Western Refining. From Western, we have Jeff Beyersdorfer who is the Senior Vice President and Treasurer for Western. And Jeff, you can – the floor is yours.
Jeff Beyersdorfer – Senior Vice President and Treasurer
Okay, thank you. If you don't mind, I am going to walk around a little bit. So again, my name is Jeff Beyersdorfer, Treasurer and in charge of Investor Relations for the company. For about the next 20 or 25 minutes, I am going to talk about three areas. One, a little bit of overview of Western and our asset base for those of you not familiar with the company. Second of all, I'll talk about the well-documented phenomena about domestic crude, particularly WTI and what's going on, how that's affecting us or what implications that has for us as a refining company. And then third, talk a little bit about the balance sheet and the strategies around our balance sheet in the near term or what our plans are for debt reduction.
So, the first slide and hopefully everyone has a presentation. These slides are difficult to read while the broadcast appear, but the first slide is just a quick asset overview. So, primarily our operations are in the Southwest. We've got two refineries, one in El Paso, Texas; one is Gallup, New Mexico, total barrels of about 150,000 barrels a day. We also have two what we think about as outlets or distribution outlets for our refined product. One is a wholesale business where we market to the big uranium and gold mining companies, all the way down to the little landscaper in Tucson, Arizona and I will talk about that wholesale business a little bit, because it differentiates us we believe versus some of our peer group for having ratable outlet for that product via our wholesale business.
And then the other business we have is a retail business about 206 retail stores throughout the Southwest, mostly concentrated in the Four Corners region of the Southwest. Again, we view it as an outlet, a ratable outlet for our refined product everyday to sell it. We also have an asset idled now in Yorktown, Virginia, a refining asset. We idled it a little over a year ago. We've been in conversations to dispose of that asset. I'll talk about that a little bit. We still have a wholesale marketing business in the Mid-Atlantic, where we are selling about 35,000 barrels a day to our customers of refined product in the Mid-Atlantic region. So, that's our asset base. The major markets we serve, the cities we serve are El Paso and Juarez, Mexico and Northern Mexico, Flagstaff, Albuquerque, Phoenix, and Tucson. That's basically our markets. So, we are a smaller independent refining company.
Next page is an infrastructure of the product disposition in the Southwest. So, what I show on here are all the product pipelines that gives refined product, where it needs to go throughout the Southwest. And why we think this is important is because of the location of our two refineries. We think we are in pretty good location geography wise to serve the markets we are in versus our competitors, because as you can see all these product pipelines are falling from east to west all product or the majority of product passes through El Paso before it goes to Tucson and Phoenix.
And why that's important is because a number of these markets that we serve have very difficult gasoline specifications. A gallon of gasoline sold in Phoenix is not the same as a gallon of gasoline sold in Tucson or Flagstaff. And that helps us from a location advantage, because we can blend components into a gallon of gasoline and supply that gallon better and more efficiently perhaps than some of our competitors in West Texas or on the Gulf Coast. So, we like these assets, the logistics nature of these assets, the location of these assets.
Again, hard to read, you can see it better in the pages in front of you, but Macquarie Bank does a regular quarterly ranking, this is all publicly available information of all the independent refineries out there that publish by refinery operating margins. So, this is gross margin minus operating cost on a per barrel basis. And you can see that over the last two years we have ranked pretty high towards the top of the list. The interesting thing about this list though is that if you have been in this industry or following this industry for a while, the old paradigm was the refineries that were based on a coast, access to water-borne crudes, big complex refineries, those were the refineries that we are going to make money. And those smaller refineries, inland, difficult to access, those were the refineries that we are going to go out of business or struggle.
And clearly, that's not the case over the last couple of years. The refineries that make money today in good margins sit on top of their crude source are basically inland refineries, very little coastal refineries, have reasonable operating costs and have interesting little niche markets for which they service. That's the commonality that we see for the refineries that are posting good margin results today. So, that's a little bit about the company and our asset base.
