Holly Energy Partners' (HEP) CEO George Damiris on Q1 2018 Results - Earnings Call Transcript

Holly Energy Partners, L.P. (NYSE:HEP) Q1 2018 Results Earnings Conference Call May 1, 2018 4:00 PM ET

Executives

Jared Harding - IR

George Damiris - President and CEO

Rich Voliva - EVP and CFO

Analysts

Theresa Chen - Barclays

Justin Jenkins - Raymond James

Jeremy Tonet - JP Morgan

Operator

Welcome to the Holly Energy Partners First Quarter 2018 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. [Operator Instructions] Please note that this conference is being recorded.

It is now my pleasure to turn the floor over to Jared Harding. Jared, you may begin.

Jared Harding

Thanks, Jason. Thank you all for joining our first quarter 2018 earnings call. I am Jared Harding with Investor Relations for Holly Energy Partners. Joining us today are George Damiris, President and CEO; and Rich Voliva, Executive Vice President and CFO.

This morning, we issued a press release announcing results for the quarter ending March 31, 2018. If you’d like a copy of today’s press release, you may find it on our website at hollyenergy.com.

Before George and Rich proceed with their remarks, please note the Safe Harbor disclosure statement in today’s press release. In summary, it says statements made regarding management expectations, judgments or predictions are forward-looking statements. These statements are intended to be covered under the Safe Harbor provisions of Federal Securities Laws. There are many factors that could cause results to differ from expectations, including those noted in our SEC filings. Today’s statements are not guarantees of future outcomes.

Also, please note that information presented on today’s call speaks only as of today, May 1, 2018. Any time-sensitive information provided may no longer be accurate at the time of any webcast replay or reading of the transcript.

Finally, today’s call may include discussion of non-GAAP measures. Please see today’s press release for reconciliations to GAAP financial measures.

And with that, I’ll turn the call over to George.

George Damiris

Thanks, Jared. And thanks to each of you for joining the call this afternoon. We are very pleased with our first quarter results which enabled us to announce our 54th consecutive distribution increase since our IPO in 2004.

HEP’s fee-based business model supported by long-term minimum volume commitments continues to provide a strong foundation for distribution growth. Pipeline volumes

volume increased 47% compared to the same period last year, primarily due to the acquisition of the remaining interest in the Salt Lake City and Frontier pipelines completed in October 2017.

HEP also had higher refined product shipments, largely driven by the turnaround that occurred in the HollyFrontier’s Navajo refinery in the first quarter of last year. As many of you know, the FERC announced the policy revision in March that would no longer allow MLPs to include the income tax allowance in the calculation of cost of service tariffs. We do not anticipate this ruling will have a material impact on HEP as we have very limited cost of service tariff.

Looking forward, our focus is to leverage our existing footprint to grow organically, especially in the Permian. This morning, we announced our intention to construct a new rack in Orla, Texas connected to our refined product system in Texas and New Mexico. This asset will serve growing diesel demand associated with the oil patch activity in and around the Delaware basin. We also have an upcoming debottleneck project for the Malaga crude oil pipeline system and plan to expand the Salt Lake City and Frontier pipelines this year.

With that, I’ll turn the call over to Rich.

Rich Voliva

Thanks, George.

On April 19th, Holly Energy Partners announced the quarterly distribution of 0.655 per unit which represents a 5.6% increase over the distribution for the first quarter of 2017. This distribution is scheduled to be paid on May 10th to unitholders on record as of April 30th.

During the period, HEP generated distributable cash flow of $69 million, $12 million higher than the same period last year. Our distribution coverage ratio for the quarter was 1.04 times. We continue to expect seasonal factors will drive coverage under 1 times in the second quarter, followed by a much stronger second half of 2018 with the coverage ratio of 1 times or higher for the full year.

Operating expenditures totaled $36.2 million versus $32.5 million in the same period last year. The increase is attributable to operating cost and expenses related to the acquisition of the remaining interest in the SLC and Frontier Pipeline.

Our CapEx for the quarter was $1.9 million including approximately $300,000 in maintenance capital and $600,000 of capital reimbursed by HollyFrontier. For the first quarter of 2018, we recognized $2.2 million of deferred revenue from prior shortfalls billed to shippers. and as of March 31, HEP carried $2.5 million in deferred revenue on our balance sheet. In the second quarter of 2018, we anticipate recognizing approximately $400,000 of deferred revenue.

Interest expense increased $4 million compared to the first quarter of 2017, due to the tack-on offering of an additional $100 million of our 6% senior notes completed during the third quarter of 2017 as well as our decision to temporarily finance all of the SLC and Frontier acquisitions via our revolving credit facility.

In February 2018, we issued a $110 million of limited partner equity through a private placement. We also raised an additional $4.6 million during the period from the sale of LP units through our At-The-Market or ATM program. These proceeds were used to repay a portion of the debt associated with the Frontier and SLC acquisitions. As of the end of the first quarter, our leverage was roughly 4.25 quarter times debt to trailing 12 months EBITDA and we expect leverage to reach roughly 4 times by the end of 2018.

Including cash and revolver availability, our current liquidity is over $500 million. We are confident that our strong liquidity and ability to access to capital markets will enable us to achieve future growth, both organically and through O&A. [Ph]

And with that I’ll turn the call over to Jason for the Q&A period.

