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Western Refining, Inc. (NYSE:WNR)

Q3 2012 Earnings Call

November 01, 2012, 11:00 am ET

Executives

Jeff Beyersdorfer - SVP, Treasurer, Director of Investor Relations

Jeff Stevens - President & CEO

Gary Dalke - CFO

Mark Smith - President, Refining and Marketing

Analysts

Jeff Dietert - Simmons

Roger Read - Wells Fargo

Chi Chow - Macquarie Capital

Cory Garcia - Raymond James

Rakesh Advani - Credit Suisse

Operator

Good morning. And welcome to the Third Quarter 2012 Western Refining Earnings Conference Call. After the speakers’ opening remarks, there will be a question-and-answer period. (Operator Instructions) As a reminder, ladies and gentlemen, this conference call is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. 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.

Jeff Beyersdorfer

Thank you Jackie and good morning. I would like to thank you for taking the time to listen in today and for your continued interest in Western Refining. Again, my name is Jeff Beyersdorfer. I am the company’s Treasurer and Director of IR.

Joining me for today’s call are Jeff Stevens, President and CEO; Gary Dalke, our 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 in 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 Statements 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 on the IR section of our website.

I’ll now turn the call over to Jeff.

Jeff Stevens

Thanks, Jeff. And welcome to everyone on the call. Today, we will discuss our third quarter performance. After my opening remarks, Gary will review our earnings in more detail and provide operating guidance for Q4 2012. Then we will open up the call for your questions.

As we have said in the past, our 2012 plan was to continue to focus on safe and reliable operations, improve the balance sheet and reinvest in the business. In the third quarter, the fundamentals for our business remained strong and Western has continued to benefit from this favorable environment.

During the quarter, we made the decision to perform some very important plan work at both our refineries to ensure continued safe, reliable and efficient operations. At Gallup, we began a full turnaround of the facility and made other investments that will allow us to expand throughput and improve reliability. At El Paso, we took some planned downtime to perform a regeneration of our reformer. This work was initially planned for the winter’s turnaround however the performance of the reformer continued to degrade throughout the summer and we made the decision to complete the work in September.

In addition, while completing the reformer work, we took an opportunistic shutdown of this Southside crude unit. The decision to do this work at El Paso will improve operating efficiency and will give us the flexibility to potentially extend the cycle of this unit.

We also expanded the scope of our Gallup turnaround and therefore incurred additional cost during the quarter. And at El Paso, the plant maintenance work created higher feedstock and other cost which impacted gross margin. We estimate, the negative impact of these additional costs was approximately $25 million in the third quarter. Both refineries are currently running well and at planned rates. And I am proud of our employees and their efforts during this plant maintenance. We are pleased with the outcome of these investments and feel that we are well positioned to continue to capture this favorable margin environment.

During the quarter, the Brent WTI spread widened, creating very strong forward margins. As a result, we added to our 2013, 2014 and 2015 crack spread hedges during the quarter, which is consistent with our stated plan to opportunistically add to our positions. A summary of our hedge positions, as of September 30th, can be found on slide five.

Over the last year, we have used our strong cash flow to significantly improve the balance sheet. During the quarter, cash increased by $164 million, and as of September 30th our cash balance of $510 million exceeded our total debt of $496 million. I would also like to highlight that cash balances during October averaged approximately $670 million. We are comfortable with the overall level of debt and we will continue to look for opportunities to improve our balance sheet in the future.

Western continues to focus on investments that will enhance our core business; one example is our Delaware Basin logistics project which is progressing very well. We expect the first phase of this project which includes the truck off loading stations and tankage to be operational by the end of the fourth quarter.

I am pleased to announce that we have increased the pipeline capacity to allow delivery up to a 100,000 barrels per day of crude oil. This expansion was driven by the strong growth in crude production in the area. We expect the pipeline phase of this project to be completed by the end of Q1, 2013.

