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Western Refining, Inc. (NYSE:WNR)

Q1 2012 Earnings Call

May 3, 2012, 1:00 p.m. ET

Executives

Jeffrey S. Beyersdorfer – Treasurer, Director of IR

Jeff A. Stevens – President and CEO

Gary R. Dalke – CFO

Mark J. Smith – President - Refining and Marketing

Analysts

Edward Westlake – Credit Suisse

Arjun Murti – Goldman Sachs

Jeff Dietert – Simmons & Co.

Chi Chow – Macquarie Research

Kathryn O’Connor – Deutsche Bank

Operator

Good morning, and welcome to the first quarter 2012 Western Refining earnings conference call.

(Operator Instructions)

Thank you, I would now like to turn the call over to Mr. Jeff Beyersdorfer, Treasurer and Director of Investor Relations of Western Refining. Mr. Beyersdorfer, please go ahead.

Jeffrey Beyersdorfer

Thanks Jackie, and good morning. I’d like to thank you for taking the time to listen in today, and for your continued interest in Western Refining. Again, my name’s Jeff Beyersdorfer, I’m the company’s treasurer and director of investor relations. Joining me for today’s call are Jeff Stevens, President and CEO, Gary Dalke, CFO, Mark Smith, President Refining and Marketing and other members of our senior management team.

We will be referencing our earnings call slides throughout the call this morning. The slide presentation, in addition to our earnings release, can be found on the investor relations section of our website at wnr.com.

Before we proceed, I would like to make the following Safe Harbor statement. Today’s presentation will contain forward-looking statements, and I refer you to the forward-looking statement section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances. In addition to reporting financial results, in accordance with generally accepted accounting principles, or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release, which is posted in the IR section of our website. I’ll now turn the call over to Jeff.

Jeff Stevens

Thanks, Jeff. Welcome to everyone on the call. Today we will discuss our first quarter performance. After my opening remarks, Gary will review our earnings in more detail and provide operating guidance for Q2 2012, then we will open up the call for your questions.

As stated in our press release and in slide three, we reported net income, excluding special items, of $85.1 million, or $.81 per diluted share, and adjusted EBITDA of $183 million for the quarter ended March 31st, 2012. These results were primarily due to strong refining margins, driven by the continuing wide Brent/WTI spreads and strong refined product values in our region. As has been well-documented, Shell crude production continues to show very strong growth prospects throughout the U.S., including the Permian Basin. Western is well-positioned, with two refineries located in the heart of this growing crude oil production. As I’ll detail later in my comments regarding our investment opportunities, we are capitalizing on our ability to process additional quantities of this better-yielding, lower-cost crude.

In terms of product values, we believe Western is advantaged compared to most mid-con refiners, as about 35% of our product sales are influenced by the strength of west coast pricing. As shown on slide four, LA product prices relative to the Gulf Coast have performed better than Chicago and the Group in most recent quarters. We believe that our crude cost advantage, coupled with the strength of the areas where we sell our products, should result in good profitability for the next several quarters.

As shown on slide five, our refineries demonstrated gross margin improvement during the quarter, with El Paso up 14% and Gallup up by 9% compared to Q1 2011. Total refining throughput was approximately 145,000 barrels per day, which was in-line with our expectations. As we stated on the last earnings call, we took some planned downtime in El Paso in mid-February to perform some work on the crude unit and FCC. At Gallup, we experienced minor operation issues which caused us to operate at lower rates. Both facilities are currently operating at full capacity.

Our Southwest wholesale business performed well in the quarter, with flow gallons up 5%, card lock volumes up 13% and lube volumes up 11% compared to Q1 2011. We also continued to grow our Mid-Atlantic wholesale business. I believe this business will become more profitable over time.

In our retail business, the addition of 60 new stores in the past year drove significant fuel volume and merchandized sales growth relative to Q1 2011. Our same-store fuel volumes and merchandise sales were also improved compared to Q1 2011. We are encouraged that our retail is well-positioned to capitalize on the upcoming summer season.

Turning to the second quarter, Brent/WTI spreads through April have averaged $16.40 per barrel. Additionally, we have seen the recent widening of the WTI cushing and WTI midland crude differential to around $5.00 per barrel, compared to approximately $.50 per barrel in 2011. We believe this is a result of increased crude production relative to takeaway capacity at Midland. Western buys all of El Paso’s barrels on a Midland WTI basis, which allows us to capture the crude discount.