Let me talk about the well-documented phenomenon going in, in the market. So you've all read about WTI and the big production estimates from the Bakken and from the Niobrara and from the Permian and from Eagle Ford and it being logistically constrained, and this differential between WTI and Brent, and all of a sudden it's going away because Enbridge bought Seaway, and all of a sudden all this infrastructure is going to be built out. I won't go through all that, you understand all that, but again we think that longer term couple of things are happening. One is the introduction of rail. We think rail is probably happening faster and sooner than everybody is expecting. We are hearing a lot about rail infrastructure. And rail, we think is a little more flexible than pipeline infrastructure. Pipeline takes products from point A to point B. Rail is a little bit more flexible.
So, we think rail probably is going to be a longer term solution to this infrastructure backlog. And that combined with the ultimate pipeline infrastructure that will be built to get crude, WTI crude that's coming out of the Permian, as an example, to the Gulf Coast. We think the ultimate WTI/Brent spread and we agree with the consensus out there, that it's going to land somewhere between $5 and $8 a barrel differential, which is the transportation economics weighted between rail and pipeline. So, rail is about $8 to $10 a barrel to transport crude to the Gulf Coast and pipeline is somewhere between $3 and $5 a barrel. So, we agree with the consensus out there. It's starting to come a little more common now that the differential is probably going to land somewhere around again $5 to $8 a barrel longer term. So, those refineries that have exposure to WTI crudes and you see those on the bottom right hand side here will continue to perform very well versus those refineries that can only process Brent-based crudes.
In our backyard, some interesting things are happening and I want to share with you what we are doing to take advantage of this crude phenomenon. So, within the Permian Basin, in West Texas there are couple of fields called Bone Springs and Avalon and their shale plays, you've heard about fracking and horizontal drilling in the shale plays and there is pretty good production estimates for crude coming out of those fields.
And we are running some of those crudes today at El Paso. We are running about 10,000 to 15,000 barrels a day at El Paso. El Paso is about 128,000 barrels a day. We are running those crudes today having them trucked to the product – to the crude oil refining line that comes from Wink, Texas to our refinery. But we have an opportunity to run additional barrels once the infrastructure is in place. So, in September, our Board approved the $5 million investment to build some gathering lines up in the Bone Springs and Avalon play to allow us to get up to about 30,000 or 40,000 barrels a day of that crude into our refinery. That crude is a better crude than what we are buying today in terms of product yields that gives us better yields for gasoline, for diesel, and it's cost competitive versus the crude that we are buying today.
Ultimately, we are going to think about potentially looking at running more of that crude with more infrastructure being built longer term and perhaps looking at maybe perhaps expanding El Paso at some point in time. Those are very early discussions right now, but we may consider that down the road.
What also is happening because of this WTI/Brent phenomenon is the forward curve this year for the cracks spread – the 321 crack spread has blown out or did blow out relative to where it has been historically. So, we part here in December of last year what the crack spread – forward cracker spread look like for 2011, 2012 such that bottom-line – the blue line and I’ve showed how through the year this forward curve has increased because of the Brent/WTI phenomenon. And Brent WTI blew out to around $25, $26, $27 a barrel that difference between those two we saw the forward curve get as high as $25 to $26 per barrel.
We’ve taken an opportunity to sell forward some of our production and take advantage of this forward curve. So, what I’ve shown here on page nine on the very next page is details of our hedging book and what we’re doing in terms of taking advantage of that forward curve. So for 2012, we’ve hedged about a third of our plan production have prices that are pretty well in excess of where market prices are today. And if you would have take the prices per barrel on the right hand side times a number of barrels that we’ve hedged the multiply those out for 2012 that represents about $425 million of cash that we’ve got coming in the door regardless of what crack spreads do. Another way to think about it is we’ve lowered our breakeven cost by about $7 a barrel as a result of hedging.