Question-and-Answer Session

Operator

The floor is now open up for questions. [Operator Instructions] Thank you. Your first question is from Theresa Chen, from Barclays. Your line is open.

Theresa Chen

Good afternoon. My first question has to do with the guidance for second quarter being below 1 times. What is the cause of the seasonal factors?

Rich Voliva

Hey Theresa, it’s primarily unit related. As you’ll recall, unit volumes run significantly lower in the second and the third quarter typically. So that’s the big driver there.

Theresa Chen

Got it. And related to your terminalling segment, what was the revenue recognition change there?

Rich Voliva

Specific to terminalling?

Theresa Chen

Yes. There is a sentence that says these increases are primarily due to higher volumes…

Rich Voliva

Yes. It was between $1 million and $2 million.

Theresa Chen

Okay. But, what was the rationale behind the revenue recognition change and how should we think about that going forward?

Rich Voliva

Yes, sure. So that’ll be pretty standard going forward. This is the accounting that relates to the RevRec standard that came into enforcement earlier this year. And we have a couple of contracts having minimum a tariff escalation; it’s greater than 0%. And the way that accounting works is you need to essentially recognize that over the life of that minimum, over the life of the contract.

Theresa Chen

Okay. And previously, you have recognized…

Rich Voliva

It would be recognized as that tariff increased. So, it has somewhat perverse effect of essentially making EBITDA, the revenue look a little higher in the early years of the contract and a little lower than the actual billing in the later year of the contract. Importantly, we have adjusted distributable cash flow for this. So, really the cash flow metrics are what the billing looks like at the end of the day.

Theresa Chen

Understood. In terms of your diesel project, can you talk about the returns on the $10 million to $20 million of expected spend, how much EBITDA do you expect to generate from this?

Rich Voliva

Yes. I don’t think we’re going to get too specific there, Theresa. I mean, we disclosed what we think the capital cost is going to be and what EBITDA multiples are for the project in the midstream space. So, you can have imputed number from that.

Theresa Chen

Okay. What about the capital cost for the debottlenecking project at Malaga, and the expansion of SLC and Frontier?

Rich Voliva

So, those are in kind of single digit million range,. Theresa, and they are embedded in our capital guidance already. So, there’s nothing incremental for those.

Operator

Your next question comes from the line of Justin Jenkins from Raymond James. Your line is open.

Justin Jenkins

Great, thanks. Good afternoon, guys. I guess, following up maybe on Theresa’s question on the Permian. Obviously, a lot of focus here on the supply high growth and basis differentials. And maybe it’s a better question for HFC’s call tomorrow. But George, you kind of referenced this in your prepared remarks. Just curious if there’s any new opportunities down the road here on the crude side, whether it’s gathering or longer haul pipelines to get even more Permian barrels into the HFC refining system?

George Damiris

I think, we are going to continue to look on getting more gathering barrels on our existing HEP systems. In addition to that, as you know, we run 100% Permian crude in Navajo. And then on top of that, we also have least capacity on a pipeline out of the Permian to Cushing. And we will get into some of the volumes there on the HFC level tomorrow.

Justin Jenkins

And Rich, forgive me if I missed that. But did we get a new CapEx number with the addition of the diesel supply project?

Rich Voliva

Yes. We are basically raising capital guidance range about $10 million. So, roughly 50 to 60 in total.

Justin Jenkins

And then, last one for me. With Woods Cross being down for a bit towards the end of the quarter and start of 2Q here, any issue in 1Q for HEP related to that and maybe potential impact into 2Q?

Rich Voliva

We don’t really expect anything. It typically runs flat -- or certainly lower in the second quarter. So, there really is not going to be any change from that. We may see some lower volumes on the SLC and Frontier lines but they were in operation to begin with. So. I am not really sure it’s going to have a huge impact at the end of the day.

Operator

[Operator Instructions] Your next question comes from Jeremy Tonet from JP Morgan. Your line is open.

Jeremy Tonet

Good afternoon. I just wanted to go back to the Permian a little bit here and see if you might be able expand a little bit more as far as how the gathering volumes trended -- trending over the quarter here?

George Damiris

I am not sure there was much of a trend over the course of the quarter. Navajo ran well, which is the base for the gathering system. And then with differential being clearly healthy, we were able to move decent number of barrels up to Cushing as well.

Jeremy Tonet

Okay, thanks. And then, I guess just turning to M&A out there, I was wondering if you might build or provide any updated thoughts. I think, in the past, you commented some of the valuations were strong out there. But, I guess, are there any opportunities kind of smaller size or anything that might be unique to your footprint that you could execute on that others might not see the same value that you do?

George Damiris

Yes. I don’t think there’s much change in the overall M&A market from what we’ve discussed earlier. We think it’s still pretty hot market especially in the Permian. And as far as smaller opportunities, there really aren’t a whole lot of smaller opportunities in Permian and that most of the smaller systems are full already. And most of the activity is oriented around new construction or the new volumes that are coming out in the area.

Operator

If there are no further questions, I will turn the floor back over to Jared for any closing remarks.

Jared Harding

Thanks again for joining the call today. If you have any follow-ups, please reach out to Investor Relations.

Operator

This concludes today’s conference call. You may now disconnect. Thank you for joining and have a great day.