Given the market environment, we added to our crack spread hedges during the quarter, and as of March 31st, our 2012 crack spread hedges represent approximately 36% of planned production for the remainder of the year. Crack spread hedges represent approximately 18% of our 2013, and 8% of our 2014, total planned production. A summary of our hedge position can be found on slide six. We will continue to opportunistically place crack spread hedges for 2013 and ’14.

As we mentioned last quarter, we have a 2012 capital budget of $162 million, with $65 million targeted for discretionary capital. Our Delaware Basin logistic project, which is located in the western portion of the Permian Basin, is on track for an early 2013 completion, and will result in El Paso processing about 40,000 barrels per day of new Shell crude oil. The El Paso refinery expansion is in the planning phase, and we are currently working with outside engineers to develop the scope and cost estimates for this project. We are on schedule for the Gallup turnaround and expansion, which will be completed later this fall. Finally, we are pursuing several small, high-return projects which will improve our facilities and allow us to maximize the value of our refining and logistics assets.

As part of our continuing goal to improve our balance sheet, we made a $30 million prepayment on our term loan on March 1st. In addition, we made another prepayment of $75 million on the term loan on April 30th, bringing our year-to-date total to $105 million. Given our strong margin outlook, we have raised our full-year 2012 debt repayment to a range of 150 to $175 million.

In April, we announced a second quarter 2012 dividend of $.04 per share, which will be paid to shareholders in mid-May. We believe this demonstrates our confidence in our business and our potential future cash flows.

Wrapping up, it was a strong quarter for Western. Our primary goals for 2012 are to continue to improve the safety and reliability performance, reduce debt and reinvest in our business, all of which will enhance shareholder value. Now I will turn the call over to Gary, who will go over our first quarter financials in more detail.

Gary Dalke

Thank you Jeff. On a GAAP-basis, the company reported a net loss in the quarter of $53.5 million, or $.60 per diluted share, which compares to Q1 2011 net income of $12.2 million or $.13 per diluted share. Excluding special items, the company had net income of $85.1 million, or $.81 per diluted share, in Q1 2012, which compares to $25.4 million, or $.27 per diluted share in Q1 2011.

A reconciliation of our net earnings to earnings excluding special items is included in our press release. Refining gross margin, excluding unrealized losses on hedging, was $20.34 per barrel during the quarter, which compares to $17.13 per barrel in Q1 2011.

Direct operating expenses at our refineries were $5.70 per barrel for the quarter, which compares to $7.42 per barrel in Q1 2011. This reduction was driven by improved throughputs and lower natural gas catalyst and chemical costs. As a reminder, our Q1 2011 throughput was significantly impaired by the freeze event we experienced in El Paso in February of 2011.

Total company SG&A was $25.8 million for the quarter, compared to $24 million in Q1 2011. SG&A expenses were up primarily due to an incentive compensation accrual, which is tied to profitability.

Adjusted EBITDA for the quarter was $183 million, which compares to adjusted EBITDA of $111.7 million for Q1 2011. I would like to note that we now include an adjustment for non-cash, unrealized mark-to-market hedging gains and losses in our adjusted EBITDA calculation.

Depreciation and amortization expense for the quarter was $22.8 million, which has decreased due to the Yorktown sale. Interest expense was $24.1 million, a $10.4 million decrease compared to Q1 2011, primarily a result of reduced debt and interest rate levels associated with our refinancing and debt reduction efforts.

Cash and cash equivalents, including restricted cash, stood at $374.3 million at the end of the quarter. A bridge from Q4 2011 to Q1 2012 ending cash position can be found on slide seven.

Total capital expenditures for the quarter were $22.2 million. As of March 31st, total debt stood at $777 million and net debt was $402.7 million. A summary of our capital structure is available on slide eight.

Our total debt-to-adjusted-EBITDA leverage ratio has improved significantly, decreasing from three times to 0.9 times over the last year. Liquidity, which we define as cash and availability under our revolver, was approximately $762 million at the end of the quarter, and has averaged approximately $940 million thus far in the second quarter. Lastly, you can find our second quarter operating guidance on slide nine.

Jackie, we will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of Ed Westlake with Credit Suisse.

Edward Westlake – Credit Suisse

Hey guys, congratulations on the results today. Just a quick question around, you said you’re making some good progress on the El Paso expansion and you’re doing all this study work you need to do. When do you think you’d be able to make a decision on that project? It seems with the Permian growth, it’s needed.

