Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Jeff Beyersdorfer - Treasurer and Head of Investor Relations

Analysts

Kathryn O’Connor - Deutsche Bank

Western Refining (WNR) Presentation at Deutsche Bank Leveraged Finance Conference October 13, 2011 8:35 AM ET

Kathryn O’Connor

Good morning, and welcome to day two of the Deutsche Bank Leveraged Finance Conference. My name is Kathryn O’Connor. I cover energy here at Deutsche Bank on the high-yield side. First up, in terms of our energy companies, is Western Refining. From the company we have Jeff Beyersdorfer. He’s the treasurer and head of investor relations.

Jeff Beyersdorfer

Good morning. Thanks for coming. Again, my name is Jeff Beyersdorfer, treasurer and head of investor relations. If you don’t mind, I’m going to walk around a little bit as I make remarks about the slides.

Over the next 25 minutes, I want to talk about three topics, or hit three things. One is a brief overview of our asset base and the markets in which we operate. Number two, talk about the well-documented already WTI Brent Spread, both what implications that has for us from an operational perspective and also from a hedging perspective. And then number three, spend a little bit of time on the capital structure of the company and talk about some of our initiatives for the capital structure longer term.

So quickly, a brief overview of the company. We’re mainly a Southwest-based/focused company. Two operating refineries, one in El Paso, Texas, one in northern New Mexico. Combined, about 150,000 barrels a day of production. We also have a retail business, about 206 retail stores, primarily in the four corners region of the U.S. We also have a wholesale business that distributes about 70,000 barrels a day of product from El Paso and Gallup.

We have some refined products terminals and asphalt terminals, and I’ll also touch on this during the presentation, we’ve got an idled asset on the east coast in the form of a Yorktown refinery. We idled it a little over a year ago. We’re operating it today as a terminal. And again, I’ll touch on this a little bit later in the presentation.

Here are the markets we serve. This is a slide that shows all the product pipelines, refined product pipelines, in the southwest, overlaid with our two refineries. And as you can see, El Paso kind of sits at the hub of this hub and spoke system. It’s a gateway for all the refined products to the west. And the major markets we serve are El Paso itself. We also serve Juarez, Mexico, Phoenix, Tucson, Albuquerque, and Flagstaff, Arizona.

And we think we’ve got a little bit of a unique advantage given our geographic location on the pipeline system, given that the gasoline specs in the southwest are fairly patchworky and require different grades of gasoline, different grades of fuel, during different times of the year. And we think, because we’re at this hub of the hub and spoke system, we can blend those products in El Paso and deliver them on perhaps a just-in-time basis relative to some of our competitors.

This slide, one of the equity analysts has, for a couple of years, ranked the independent refiners on a refinery basis - this is all publicly available information - on an operating margin per barrel basis. And you can see the yellow highlights are our El Paso and Gallup refineries, and we’ve moved up to the top quartile of this ranking over the last year and a half or two years.

But more interesting than that, though, is the common theme that all of these top-ranked refineries have. That is, they sit on top of their crude source, number one. This is not a demand-driven margin environment today we’re in. It’s a crude-driven environment. So they all sit right on top of their crude source. Number two, they tend to be smaller, inland-based refineries. So there are some common themes for those that are doing fairly well on a margin per-barrel basis versus everyone else.

Okay, a couple slides on the WTI Brent Spread. So it’s been, as I said, fairly documented by a number of folks out there what’s transpiring in the U.S. domestic crude market. Again, quick summary. Historically, WTI and Brent have traded at parity, or close to parity. And at the beginning of this year, those two benchmarks started to break apart, or disaggregate in terms of their pricing, with WTI now trading at about $24-25 less than Brent crude.

And that’s primarily driven because of some technologies that have now been introduced, hydraulic fracking, horizontal drilling, in some mature fields - the Permian, the Bakken, Eagle Ford - and we’re now seeing a number of independent producers, as well as large producers, forecast pretty significant volumes of crude.