Because of El Paso’s proximity to the Permian Basin, we are already benefiting from access to the growing crude production. We believe there will be additional low cost, high return logistic projects that will enable us to further enhance the economics of running this advantage crude. Based on these opportunities, we are seeing, pending board approval, we expect a CapEx budget in 2013 to be around $200 million to $225 million with a significant portion dedicated to discretionary capital.

In the third quarter, we generated $236 million of adjusted EBITDA. This performance due to continued strong refinery margins, driven in part by the continuing wide Brent WTI spreads. In addition, product values improved during the quarter and have continued at alleviated levels in the fourth quarter especially areas impacted by the West Coast margins.

Our Southwest wholesale and retail businesses performed well in the quarter. Wholesale fuel and lube volumes were improved compared to Q3, 2011 and in retail, fuel margins were significantly improved and fuel volume and merchandize sales were up due to the performance of locations added through acquisitions.

Turning to the fourth quarter, the average Brent WTI spread in October was the widest spread we seen all year. In addition, the WTI Midland/Cushing differentials have widened out and Southwest product margins have remained strong. These factors are providing strong refinery margins for Western and the investments we made in the third quarter will allow us to have another outstanding quarter.

One of our priorities continues to be returning cash to shareholders. In July, our Board approved $200 million share repurchase plan and through October we have repurchased more than $60 million of our shares. Our intent is to use share repurchase to partially offset potential dilutive effect of our convertible bonds.

In addition, in October we announced that we will pay a dividend of $0.08 per share in the fourth quarter which will be paid on November 9th. Including this upcoming dividend, we will have returned more than $80 million in cash to shareholders since the beginning of the year.

In closing, it was another solid quarter for Western. We anticipate that the strong margin environment that we are seeing currently will continue into 2013 and we have positioned Western to continue to capitalize on this outstanding opportunity.

Now I will turn the call over to Gary who will go through our third quarter financials in more details.

Gary Dalke

Thank you Jeff. On a GAAP basis the company reported net income in the quarter of $6.3 million or $0.07 per diluted shares, which compares to Q3 2011 net income of $84.9 million or $0.81 per diluted shares. Summary of third quarter highlights and key financial information can be found on slide 3. Excluding special items the company had net income of $105.2 million or $0.99 per diluted shares in Q3 2012 which compares to $146.4 million or $1.37 per diluted shares in Q3 2011. The special item in the quarter was a non-cash unrealized hedging loss of $152.8 million, a reconciliation of our net earnings to earnings excluding special items is included in our press release.

As shown on slide 4, our refineries demonstrated very strong gross margins during the quarter with both facilities generating more than $28 per barrel. However as Jeff mentioned the plan worked negatively impacted gross margins by approximately $17 million primarily through increased costs of certain more expensive feed stocks. Direct operating expenses at our refineries were $6.47 per barrel for the quarter, which compares to $5.41 per barrel in Q3 2011. This increase was primarily due to the cost and reduced throughput resulting from the planned maintenance at both El Paso and Gallup.

A Gallup maintenance turnaround expense in the third quarter was approximately $31 million. During the third quarter at El Paso we increased our property tax accrual last month by approximately $9 million resulting from revised property appraisal roles for 2012. We believe the appraised property values to be in there and filed a lawsuit in State District Court to appeal the suppressed value.

Total company SG&A was $27 million for the quarter compared to $27.2 million in Q3 2011. As Jeff mentioned, adjusted EBITDA for the quarter was $236.3 million which compares to adjusted EBITDA of $296.9 million for Q3 2011. As a reminder, we now include an adjustment for non-cash unrealized hedging gains and losses in our adjusted EBITDA calculation.

Depreciation and amortization expense for the quarter was $23.6 million, a decrease of $12 million compared to Q3 2011 due to the Yorktown sale. Interest expense was $18 million, a $15.2 million decrease compared to Q3 2011 primarily a result of our significantly reduced debt level. Cash and cash equivalent stood at $509.8 million at the end of the quarter, a bridge from Q2 2012 to Q3 2012 and in cash position can be found on slide six.