Jeff Stevens

Ed, you know, obviously, we’re as anxious as anybody to get started on this project and take advantage of what we’re seeing in the Permian Basin. We really have a couple different options to increase crude there, and we need to make sure that we do the right project there. So I’d say probably over the next three to four months, we’ll have a better idea of the scope and cost of the project and then, obviously, one of the hurdles will be a permitting process that we’ll have to go through to get the project.

But ideally, we’d like to tie it into our 2014 turnaround that we’ll have on the South side of the plant. That would really work out well for us if we could put that timing in place.

Edward Westlake – Credit Suisse

And obviously, the discount is split out to, you know, well, more than $5 recently, but $5 at the moment, and there was some problems on the – some of the pipelines. But in terms of the growth you’re seeing locally, there’s still quite a lot of West Texas production growing. So maybe just an update on your thoughts around where that discount might settle out, say through 2013, ’14?

Jeff Stevens

Well, there’s a couple discounts we’re now factoring in. You know, obviously PI Brent has been an impactful business for Mid-Continent and us in the Permian Basin. And you know, obviously with the growth that we’re seeing particularly in our area where we primarily gather and buy our crude, we’re starting to see that bottleneck in the Midland market and we’re seeing the Midland Cushing widen out. We thought it would tie on some basis, $8 a barrel, but certainly we don’t think that that kind of discount is substantiable. And then there’s kind of a third discount and that’s the location of where our assets are, particularly, you know, this project we’ve got in the Delaware Basin right now allows us to pick up the crude before it’s even transported to Midland. So we’re able to even pick up a little bit more discount relative to the transportation cost just to get it to market.

So you know, I think that there are some, you know, just – the Brent PI will be volatile – I think these other will be volatile, but you know, there’s some permanent change in the marketplace because of the takeaway cost of getting the barrels out of the market. So you know, I think overtime, as these projects get going, that will be more stable, that pricing will be more stable. But I think we’re going to continue to have volatility like we’ve seen over the past 12 to 24 months all the way through 2013, Ed.

Edward Westlake – Credit Suisse

And to come back to that Permian Midland discount versus WTI, I mean, a guestimate as to where that should settle out on a sustainable basis?

Jeff Stevens

You know, long-term, we could see it in the $2 to $3 range.

Edward Westlake – Credit Suisse

All right. That’s very helpful. Thanks very much.

Jeff Stevens

Thank you.

Operator

Your next question comes from the line of Arjun Murtin with Goldman Sachs.

Arjun Murti – Goldman Sachs

Thank you. Maybe a little bit of follow up on the first question there. It’s obviously your early days in this kind of latest renaissance in the Permian. I’m curious if you can quantify what sort of magnitude you have for debottlenecking or lower cost expansion projects, I guess at either El Paso or Gallop? I know you’ve not quite quantified the first project, but will this be it and then the next round of investment would be materially higher, or do you have – can you do a series of lower cost debottlenecks? Thank you.

Jeff Stevens

You know, relative to El Paso, it probably, with this next crude expansion that we’re thinking, you know, in the 20 to 25,000 barrels per day range, any future expansion then we would probably have to get too far down into the other strengths of the products, other strengths of treating and that would significantly raise the cost. But we think this project we’re working on right now is going to be cost effective. Obviously, in Gallop, we’ve got a lot little project that we’re doing as part of the turnaround and we’re going from 23 to 25, which is a little under 10% increase. I’d say there’s probably other projects that we’ll look at at Gallop as that crude oil supply rises and the opportunities to process more crude in that area, you know, I think that will be an area that we can see another 10 or 20% of expandable at that asset.

Arjun Murti – Goldman Sachs

That’s great and then you also mentioned like in the Delaware Basin, you know that you’ve got some projects to ensure you get kind of direct access to the new crude production, it’s not all bought at Midland. How important of a component of crude source team will that business – I don’t know if you’d call that gathering or not but Permian is a big area and not everything gets to Cushing, not everything gets to Midland. Will you all be investing more in those types of projects to ensure that you get the most discounted crude?

Jeff A. Stevens

Absolutely, I think that this is one of the things that’s being missed by most of the people in the market is, when we buy a Midland barrel we’ve lost control of that barrel and you know it’s probably had some blending associated with that barrel, we call that basically a common stream barrel, but buy going directly to the well it allows us to tie in and pick up these [inaudible] barrels and deliver them directly to the refinery which we believe will help our overall yield pattern. So not only will be picking up the discount but we’ll be picking up a better crude and so this is kind of what I would say is the first step in securing kind of the low hanging fruit that’s out there as far as getting some shell barrels directly to the refinery but based on talking to the producers and what we’ve seen out there I think there will be several other projects like this that we’ll be able to capitalize on.