So because of that, we’ve seen this disconnect between WTI and Brent, and the theory goes that until that crude, WTI, that has this forecasted significant production, can get to water, basically, can get to a home, it’s going to trade at a discount to Brent. And how does it find a home? Infrastructure has to be built. Rail in the short term, trucking in the short term. Longer term, pipelines.

And so most of the experts out there predict that it’s probably 2013 or so before all that infrastructure can be built and then these two crude benchmarks trade at parity or close to parity going forward. And in the meantime, those refineries, or those refiners - on the bottom right hand corner I list a number of them - that have exposure to that WTI crude - we by the way have about 100% exposure to that WTI crude - are going to enjoy this disconnect, and enjoy good margins until that infrastructure is developed out.

Here’s how it has implications for us on the operations side. In the Permian, which is in our backyard for the El Paso refinery, we’ve got a play that’s known as Bone Springs, and Avalon. And we have done some testing of that crude at the El Paso refinery, and it tends to be a super sweet crude, and easily processed at our refinery. And so today we’re running about 5,000-10,000 barrels a day of that crude at our refinery, and it’s being trucked there.

Again, you heard me say a couple of minutes ago in order to run a big amount of crude, or get this crude out, you’ve got to build pipelines. So we’re in the process of evaluating pipeline infrastructure from this Bone Springs and Avalon field into the El Paso refinery that perhaps in a couple of years will allow us to process maybe up to 35,000 or 40,000 barrels a day of crude at El Paso. It’s a better crude than we’re running today. It’s got a better yield, and it tends to be pretty price competitive.

So that’s how it’s helping us on the operational side. On the financial side, we have seen, because of this WTI Brent phenomenon, the forward curves for the Gulf Coast 321 Crack Spread - which, again, is a proxy for our gross margins - we’ve seen that forward curve increase pretty precipitously since the end of last year, the beginning of this year.

So if you look at forward curves, the bottom curve over on the right hand side, the [12/31/10] curve, you can see it averaged a little under $10 through 2012. And today, at the end of September, you can see it’s a downward sloping curve, but we’re averaging about $30 in the near months and still averaging about $20 in the outer months.

So we’re able to take advantage of that by hedging some of our future planned production. And so starting in February of this year, we began implementing hedges, gasoline cracks, diesel cracks, and here is our hedge book as of September 30. Unfortunately, all these hedges don’t qualify for hedge accounting. So they go through the income statement. They’re mark-to-market through the income statement.

And what we show here on the right hand side is the realized and unrealized losses for each quarter and the third quarter - this is new information in anticipation of our third quarter earnings call - we have a realized mark-to-market - that is, the hedges that were realized during the third quarter of about $11 million negative, but unrealized losses of about $95 million negative.

And again, what’s transpired is since we’ve been putting these hedges on in February, March, April, and May, the margin environment continued to go up. The forward curve continued to go up. So the strike prices were below the market, and continued to be some below the market today. As you mark those things to market, we have to record a loss through the income statement. But again, 70% of our business is exposed to the higher margin environment continuing to increase.

I wanted to depict where our average strike price is for these hedges that we’re putting on. So what we’ve done is looked at gasoline cracks and diesel cracks, which are the two components of the Gulf Coast 321. You can disaggregate it into gasoline cracks and diesel cracks.

Here’s historically the gasoline cracks since 1996. You can see the actually results. In 2005-2010, the averaged around $8.50 a barrel. There were some spikes in there because of weather related things, or unplanned downtime, but what we’ve seen is unprecedented margin environment for gasoline cracks in the future.

And you can see where we’ve averaged our hedges. In 2012 they were a little over $17 a barrel. That’s about a doubling of the last 5-6 year historical average. So, again, we think it’s the right thing to do given our capital structure, which I’ll talk about in a second. It’s the right thing to do, we believe, for us, to sell some of our product forward in the forward markets and lock in some of that cash flow going forward.