Cash flow from operations for the quarter was $247.4 million, which compares to $255.8 million in Q3 2011. Also during the quarter Western entered into an agreement with Glencore which enables both companies to grow the East Coast wholesale business. We also sold the inventory associated with our East Coast business to Glencore as part of the transaction.

Total capital expenditures for the quarter were $71.3 million. As of September 30, total debt stood at $495.8 million, which is below our total cash level. A summary of our capital structure is available on slide 7. Our total debt-to-LTM adjusted EBITDA leverage ratio improved significantly, decreasing from 1.8 times to 0.5 times over the last year. Liquidity which we define as cash and availability on our revolver was approximately $850 million at the end of the quarter and has averaged about $1.1 billion thus far in the fourth quarter. As a result of our improved financial position, we received an upgrade from S&P in July with our corporate family rating moving from B flat to B plus and our Senior secured rating moving from B plus to BB flat.

Lastly, you can find our fourth quarter operating guidance on slide eight. I would like to note that we completed the Gallup turnaround in mid-October and in the fourth quarter we expect turnaround maintenance expense to be approximately $12 million. In addition, we will be completing a turnaround of El Paso’s north side in Q1 2013, and the anticipated maintenance turnaround expense in the first quarter will be $30 million to $35 million, which we recorded separately from direct operating expenses. Jackie, we will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line Jeff Dietert with Simmons.

Jeff Dietert - Simmons

You mentioned in your opening remarks that your expanding gathering system, I believe the previous guidance was 40,000 barrels a day and you are going to a 100,000 barrels a day and if you would confirm that and talk about how you expect that supply to ramp up in the quarters ahead?

Jeff Stevens

Sure Jeff that project is really kind of a two phased project, the first is the truck station and the tank each in connection into the line going to El Paso. The truck station should ramp up we believe up to about 15,000 to 20,000 barrels a day of crude oil of the light sweet crude that we have talked about and that should come in the first quarter. As the pipeline connection gets finished in late Q1 of 2013, we believe that that will ramp up over the next 90 to 120 days to an additional 30,000 to 40,000.

So we believe probably by mid-2013 between those two projects, we should be bringing in somewhere between 40,000 and 60,000 barrels a day, but I will just tell you that there is a lot of new crude coming online and frankly that’s why we have expanded the size of the pipeline for this project because we believe over the next 12 to 16 months we will be able to ramp that up to about close to 80,000 to 90,000 barrels a day potentially coming in from this area.

Jeff Dietert - Simmons

In some of your presentations you get some nice graphic showing the new pipeline projects Permian Express, West Texas Gulf, Long Horn coming into the Permian basin, could you talk about how you expect that to influence the WTI cushion, WTI midland pricing relative to the coast?

Jeff Stevens

Well, I mean obviously today Jeff, we are at a point where it’s a pretty strange system on getting barrels out, what we seen this year as anybody had any hit up whether it’s a pipeline company, whether its one of the local refineries, we’ve seen some pretty dramatic spikes in the differential between the Midland and Cushing. And obviously some of these projects have the potential of being done sooner than later, but a great of it still has permitting and some pretty long time tables to get billed and get going.

So really what we look at is the next 12 to 24 months we think will continue to see volatility in that differential and continue to see wider Midland/Cushing spreads than we’ve historically seen. And anytime that is either planned or not planned outage with one of the local refineries we are going to see that volatility. So we just recently seen that just in the last week we have seen that differential between Mid and Cushing as wide as $6. So it doesn't take much to cause that spread a widen out.

Jeff Dietert - Simmons

As your shale Permian Express provides some relief on the basin pipeline from Wichita Falls and West Texas Gulf from Colorado City. Do you think that release the Cushing bottleneck more so then specifically the Permian Basin bottleneck?

Jeff Stevens

Well, I think that a lot of this things when they are contemplated just seen to relive or seem to have some type of relief towards the constraint that we are seeing whether it’s a Cushing or whether it’s a Midland. I think the problem that we are going to have going forward is that the crude that's coming on line whether its in the Permian basin, whether its coming from Canada, whether its coming from the Bakken continues to think outpace what the estimates are and so I think that relief is kind of an understatement for the next couple of years until we really get a handle on what the production levels are going to look like.