Arjun Murti – Goldman Sachs

That’s great, thank you so much.

Operator

Your next question comes from the line of Jeff Dietert with Simmons.

Jeff Dietert – Simmons & Co

I was wondering on the El Paso expansion, there’s obviously rapidly growing supply in the area, how do you see the demand for additional product out of El Paso? Do you see it growing or would you be displacing product from other areas?

Jeff A. Stevens

I think that – I mean obviously we believe we can place the barrels or we wouldn’t be looking at the project. The one thing about this that’s unique a little bit about this project, it’ll be more weighted towards distolet and I think that based on what we see even in the market today where the economy’s still recovery from a pretty severe downturn, we believe that we’ll be able to place the disolet barrel pretty easily into the market and be able to move the products and run it at full capacity. So you know right now, obviously gasoline has remained kind of flat or down in our market but distolet demand has remained pretty strong particularly when you look at the mining business and the railroad business.

Jeff Dietert – Simmons & Co

Switching topics, you guys have done a terrific job bringing down and based on our numbers your debt reduction targets for this year look very achievable. I think initially, perhaps the hedging program had a piece of protecting cash flow associated with it and now with your debt down substantially, could talk about your hedging strategy and is it more a matter of maintaining or making cash flows projectable or are you concerned that those differentials are going to come in and that margins could weaken in the 13th, 14th time frame?

Jeff A. Stevens

Yes, I think that’s a fair question Jeff, you know obviously our goal a year ago was to get our balance sheet you know down in a more manageable role and we’ve been obviously very successful in doing that in a very short period of time. I think the way we approach hedging is we believe because of the volatility in the market place that there are some opportunistic times to essentially lock in what we would say are margins significantly over what we see as kind of a five year average and I think to the extent of locking in up to potentially a third of the volume that we have in the southwest. If we see Brent TI widen out like we did in 2011 and a little bit like 2012 then we’ll step in and take advantage of that. Otherwise if the Brent TI comes in I think you’ll see us just work off what we’ve got out there and just finish the program at – but we want to be opportunistic because I think as you see pipeline’s announced you’ll see the Brent TI come in and then when people realize that the production is significantly higher than what the take away is, I think we’ll see it widen out. We just want to be in a position to take advantage of that.

Jeff Dietert – Simmons & Co

And as you bring your debt down, you start looking a lot more like some of your competitors, some of which have started returning cash to share to shareholders and through dividends, special dividenciary purchases. What metrics are you looking at or what growth cap backs do you have that you would compare to before you’d start returning cash to shareholders?

Jeff A. Stevens

Well I mean obviously we started the dividend program back up in the fourth quarter and we fell it’s important to establish it even if it’s at a modest rate at this point. So I think the way we look at things is we still you know have a little work to do and debt repayment that we want to make sure that we achieve. I think number two is when we’ve got the capital projects out in front of us that have the returns that they do, I think we’re going to continue to invest in the business, particularly the logistics business and then I think we’ll continue to look at returning cash back to the shareholders either through the dividend or we’ll look at the potential of stock repurchase but that’s kind of the order in which we’re looking at things right now, Jeff.

Jeff Dietert – Simmons & Co

Thanks guys.

Operator

Once again if you’d like to ask a question please press start then the number one of your telephone key pad. Your next question comes from the line of Chi Chow with Macquarie Capital.

Chi Chow – Macquarie Research

Back on the El Paso crude project, did the timing slip a little bit on that, Jeff, it seemed like, I think last time it was the 3Q completion?

Mark J. Smith

Yes Chi we’ve been trying to optimize the design and initially we were going to do a significant amount of work in our ’13 turn around on our north crude unit and you know the harder we look at it and the more we want to optimize that project, it’s looking more like a project in ’14 on the south side but again we’re in engineering shops with it, we’re working it and just trying to get an optimal project.

Chi Chow – Macquarie Research

Okay thanks, actually I was referring to the, I think, crude logistics projects, Jeff I think in your remarks I think you mentioned it was early ’13 project at this point start up?