We’ve done this for 2013 as you can see up here, and a little bit for ‘14. What we like to get to be as where we are in, for ‘12 about a third of our production hedged for ’13, we'd like to get to about 15% hedged than the same thing for ‘14 somewhere around 10% to 15% hedged. Unfortunately the market has gone away over the last couple of weeks. We’re not necessarily seeing a window now, which to do that, but again that’s our goal in order to hedge forward and take advantage of what historically has been pretty robust spread.
I’ve showed in terms of pictures this is the gasoline crack. So our Gulf Coast 3 to 1 crack is composed of a gasoline crack and a diesel crack. This is the gasoline crack, gasoline versus WTI, the price of gasoline versus WTI part it since 1996 and you can see what we were looking at when we first started looking at these hedges back in February of this year. We saw that there have been days or weeks when the crack spread got really out of whack, but it was because of short-term phenomena like hurricanes or crude prices or something like that. But never, at least in the history that we have been doing this has the market offered us a very long duration for elevated crack spread particularly gas and diesel crack spreads. So for 2012, we can see our crack spread book is about $17 a barrel that’s the price that we’re hedged at for 2012.
Today, that forward curve was about $8 a barrel. So, I think we’ve locked in some nice hedges for ’12, the same thing for diesel when you’ve got 12 and 13 up here, 2012 hedges are little under $29 a barrel, then the 13 and 14 hedges a little longer $28 a barrel and again the today’s crack spread is well below that today I’ve looked I think in the screen was little under $27 a barrel so, we’ve again locked and we think some pretty favorable pricing for the future. So again with this crack spread hedging, it gives one and insight into what our cash flow is going to look like over the next couple of years, some certainty of cash flow that we are going to have available to reduce debt, which I’ll talk about in a second.
Let me turn to Yorktown, something that we’ve talked about for several quarters now. Well, I can say is that conversations for the sale of the asset or mature, we’ve been in conversations for quite a while to try to monetize its asset and the proceeds will be used to target debt reduction. So, hopefully we will be in a position to announce something fairly soon. We continue as I said upfront have a marketing business in the Mid-Atlantic region, where we're buying product either from the Gulf Coast through the Colonial Pipeline or from the New York harbor or via barge about 30,000 to 35,000 barrels a day and selling that product to our customers in the Mid-Atlantic region. That business today generates around $7 million to $10 million of EBITDA, a fairly modest business, but one that we’ll retain going forward.
Talk a couple minutes, before I get into financials about these two separate businesses that again, we view as outlets, ratable outlets for our product distribution. So, I mentioned upfront the wholesale business. We have a wholesale business primarily that’s based in the Southwest that sells product from the big guys, the mining companies as I mentioned all the way to the little landscapers in the Southwest. We got about 3,000 customers out there and who are buying products from us in daily. We sell about 80,000 barrels a day through our wholesale business through those outlets to get it to our wholesale customers. So, again it’s a ratable, what I mean by that is we know where our products going everyday ratable business that we view as a distribution outlet for our refined product.
This we think sets us a part from other refiners. We don’t believe too many other refiners have a business quite like this, most other sell product at the rack. They don’t know the final disposition or where their product ends up. We sell all the way through to the end customer. It helps us keep a pulse on the end markets what's going on in the end markets, and again gives us that ratable distribution for our product.
The other outlet that we have is our retail stores. We owned about 206 retail stores primarily in the Four Corners region of the U.S. The convenience stores operator under a couple of different brands, Shell, Chevron, Conoco, Giant about 70% of Gallup's refinery, Gallup's gasoline production goes to supply our convenience stores. So, again we view this as a ratable outlet for our gasoline coming out of Gallup in order to dispose to the market. Both of these businesses independent, one other generate about $20 million, $25 million of EBITDA pretty consistent year end and year out.
Okay, turning to the financials. Couple of more slides and then I'll wind it up. This is all public. This is third quarter information. Operating metrics in terms of margin per barrel for our two refineries in the terms of EBITDA the $202 million versus the $91 million third quarter last year versus third quarter this year. Again, the main reason we're showing good results because of this WTI phenomenon. We are right in the middle of it. Our assets can take advantage of it because we process a 100% WTI. So that’s the primary reason why our results have been so substantially better than last year.