Operator

Your next question comes from the line of Roger Read with Wells Fargo.

Roger Read - Wells Fargo

Could we just real quickly review again the sort of OpEx issues that hit you in Q3 and again compare those to the Q4 and Q1 expectations of $12 million in the $30 million to $35 million, just what was the magnitude of the turnaround expense for both units in the third quarter?

Unidentified Company Speaker

Mark you want to go ahead and answer that?

Mark Smith

Sure, in the third quarter, our guidance on the turnaround expense was $25 million. We ended up spending in the third quarter $31 million and we anticipate an additional $12 million in expense in the fourth quarter. And for the work outage in El Paso about $2 million was spent during that outage.

Roger Read - Wells Fargo

And then as we think about the impact of ramping the 40,000 barrels a day, maybe ultimately a 100,000 barrels a day of crude through your own pipeline and trucking operations, can you refresh us again on sort of the expectation for what that would do for I guess in a sense yields but mostly just the quality of the crude coming in and how that's do help you run?

Jeff Stevens

Well, we have stated before Roger that the crude that we are going to be bringing in versus the crude that we have historically run, it’s a higher quality crude with less bottoms and we have a much better yield process and then we have on top of it because these crudes were getting are closer in location to El Paso we are able to get some location discount. So the way we are looking at it is kind of on the conservative and it should improve economics anywhere from $1.50 to $2 a barrel versus what we've historically run is what conservatively we are kind of counting on.

Roger Read - Wells Fargo

Is that kind of a 50-50 delivery versus yield improvement or much more one of the other?

Jeff Stevens

It’s probably a little more 60-40.

Roger Read - Wells Fargo

And as we look at Gallup, I mean there has been talk about and falling off the pipeline discussion, talk about the pipeline that runs up to that part in New Mexico potentially being reversed, anything along those lines to add today?

Jeff Stevens

Well, I mean that's going to be predicated on what we see as far as crude production out there. Today, as there is more crude than we can currently run, we are bringing crude down to Gallup and loading railcars and moving that crude through railcars and what we said is there is a lot of expectations that the crude could expand quite a bit in that area and we want to be ready if it does to be able to move that crude.

So right now, like I said we are moving it via rail, the additional barrels but if the crude ramps up to what some of the producers’ expectations are we certainly could put that line back in service and move crude that way.

Roger Read - Wells Fargo

Any timing on that or just you had to see the barrels and that’s what defines it?

Mark Smith

Yeah, I mean, we need to see the production. We do have some money and the capital budget in 2013 to do the things that to get ready to potentially reverse that line and understand all of that stuff. So we're going to be prepared if that crude comes.

Operator

Your next question comes from the line of Chi Chow with Macquarie Capital.

Chi Chow - Macquarie Capital

Thank you. Jeff you mentioned that you bought back 60 million of stock. Was that all in October? Was there some in the three quarters as well?

Jeff Stevens

Chi, it's Jeff. We did by a modest amount of stock back as of September 30, but the majority of the 60 million happened in October.

Chi Chow - Macquarie Capital

Okay, and do you have sort of targeted timing on completing the $200 million buyback program?

Jeff Stevens

The approval we got was from the year we announced it in early July. We got a year to do it from a board approval standpoint. We don’t have any other timeline besides the approval that’s been granted by the board.

Chi Chow - Macquarie Capital

Okay and on the strategy, is it more, how are you looking at certain price points to implement those buybacks or is it just more ratable repurchases?

Jeff Stevens

We will be opportunistic in buying shares back.

Chi Chow - Macquarie Capital

Okay, and there was some talk earlier about that (inaudible) pipeline or products line from El Paso into Northern Mexico and possible expansions, have you any update on that front?