Same thing on the diesel side. This, again, is a graph of ultra-low sulfur diesel cracks. ULSD diesel cracks. And you can see 2012 our average strike price for hedges is a little under $29, and for ’13 and ’14, a little under $28, well above where the 2005-2010 average has been of about $15. So, again, we believe that the prudent thing to do from the financial perspective, given our balance sheet, is to lock in some of these margin environments that lock in that cash flow.

Okay, a couple of other comments about our business, and then I’ll get into the capital structure. Yorktown is an asset, a refinery, that we idled a little over a year ago, located on the Chesapeake Bay, in Virginia. We have been working on a dual track in terms of leasing up the terminal asset portion of the refinery. We’ve got a disproportionate amount of storage at that facility, about 5 million barrels of storage.

We’re going through a process of trying to lease that up while also talking to a couple of third parties about the potential sale of that asset. And as we mentioned on our second quarter call, two parties have talked to us about the potential sale of that facility and we expect hopefully to monetize that facility in the near term and make an announcement.

The other two businesses I want to talk about are other distribution networks for our refined product. So the first is our wholesale business. We have a wholesale business that we believe is unlike most others in that we sell refined product all the way through to the end user, to the railroads, to the mining companies, to the little landscaper in Tucson who’s got three trucks that he’s got to fill up on a weekly basis. All those guys are customers of ours, unlike our competitors, which sell at the rack. They sell just right at the rack and don’t know, necessarily, where the final disposition of their product is going.

So it allows us a couple of advantages. It allows us ratable outlet for our production. We, again, sell about 70,000 barrels a day through our wholesale network. And it allows us to keep a pulse on the margin environment and the market. We get some demand feedback from our end customers that perhaps some of our competitors don’t get. So that’s one distribution network for us, is our wholesale distribution.

The other distribution network for us is our retail. And as I mentioned upfront, our retail operations are focused in the four corners area. We have recently added about 50 sites, so we’re up now to around 205-206 sites across the Southwest. About 70% of Gallup’s gasoline production goes to feed our retail sites. So it’s an important distribution outlet for us that we like and we enjoy. So, again, two strong distribution outlets. The wholesale side, the retail side, got good disposition to the end users of our products. We have ratable distribution every day. We know where our product’s going at the end of every day.

Turning to financials, and then I want to talk about the capital structure. These are second quarter financials. You can see what the margin environment was like in the second quarter. This is old news. The Gulf Coast 321 continues to increase on a per-margin per-barrel basis. During the third quarter it was around $32.60 a barrel. In October it was around $33 a barrel. So you can see the implications of that. The margin environment continues to strengthen and remain strong.

Capital structure. I’d like to spend a couple minutes on this page and provide for you some details about what we’re doing with respect to our capital structure and our uses of cash. So first of all this is the end of the second quarter. Since then, we’ve revised or amended our revolver, and increased the size to $1 billion - it was $800 million - and extended the maturity through September of 2016.

We, despite recent results, recent results in the crude market, believe crude prices are headed higher over the midterm. And as crude prices head higher, that requires more liquidity on our part in order to pay for that crude. So we thought it would be prudent to increase the size of the facility from $800 million to $1 billion. So we announced that a couple weeks ago.

The second piece of debt in our capital structure is a term loan that we amended back in March, and we extended the maturity to March of 2017. The fixed rate on that term loan is 7.5%. And so we feel pretty comfortable about that piece of paper for the time being. We’re treating it as our pre-payable debt. So any kind of cash we get in that we can’t find other uses for, that’s our pre-payable debt in the capital structure.

The third piece is the senior secured floating rate notes. This is the instrument that we have been fairly vocal about calling, in December of this year, with cash on hand. It’s a high coupon. It’s at 10.75%. It becomes callable in December, and our expectations are as of right now to call that instrument in December when it becomes callable.