Jeff A. Stevens

Yes it’s really a few different phases, Chi. You know we’ve got the truck loading station that’s being constructed now and that’ll be up you know towards the fourth quarter of this year. And then the other phase of it is pipeline, hard pipeline into the well heads and those you know when we say completed, be fully completed but we’re starting to get barrels now by truck. We’ll ramp that up with our truck station, be able to substantially off load a lot more trucks than we can today along with some storage facilities that we’ll have there and that’ll be done you know really towards the end of the fourth quarter of this year. And then it’ll be a ramped up phase to ’13 to have all the pipeline done and hooked up into the facility.

Chi Chow – Macquarie Research

Okay, great, you made some reference of this but as far as the pricing on the Avalon and Boone Springs crudes are you saying they’re at a discount in Midland and have that dynamic with the Midland differentials widening.

Jeff A. Stevens

The way to think about it, it’s a location differential, Chi and essentially we’re taking the barrels out into the fields and giving them a better – giving producers a better option than the logistic asset to get the barrels to Midland. So all of the barrels are priced off Midland depending on where the barrels are gathered and where the come into our system. We can see that additional dollar to $2 discount relative to Midland.

Chi Chow – Macquarie Research

Okay $1 to $2, and then on the yield uplift, you’ve already got it pretty high like [inaudible] El Paso, bringing these crudes in, can you talk a little bit about how that yield change going forward with these crudes?

Jeff A. Stevens

Well I think what it does is, you know obviously it’s going to help you know reduce the amount of bottoms that we make but we also believe that by having the capability of blending the different crudes and kind of controlling the quality of the crudes which we haven’t had at that same control in the past, we’ll be able to optimize more distolet you know when it make sense and it – but it’s really just an overall light product and yield pattern that we’re seeing.

Chi Chow – Macquarie Research

The risid will go down going forward?

Jeff A. Stevens

Yes.

Chi Chow – Macquarie Research

Okay I guess finally, at Gallup, Mark you know the outback still seems to be trending a bit high there, any prospects for improvements on that end?

Mark J. Smith

Yes I think so, Chi. We had a down in January and the actual cost in January drove the results for the quarter so both February March look much better.

Chi Chow – Macquarie Research

Okay great, thanks a lot.

Operator

Your next question comes from the line of Catherine O’Connor with Deutsche Bank.

Catherine O’Connor – Deutsche Bank

I think you touched on hedging a little bit earlier but could you tell us specifically how much in each year the board has allowed you guys to hedge in the next few years.

Jeff A. Stevens

We’ve said that in 2012 we’ve obviously got about 35% hedged and we have basically that same authorization in 2013 and 2014. So we have that option to date, we’re certainly not there particularly as you go out into the ’14 so we would need to see to get up to that 30% we would need to see the Brent TI widen back out closer to the levels we saw in 2011 to get to that third but it’s a third in 2013 and a third in 2014.

Catherine O’Connor – Deutsche Bank

Okay and then it sounded like before you were basically saying you couldn’t really foresee even in an elevated margin environment, you couldn’t really see going back to get any more authorization, is that true? Is that what you were saying? That you really wouldn’t see doing more than a third or is there any scenario under which you would go for more authorization/

Jeff A. Stevens

I would say at this point you know we’re comfortable with a third of the production being hedged but you know if obviously it presented itself and it made sense to raise that up. I just don’t see significantly raising it up above the third at this point just because you know we want to make sure that we’re capturing the market volatility in this business that it gives us.

Catherine O’Connor – Deutsche Bank

Okay that’s what it sounded like and then just from the reading agency prospective, have you guys been talking to them, obviously given your performance recently, have you been in active discussions with them about your credit rating and the possibility of an upgrade?

Jeffery S. Beyersdorfer

Catherine we saw the agencies early this year in March for our formal review and I think they’ve got a positive view of the company and our outlook so I would expect that we would be in a pretty good position to see some movement from Moody’s and perhaps S&P over the next couple of quarters.

Catherine O’Connor – Deutsche Bank

Okay great that’s it for me.

Operator

Thank you I would now like to turn the call over to Mr. Jeff Stevens.

Jeff Stevens

Wrapping up, it was a very good quarter for Western. I’d like to thank our employees for their hard work, continued focus on safety, reliability, and cost. Thank you for your participation in today’s call and your continued interest in Western.

Operator

Thank you, that concludes today’s first quarter 2012 Western Refining earnings conference call. You may now disconnect your lines at this time and have a wonderful day.

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