- Merchant refiner PBF Energy's share price has declined in 2018 to date amid broader market turmoil following a terrific second half to 2017.
- While energy market volatility and a declining Brent-WTI price differential hamper the company's immediate outlook, overall operating conditions are steadily improving.
- RIN prices have fallen sharply in response to an intervention by the White House and government analysts are forecasting continued domestic petroleum production growth and strong refined fuels demand.
- This article considers the valuation of PBF Energy's shares in light of these recent developments.
Investors in merchant refiner PBF Energy (NYSE:PBF) must be disappointed with how the company's share price has performed in 2018 thus far. It had a stellar 2017 as its share price gained 30% over the course of the year following dismal returns in 2016 and the first half of 2017 (see figure). The second half of 2017 was especially strong as hurricane damage to other firms' Gulf Coast refineries in August and September caused U.S. crack spreads to surge. This development was followed by a 33% decline to the price of the largest Renewable Identification Number [RIN] credit category in November and December, which further buoyed investors' spirits given PBF Energy's vast RIN expenditures in previous years. The company's share price welcomed the new year by breaking $37, falling only a bit short of its all-time high closing price of $41.75.
The first two months of 2018 have been a return to the volatility of previous years, though, unfortunately for PBF Energy's investors. The company's share price has declined by 15% in 2018 YTD as a strong YoY improvement to its Q4 earnings and a sharp decline to RIN prices has been unable to overcome broader market turmoil. This is especially apparent in the steady declines to the company's trailing and forward EV/EBITDA ratios (see figure), and the former is approaching lows not seen since late 2014.
The Q4 earnings report
PBF Energy's Q4 earnings report, which was released last month, presented a very positive quarter even as it was unable to repeat Q3's blockbuster results. Adjusted diluted EPS jumped from $0.54 to $2.14 YoY as revenue increased by 38% over the same period on higher refined product prices. Much of the EPS improvement was attributable to the implementation of 2017's tax reform legislation, although EPS excluding special items still increased from -$0.71 to -$0.04 over the same period. Likewise, adjusted Q4 EBITDA increased strongly from $4.9 million to $147.5 million YoY (the most recent non-adjusted number came in at $585 million). Annual adjusted EBITDA more than tripled from $222 million to $752.5 million YoY in large part due to the Q4 result, which was only surpassed by the Q3 result for the year.
The Q4 results benefited from several different factors. First, throughput at PBF Energy's refineries increased by 12% YoY, reflecting the additional volume provided by its Torrance acquisition (and despite that facility's technical problems in the summer of 2017). The addition of this capacity was well-timed to take advantage of a widening of the Brent-WTI spread that persisted throughout Q4. This in turn contributed to double-digit crack spreads for PBF Energy across the board as fuel prices remained high even after the end of the Caribbean hurricane season. The company's gross refining margin (excluding special items) increased by almost 22% YoY even as falling natural gas prices caused operating expenses to decline on a per-barrel basis.
PBF Energy also benefited from regulatory expenses in Q4 that were low relative to Q3 and management's own expectations for the last quarter. RIN prices moved strongly higher over the course of the year from $0.65 on a weighted basis in Q1 to $0.89 in Q3 (see figure). Reflecting this strength, the company's management estimated during its Q3 earnings call that it would spend a record $350 million on RINs in FY 2017, or nearly triple its 2015 total. PBF Energy's management has been very outspoken about the negative impact of RIN prices on its earnings going back to 2013. While government and academic analysts believe that refiners have been very effective at passing their RIN costs on via crack spreads, record RIN expenditures could be expected to have a negative impact on PBF Energy's share price due to the headlines alone. The aforementioned decline to RIN prices late in the year made this a moot point, however, as it allowed the company to report only $294 million in total RIN expenditures for 2017. While still high compared to earlier years, this amount represented a YoY decline of 15.5%.
Source: EcoEngineers (2018).
PBF Energy's share price barely moved in response to the release of the Q4 earnings report, likely reflecting the fact that investors had already pushed it higher near the end of 2017 in reaction to the strong operating conditions that prevailed at the time. The relative transparency of petroleum prices and refining margins makes the industry very forward-looking when it comes to the relationship between share prices and operating conditions. While PBF Energy's outlook is not as strong as it was at the end of 2017, there are a number of reasons for investor optimism.