We'll note that third quarter that $202 million is net of around $94 million of unrealized hedging losses. Those are the hedges we have out going forward fourth quarter and beyond that were mark-to-market at the end of the third quarter, where we have to recognize on that unrealized loss because those edges don’t qualify core edge accounting. So, our actual, quote, cash adjusted EBITDA was more like $300 million. If you are looking for some insight into how well our third quarter was this year versus last year.
Okay. The balance sheet I do want to spend a couple minutes and help you understand the current state of our balance sheet and where we are going with things. So, at the end of the third quarter, we had a little over $1 billion of debt and about $403 million of cash. Let me quickly go instrument by instrument and describe to you each instrument and what we're doing with each instrument. The revolving credit facility, we renewed that in September of this year. Bank of America was our agent bank on that facility. We increased the size from $800 million to $1 billion. It’s an ABL facility borrowing base, formula-driven on accounts receivable and inventory. We primarily use it for letters of credit to procure crude costs or crude for refineries. That matures in 2017. So, we are happy with the execution that will be put to bed for several years. We reduced the rate on it. Our rate today for borrowings is LIBOR plus 200 and for letters of credit its LIBOR plus 300.
The term loan we refinanced earlier this year, again, Bank of America was the lead on that. We extended the maturity through 2017 about $320 million of outstandings on that. That’s what we view as our pretty payable debt on the balance sheet. So, any free cash flow we have and we can't use it for anything else, we'll use it to repay the term loan. That’s what we view as our pre-payable debt.
The next instrument is senior secured floating rate notes and you'll note about two weeks ago, we issued a press release and an 8-K that we plan on calling those notes on December 21. The par amount is $275 million, so with the 105% premium, 105% call, we'll expand about $290 million, use $290 million of cash to take out those floaters. So, that’s what the adjustments column is for is to show the adjustments for pro forma calling those notes.
The Senior Secured Notes, those are the 11.25% notes that come due in 2017, that are callable in 2013, a very expensive piece of paper, one that we'd like out of the capital structure. Unfortunately, the only way to get them out now is to probably tender for those. With the high yield market being fairly robust, it comes and goes as everybody knows, but if we find a window we may decide to issue a new piece of paper and use those proceeds plus cash on hand to tender for the 11.25% that doesn’t help us out from necessarily a balance sheet perspective, but it certainly helps us out from an income statement perspective by reducing interest rates, what could be pretty substantially reduction in interest rates.
The senior convertible notes are due in 2014. We view that as kind of a benign piece of paper. It accrues at 5.75% interest as they wait to convert. It's in the money today. The conversion price is $10.80 for the common stock and we'll probably just take that out at maturity with cash. So, as you can see with pro forma, the floaters coming out we run from about 1.8 times to 1.4 times leverage pro forma for those floating rate notes.
The final thing is just some windup comments. Again, we are looking at cash uses for taking advantage of the logistics asset opportunities in the Permian Basin to run more crude – more that type of crude at El Paso perhaps to run some of the crude at Gallup that hopefully will increase our margins. We talked about Yorktown, but we are also looking at our logistics asset base in the Southwest. We are trying to figure out how to maximize value there whether we bring in a strategic partner or financial partner to help us monetize those assets, maybe grow those assets, maybe put into an MLP we are looking at all those opportunities right now.
And then the final thing I want to leave you with is where we want to take the balance sheet in the mid-term. We would like to be a BB rated company in the mid-term. And if I look at the metrics for BB rated companies, it's about 1 to 1.5 times leverage through mid-cycle conditions. Our mid-cycle EBITDA is about $300 million to $350 million based on historical mid cycle. Take 1.5 times that, that tells us our leverage needs to be around $500 million. We're at $1 billion today. We got about $600 million –$500 million or $600 million to take out of the capital structure in terms of debt before we get to where we want to be. So, that’s our plan. That's where all cash flow is going, over the near term is towards debt reduction. And hopefully I've been able to share with you on the prior page about some of the initiatives we are contemplating in order to reduce that and put the balance sheet in shape for us to continue to grow the business longer term.