Senior secured notes, 11.25% coupon on those notes. We cannot call those until the middle of 2013. And they’re the highest coupon in our capital structure. So we’re a little bit hamstrung as to what to do with those notes. But if the high-yield market comes back around again in favor of us, we may take an opportunity, perhaps, to look at issuing paper with a short call structure on it and use those proceeds, plus some cash on hand, to tender for those 11.25%s. Again, depending upon where the high-yield market is.

And then finally, the senior convertible notes. Those mature in 2014, and again I’d like to remind everybody who’s wearing an equity hat out there that these notes have to be considered when you’re calculating EPS on a quarterly basis, or you’re running your models and calculating EPS on a quarterly basis. They are a dilutive security, and depending upon the net income that we might generate in a quarter, they might be dilutive. And the break point is about $20 million a year.

So if we make more than $20 million a year of net income, which we did last quarter, these securities are dilutive, which means we have to assume that they’re converted, and the math is about an extra 19.9 million shares that you have to add to the base share count of 90 million. And you have to reduce interest expense by about $3.6 million after tax per quarter to make the correct adjustments. Again, if you’re EPS-focused.

So we’re making progress on the capital structure. We think we have a plan short term and in the mid-term of where we’d like to go and how we’d like to reduce debt. Where we’d like to be is a BB credit in the mid-term. We’re B today. BB credit, the statistics attendant to a BB credit is about 1-1.5x levered through mid-cycle conditions.

And we think, at least historically, mid-cycle conditions for us results in EBITDA of around $350 million or so. So you’re looking at 1.5x that. That’s about $500 million of debt. We have a little over $1 billion of debt today. So we’ve got to reduce debt by about $600 million to at least theoretically get us to where we want to be from a credit standpoint. And that is the short term goal of management.

Final page, just some takeaways. Again, we’re working on this Permian Basin phenomenon, this crude that’s coming on board. We’re evaluating the potential of how do we run more of that crude coming from the Bone Springs and Avalon play. So that’s near term capitalizing on the Permian Basin dynamics. We have a turnaround at Gallup, a maintenance turnaround at our Gallup, New Mexico facility, next fall, and we’re evaluating the potential of increasing crude throughput there by a couple thousand barrels a day.

We’re looking at our logistics assets. You know, I shared up front that we’ve got a number of product terminals, asphalt terminals, pipelines, gathering systems, and we’re evaluating the best way to maximize those assets, whether that’s through a strategic partner or a financial partner, doing something on our own in the NLP world. We’re going through that evaluation process of making sure we understand all those opportunities available to us.

But most paramount in the short term is fixing the balance sheet. I took you through the steps in how we’re planning to get from A to B. And that is management’s focus short term, is to pay down debt, strengthen the balance sheet, and make sure we’re set up for the future.

Okay, any questions?

Question-and-Answer Session

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

Yeah, the question is what risk do we have for pipeline infrastructure to be built, in particular to Western? The first one that comes to mind, for example, is the Magellan Pipeline. So Magellan’s a products pipeline today that runs from the Houston Ship Channel to El Paso, and Magellan has been fairly active in announcing that they plan a reversal of that pipeline from about halfway across Texas back to Houston, and turn it into a crude line.

That helps and hurts us. And so we think it’s a net neutral. It hurts us because there’s another competitor for, perhaps, some of the crude that we are planning on running. That gets crude out of the West Texas market back to the Gulf Coast. So it’s taking crude away from our system. But it’s a positive for us because theoretically it limits the amount of product that comes west through El Paso into Tucson and Phoenix that competes with us. But net-net, we think it’s a neutral.