The first reason is that RIN prices have continued to fall in 2018 to date (see previous figure) as President Donald Trump has personally intervened in the debate over refiners' RIN expenditures. As recently as last week I expressed skepticism over Mr. Trump's ability to find a compromise between merchant refiners and biofuel producers and both sides' advocates. Indeed, an argument was to be made that, by intervening, Mr. Trump had painted himself into a corner as far as his 2020 reelection is concerned given his conflicting 2016 campaign promises to unwind federal government environmental regulations and boost U.S. ethanol consumption.
Last week's decision by Mr. Trump to implement steep tariffs on steel and aluminum has called this political calculus into question, however, with NBC News reporting that the decision was made at a time when he was "angry and unglued" rather than as a rational act of policymaking. The fact that Mr. Trump completely bypassed the White House bureaucracy as part of the policymaking process likely contributed to Friday's no-news 14% decline to the price of the largest RIN category, one of the largest single-day declines in the history of the RIN markets. While serious legal doubts exist as to the ability of the White House to permanently reduce RIN prices via administrative action, it would take months or even years for the courts to adjudicate the issue in the event that Mr. Trump decided to shore up his support by side-stepping White House policymakers on this topic as well. In the meantime, merchant refiners' share prices would immediately benefit from the news surrounding such an announcement. Again, it is debatable whether or not merchant refiners such as PBF Energy are as negatively impacted by high RIN prices as their advocates claim, but a surprise decision by the White House in their favor would certainly have a positive headline impact on PBF Energy's share price.
Second, the integration of the Torrance refinery has given PBF Energy a broad exposure to the U.S. refining markets that will in turn provide the firm's earnings with safety through diversification. The company now owns and operates refining assets in four of the five continental PADD regions, mitigating the sensitivity to the Brent-WTI differential and East Coast margins that characterized its earnings in previous years. While its PADD 1 operations continue to be an outsized contributor to throughput, they no longer provide even a majority of total volume. The outsized volatility that has characterized PBF Energy's share price in previous years should be a thing of the past as a result.
Finally, the domestic energy market continues to develop in a manner that can be expected to benefit PBF Energy. The U.S. Energy Information Administration [EIA] expects domestic petroleum production to jump by 14% in 2018 and another 6% in 2019 as higher prices drive inland extraction. Refined fuels consumption is also expected to continue to grow despite the presence of higher prices. Any widening of the Brent-WTI differential and domestic crack spreads in response to this dynamic would have more of a positive impact on PBF Energy's earnings than in the past due to its recent geographic footprint diversification.
Several analysts downgraded PBF Energy's firms in the wake of last year's impressive share price rally. This does not appear to reflect its recent decline, however, given that both forward EBITDA and EPS estimates have steadily climbed in 2018 to date (see figure). Since the beginning of the year the FY 2018 EPS estimate has improved from 2.92 to 3.13 while the FY 2019 EPS estimate has improved from 3.25 to 3.81. Both of these estimates place the company's share price in single-digit forward P/E ratios. Likewise, PBF Energy's forward EV/EBITDA ratio is 33% lower than its 5-year median value, which also suggests that its shares are undervalued moving forward (see figure).
The rough start to 2018 experienced by PBF Energy's share price does not tell the whole story given that it has largely been driven by broader market turmoil than by operating conditions. While the Brent-WTI differential has declined from its 2017 highs of late, the outlook for rising U.S. petroleum production and continued strong consumption of refined fuels will benefit refiners, especially those like PBF Energy that have a broad geographic range of operations. Furthermore, the company's RIN expenditures fell short of expectations for 2017, and RIN prices have steadily declined in 2018 as the White House has worked to reduce merchant refiners' expenditures. Finally, the company's low forward valuation in terms of both P/E ratio and EV/EBITDA ratios provide investors with a margin of safety on top of its 4% forward dividend yield. While the consensus is for EV to improve by a modest 4% in 2019 on a YoY basis, the company's forward EV/EBITDA ratio would need to increase by nearly 50% just to return to its 5-year median value. PBF Energy currently looks more attractive as a long investment opportunity than it has in quite some time.
This article was written by
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