Vertex Energy: Formative Moves Toward Formidable

| About: Vertex Energy, (VTNR)

Summary

In early February, Vertex Energy announced it entered into a new credit agreement demonstrating stewardship over its balance sheet.

The announcement also revealed a disconcerting setback in a key operation of the business - street collections.

But Vertex had already pegged 2017 as the year for street collection acquisitions to play out.

Vertex Energy (NASDAQ:VTNR) is a UMO (used motor oil) re-refiner. Since the downturn in oil prices, the company has found several ways to salvage its business operations. But, its true triumph has been the transformation in its debt obligations.

In 2014, Vertex Energy found itself in default of its credit agreement with Goldman Sachs. Goldman subsequently agreed to amendments which included waiving the default. At year-end 2014, Vertex Energy owed just over $40 million in long-term obligations. It faced a requirement to raise at least $9.1 million by June 30th, 2015 to meet conditions under the second amendment of the Goldman agreement.

At the end of June, 2015, Vertex Energy issued approximately 8.1 million shares of Series B preferred stock and raised $25 million to help meet its obligations. The proceeds were used to pay down $15.1 million (32%) of its debt. This was the first major step in turning the ship. By the end of the 2015 third quarter, Vertex owed $27.44 million in long-term debt.

In February, 2016, Vertex announced the sale of a base lubricating oil production plant in Nevada (its Bango facility) to Safety-Kleen Systems, a subsidiary of Clean Harbors (NYSE:CLH). Vertex used approximately $16 million to pay down its long-term debt. The obligation to Goldman now registered around $7 million.

Vertex announced a private placement of preferred stock in May, 2016. It raised approximately $19.3 million. The first use of the proceeds was to repurchase and retire $11.2 million worth of the Series B preferred stock issued in 2015 or approximately 3.6 million shares.

The remainder of the $19.3 million, $8.1 million, was used to pay down debt and for working capital needs.

By third quarter reporting in November, 2016, the total of Vertex Energy's obligation to Goldman was less than $5 million. Earlier in 2016, in conjunction with the sale of the Bango facility, the company had provided a promissory note to Fox Encore for $5.15 million. The net effect of the subtractions and additions meant the company's long-term debt registered at just over $15 million.

On Feb. 8, 2017, Vertex Energy announced it had secured financing for up to $30 million from Encina Business Credit. The availability comes in two forms - $20 million is available under an EBC credit agreement and $10 million under a revolving credit agreement. Vertex initially borrowed $11.3 million of the $20 million and used the proceeds to consolidate several of its debt obligations including the Goldman credit agreement and the Fox Encore promissory note.

The company also used funds to close on another collection route in Louisiana. Debt management may have been the primary focus for the past two-plus years. But, street collection ran a close second. In February 2016, the company even advertised its hunt for small collections businesses.

Street collection is the segment of Vertex Energy's business where it gathers used motor oil from local generators. In 2015, Vertex Energy was paying generators $1.00 per gallon for UMO. Pressures in the overall industry allowed Vertex to migrate from a pay-for-collection model to a charge-for-collection model. At last reporting, the company now charges generators $0.32 per gallon for collection.

The shift in the pricing model has had a positive impact on Vertex Energy's cash flow. In the 2015 second quarter earnings call, Vertex Energy CFO, Mr. Chris Carlson, shared the financial impact of local collecting.

Analyst: Is there a meaningful difference in the price paid per gallon there versus what you guys are obtaining through aggregators or third-party?

Mr. Carlson: I think it has probably $0.45 distribution margin.

At that point, the company had just begun reaping the benefits of implementing its charge-for-collection model. One can only surmise the margins have improved. The company has reiterated on numerous occasions how crucial it is to profitability that street collection volume increase. However, it appears Vertex Energy lost ground on collected volume only recently.

In the 2015 second quarter earnings call, Mr. Ben Cowart, CEO, shared Vertex Energy's street collection volume was tracking at "22 million to 24 million gallons." The company had also announced the acquisition of a collection route in Louisiana representing an additional 1-1/2 million gallons.

In the 2015 third quarter earnings call in November 2015, Mr. Cowart verified the street collection volume.

Yes. I think we are probably about 25 million gallons that our collection operations account for in total volume.

The company also validated progress on the pricing front.

Our average charge for the services at the end of the third quarter was $0.10 per gallon for the oil that we collect.

A year later, in the 2016 second quarter, Vertex Energy reiterated its street collection growth.

We expect our street collection growth to track with our trailing 12 month, year-over-year 12% to 14%, as we go forward and that doesn't include possible acquisitions.

If street collection volume in the 2015 second quarter was 22 million to 24 million gallons, a 12% to 14% improvement based on both midpoints would equate to 26 million gallons.

In the Q&A segment of its earnings call, Vertex Energy detailed volumes.

Mr. Cowart: We are looking at somewhere around 90 million to 100 million gallons of UMO.

Analyst: And you're collecting how much of a 90 million to 100 million today?

Mr. Carlson: 20% to 25%.

Quick calculations reveal the full range for street collection would be from 18 million to 25 million.

In November 2016, Vertex Energy reported a slight improvement from the previous year.

Our trailing 12 month collection volumes grew at a rate of 3% and we expect to grow, to continue and improve beyond 2016.

A 3% improvement over the street collection volume of 25 million gallons reported in the 2015 third quarter equates to 25.75 million gallons. The number tracks consistently with the equation from the 2016 second quarter reporting of 26 million. But, it also reflects a temporary stall in growth.

In a Q&A session published on the company's website dated fourth quarter 2016, Vertex Energy validated the 25 million gallon marker.

What percent of aggregated used oil do you expect to make up the company's category?

Self-collected gallons today are approximately 25% of our overall production. We anticipate increasing this to 30% next year, while we expand our overall production volumes.

However, when the company announced its newest credit arrangement on Feb. 8, 2017, the numbers and the projections appear to have been clipped.

With approximately 90 million gallons of processing capacity, we believe that our collections vertical is key to our growth. Our self-collected gallons today are approximately 20% of our overall production. We anticipate increasing this to 25% in 2017, while we expand our overall production volumes.

Based on these statements, Vertex Energy is only collecting 18 million gallons at the local generator level. If production volumes increase 15% in 2017, the total increases to 103.5 million gallons. If collected volumes increase to 25% of the production volume, the collected volume would return to the 25.88 million gallon mark previously reported from the 2015 second quarter through the 2016 fourth quarter.

The realization is disconcerting. Without further acquisitions, Vertex Energy certainly seems to be stating it will end 2017 basically flat relative to street collection growth.

Ironically, 2017 was exactly the time frame noted in early 2016 for acquisition activity.

The company is evaluating opportunities to expand when the time is right, but Cowart said he expects more acquisitions to 'play out' in 2017 because the market is still in flux.

When the company announced its new credit arrangement two weeks ago, Mr. Cowart first highlighted the importance of stewardship over the balance sheet. But, he ended the press release focused on growth - developing higher margin products, increasing production volume and expanding street collections.

2017 should be a formative year for Vertex Energy moving toward formidable.

Disclosure: I am/we are long VTNR.

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.

Additional disclosure: I belong to an investment club that owns shares in VTNR.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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