So, with that, I'll answer any questions that you might have. We need a microphone, because we are on the webcast.
I am sure everybody likes to see that you guys have a target for BB, but like what kind of interest savings or what's your purpose in getting to a BB rating? Do you just see that the interest savings will be so accretive or…
That will be accretive. I think we believe that trying to achieve an investment grade rating and maintaining an investment grade rating while having a business plan longer term to grow through acquisitions perhaps or a little bit difficult to maintain both those objectives. So, we think a BB or a strong BB makes sense for us rather than trying to be investment grade simple as that.
But I mean why not just stay at B, I mean since you guys seem to be managing okay at your current rating?
When this industry inevitably goes through another difficult period, which it will – we know that refining industry is fairly volatile. We rather not have the leverage balance sheet, a B balance sheet, going through that difficult time again, we rather have a little stronger balance sheet, a BB rated balance sheet to weather those tough times. Given the, I'm sorry.
Given the pressures in the U.S. whereby the – we are now becoming a petroleum products exported is that going to put pressure on you to deleverage your balance sheet to continue to grow your business through that cycle?
I am not sure that that's the catalyst. We would have done that anyway. I did read that article in the journal today about the U.S. becoming now a net exporter. We knew that was happening for diesel and we are the beneficiary of that, because it's the coastal refineries that are exporting diesel and we are backfilling the domestic demand for diesel. So, we are getting some benefit from that and I did see that gasoline is starting to be the net exporter too, but I am not sure that has implications for us de-levering. We were going to do that anyway. We knew we had a levered balance sheet. It was difficult to go through the inevitable next downturn of refining with that balance sheet and be able to sleep at night. So, we wanted to de-lever to make sure we weather again that next downturn that we will go through at some point in time in the refining space.
Yeah, given your debt reduction goals, have you looked at flushing the convertible? It doesn't really work with the stock at 12, but stock at 18 or so it's a valid strategy is an easy way to reduce debt?
We have been approached by a couple of parties to look at doing, and yeah, we consider that at the stock gets to be at a certain level and maintains itself at a certain level probably makes sense. And we know there is potentially some significant dilution when those converts mature in 2014. They represent about $19.9 million shares. So, we know there is dilution and then the equity guys would rather not have that. So, we can find an economic way to take care of that beforehand, yeah, we'd consider that.
So, including the equity piece of the puzzle is important.
Jeff, can you talk about – it seems like there is quite you noted in one of your first slides about where the best places to have refineries are landlocked with crude supply nearby and able to send your product to specified areas. But given everything that's going on with kind of the changing dynamics with them, where production is coming from and that sort of thing. Where do you think the best opportunities for you guys are in terms of – is it organic opportunities or M&A opportunities or logistics opportunities or refining opportunities? What do you think the best opportunities for you guys are as we sit here looking out a year or two?
Again, the first use of cash, Kelly, is going to be debt reduction. So, we've got to fix the balance sheet. We've got to get Yorktown sold and that will bring in some more cash we can use to further reduce debt. We are looking at, again, alternatives for those logistics assets and how to maximize value there. Those assets are trading at three times are embedded in the three multiple refining entity when they could be trading at 8 or 10 times, MLP multiple, not to say, we'll do our own MLP, but we want to figure out how to maximize those assets. And then longer term, we do want to grow selectively and the markets there where we want to grow have to have characteristics that are similar to both El Paso and Gallup. And those are probably west to the Mississippi for the most part that we see those market dynamics.
I think that's all we have time for right now. We have 10 minutes in between presentations.
Jeff Beyersdorfer – Senior Vice President and Treasurer
Thank you very much.
Exchange, but Jeff thanks for coming.
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