Unlocking Value In The Refining Sector

Includes: ALDW, CLMT, CVI, PBF
by: Rick Husband


Refiners historically have been a value trap.

Recently, an LP corporate structure shows signs of unlocking its value.

There are two new players that appear to have significant upside as a result.

I recall years ago the Value Line analyst for refiners remarking or lamenting that while they all had solid balance sheets, do the right things for the shareholders, and are in an essential industry, they trade at low valuations. I second that. Looking at recent NPV snapshots I did, major independent refiners tend to trade at a discount.

Company Symbol Discount/Premium
Valero VLD -30%
HollyFrontier HFC -35%
Tesoro TSO -7%

Formerly integrated refiners tend to be only fairly valued without much of a premium.

Company Symbol Discount/Premium
Marathon MPC 14%
Phillips PSX 19%

We're not setting any fires here when we compare the group as whole to other industries.

Being a value investor, I generally want something at a discount or at a fair price. But I also want a catalyst. These companies will do better when crude is high, which is also counter intuitive, as crude is the major factor of production. When oil prices are tighter, so too are the crack spreads, as there is less flesh in the food chain. Beyond a price anomaly resulting from news, etc., we are looking at a value trap or long term, stable appreciation at best.

Enter Carl Ichan, who buys CVR Energy (NYSE:CVRR), which has a couple Midwest refineries, and restructures the company as an LP, and by the same NPV measure is trading at a 49% premium. In addition, it is distributing a 6.5% dividend. Was he looking at Calumet (NASDAQ:CLMT) which also adopted an LP structure a year or two before? I have it at a 170% premium and it has on the current entry price a yield well north of 8%.

I argued in a comment to an article on this site that CLMT is somewhat different than other refiners being into branded products and so on, as well as not having some recent acquisitions reflected in the cash flow numbers I used in the valuation snapshot. Calumet also had significant capital appreciation in the current bull market. The new CVI has not been around as long. That said, I'm asking myself, is the LP corporate structure a way to unlock the value of these otherwise boring stocks? Total return at last?

Seth Klarman in the last two quarters has significantly raised his position in a newly formed refiner LP, PBF Energy (NYSE:PBF). By the same measure, I have this at a recent 85% discount to NPV and a 4% yield. One of the three refineries it bought was previously in mothballs, which the parties who formed the company felt like they got a pretty good price for, and PBF recently spun off a logistics LP subsidiary, raising a fair amount of cash. There is suggestion of another acquisition. Klarman also bought into an Alon subsidiary spinoff of its Big Spring Refinery to supposedly capitalize on low Permian transportation differentials given the E&P activity in the vicinity of the refinery, Alon USA Partners, LP (NYSE:ALDW). I have it at a 68% discount and a 16% yield per Yahoo, but note it has next to no dividend history, along with PBF. Let's summarize the new refining animals:

Stock Symbol Disc/Prem Yield (Yahoo)
Calumet CLMT 170% 8.6%
CVR CVI 49% 6.5%
PBF Energy PBF -84% 4%
Alon Partners ALDW -68% 16%

LPs tolerate more debt, have complex ownership structures (see the 10-Ks), and are potentially tax advantaged for the investor. My numbers are before tax, while the other players above have Federal, corporate income tax in the NPV valuation snapshots. Your numbers are the same if you are in a Roth VS a taxable or tax deferred account, but I'm not a tax expert. But apart from driving your tax accountant batty, I'm curious how the newer refiner LPs PBF and ALDW will perform. Will they become good total return plays like CVR and Calumet? Most of the other refinery companies above have spun out logistics or pipeline/terminal subsidiaries as LPs for an additional financing option. Yet refiner LPs themselves are a relatively new phenomena, and the newer ones, ALDW and PBF, have attracted Klarman, as noted above. Baupost has 7.77% of PBF and is the third largest holder.

Disclosure: I am long HFC, PBF, CLMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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