Other just generic pipelines, as pipelines are announced and built, all the pipelines we suspect that are announced out there won’t necessarily get built. But those pipelines, as they’re built, and as they’re constructed, again, theoretically, may, or probably should, contract that WTI Brent Spread and that has implications for the Gulf Coast 321 Crack Spread. It will decrease that spread also going forward.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, when I was speaking about the capital structure and debt, did I say that we needed to reduce debt by about $600 million? Yes, that’s our target. Again, we’d like to be a BB credit. And again, I’m using the credit statistics [unintelligible] to a BB credit, about 1-1.5x, through mid-cycle conditions. That tells us we’d like to have about $500 million of debt remaining on the balance sheet. So to get from the 1.1 today to the $500 million, it’s $600 million of debt reduction.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

Yeah, so the question is, how we get there is perhaps the floaters, paying those down first, plus redeeming the convert when it becomes due in 2014, and then maybe treating the term debt as more prepayable debt, perhaps, and then perhaps refinancing that and then refinancing the 11.25s? That’s perhaps one way to get there, yes, is in the near term, pick up the floaters - which, again, we’re planning on doing later this year - perhaps addressing the convert. Or, that term debt - again, we can treat it as prepayable debt, and we have it prepayable at any time. That’s another way, perhaps, that we can get to our desired capital structure.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is have we talked to the rating agencies and discussed with them our view of the future and what’s their feedback? We have pretty regular dialog with the agencies. They like our plan. As you can imagine, though, they’re not going to give us credit for it until we actually carry out and execute that plan. But for the near and mid-term, they think debt reduction is paramount for us. And so they agree with the plan that we have in place to get where we need to be in terms of the capital structure.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, today, you’re correct that El Paso, we’re trucking around 5,000-10,000 barrels a day of the Bone Springs Avalon crude into El Paso? What are the costs for building out the pipeline? We’re still in the evaluation phase, so we don’t have a number for you, but perhaps in the next couple of earnings calls, we’ll be able to share a number with the market and be able to share kind of the overall economics of what that crude dynamic looks like.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, what is the range of expected proceeds from the Yorktown? I think, early on when we announced that we were looking at strategic alternatives for Yorktown, we gave some guidance in terms of after we had that facility leased up, it might be able to generate around $20-25 million of EBITDA. We have not given guidance on any earnings or proceeds expectations, but when we did that, the analysts out there gave their projections, so I’d ask that you refer to all of the analyst reports in terms of actual proceeds. We haven’t given guidance on what proceeds might be.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

What percentage of our 2012 is hedged? It’s a little over 30% that’s hedged today. And that’s about where we want to be for 2012.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, is Yorktown affected by the backwardation of the crude environment today? That really doesn’t have any implications for the terminal asset that we talked about disposing. That’s really a fee-based business, where you’re just generating fees from storing refined products or selling it over the rack. So the crude market really doesn’t have any implications for the value of the terminal.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, the 5,000-10,000 barrels a day that we’re trucking into El Paso, how much can we increase that by? Via truck or via the pipeline that we’re evaluating?

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

I think it’s very little. It’s been pretty well documented that part of the reason that this WTI Brent Spread has been so wide is the lack of available trucks, and more specific, the lack of drivers for crude trucks. And as a result, I don’t think we’re going to be able to do much more than what we’re doing today, until that gathering system and pipeline is built to deliver that crude to the refinery.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

It’s close to what we’re paying today, for WTI that we’re buying today. But again, it’s got a better yield for us, because it’s a super sweet crude. So we get better product yields from the crude.

Unidentified Audience Member

[inaudible]

Jeff Beyersdorfer

The question is, the availability of crude drivers, what’s the roadblock, if you will, or barrier to entry? You actually need somewhat of a sophisticated driver to drive crude trucks, to do math calculations for crude deliveries. It’s not like driving a regular transport truck to deliver commodity packaged goods or anything like that. And I’m sure there are lots of people trying to figure out how to become crude drivers today, but we just have read and have talked to a number of people that have shared with us that it’s really difficult to find crude transportation drivers today.

Any other questions? Okay, thank you very much for your time. We certainly appreciate it.

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: transcripts@seekingalpha.com. Thank you!

Source: Western Refining's Management Presents at Deutsche Bank Leveraged Finance Conference (Transcript)
This Transcript
All Transcripts