Jeff Stevens

You know, Chi, obviously Mexico continues to by very start, finished products coming, into their country as far as imports and there has been talk about expanding the system down into Mexico and moving particularly further west. As far as we know at this point it’s only been talk we haven’t seen anything that we believe anything is going to happen in the near future, but certainly the entry point through El Paso is still a major important gateway to get product down there and I think that as they look at their future needs that they will have to expand their pipeline if they are going to continue to meet their demand.

Chi Chow - Macquarie Capital

Can you remind us how, what the capacity is on the pipeline and any comments on how much volume or shipping down there right now?

Gary Dalke

Well, the pipeline capacity going from the one that we access out of our refinery that goes south is approximately about 30,000 barrels a day of product and we have said kind of on a combination between diesel and gas we average about 17,000 to 20,000 barrels a day of product that we export to them.

Chi Chow - Macquarie Capital

Okay, great. Well given all the talk on the expanding crude production in Delaware and Mexico demand any further thoughts on expanding the El Paso refinery going forward?

Gary Dalke

Absolutely, we have some plans that we would like to move forward on and as I said before I think our biggest hurdle will be the permitting process. So we are moving as fast as we can through the permitting process, but I have been warned that it’s going to take some time to do it but we believe that we could expand El Paso for a reasonable amount of capital 25,000 to 30,000 barrels a day of additional capacity, but I think the thing that's is hold it up right now is just the permitting process but we are spending some capital in 2013 to get ready for that Chi, but I just think that we need to be realistic that it’s going to take a while to give the permit.

Operator

(Operator Instructions) Your next question comes from the line of Cory Garcia with Raymond James.

Cory Garcia - Raymond James

Just wanted to sort of several back to that ‘13 budget there you guys throughout 200 to 225, would you able to provide any sort of granularity in the split between the actual discretionary portion itself, so how much would be figured toward your pipeline logistics out of them, the majority of that versus sort of this refining capital projects that you guys have?

Gary Dalke

Sure, well, the overall budget about 60% is discretionary capital and then when you kind of break it out about $40 million would be tied directly to logistics additional pipelines and tank each and other stuff to support mainly the crude supply, crude gathering for El Paso will be the biggest part of that.

And then the last big piece of that is at El Paso and that's really to support some individual projects that helped with their overall efficiency and reliability but also some of it has to do with the potential expansion of the facility that we have talked about in either 2014 or 2015 and that's obviously predicated on the permit process.

Cory Garcia - Raymond James

Sure, okay. What sort of capital if I could tie it down to a rough amount for the El Paso portion itself in terms of the expansion relative to some of the other efficiency projects.

Gary Dalke

It’s just; it’s about $25 million to $30 million of it.

Operator

Your final question comes from the line of Rakesh Advani with Credit Suisse

Rakesh Advani - Credit Suisse

I guess with your announcements on expanding the off tick out of the crude logistics project, do you think that you are building up sufficient skill to even possibly look at doing an MLP down the road of the logistics assets?

Unidentified Company Representative

Well, I mean two things, one is we have a set of existing logistic assets within Western today that are very good logistic assets that certainly meet the criteria in an MLP. And certainly, we've talked about these additional ones that we are working on right now and the ones we will be working on 2013 meet that criteria. We continue to look at all of our options. We realized from a multiple standpoint, we are not getting credit for our logistics assets and I think we are going to continue in 2013 to look for strategies to make sure that we get the highest value we can out of these assets so one of the things I've always said to people is that Western is the primary user on most of these assets and the first thing we needed to do was get our balance sheet in order and make sure that our underlining credit, we didn't take a discount on this. So as we've done that and have gotten to this point, we can now focus on these assets and make sure that we get the right value for them.

Operator

That was our final question. I would like to return the call to Mr. Jeff Stevens.

Jeff Stevens

Thanks Jackie. And I want to thank everybody for your participation today and your continued interest in Western. Thank you.

Operator

Thank you. That concludes today's third quarter 2012 Western Refining earnings conference call. You may now disconnect your lines and have a wonderful day.

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