Delek US Holdings, Inc. (NYSE:DK) Q1 2019 Results Earnings Conference Call May 6, 2019 9:30 AM ET
Keith Johnson - VP of IR
Uzi Yemin - Chairman, President and CEO
Assi Ginzburg - EVP and CFO
Danny Norris - CAO
Fred Greene - EVP and COO
Conference Call Participants
Manav Gupta - Credit Suisse
Carly Davenport - Goldman Sachs
Phil Gresh - JPMorgan
Matthew Blair - Tudor, Pickering, Holt
Kalei Akamine - Bank of America
Brad Heffern - RBC Capital Markets
Good day, ladies and gentlemen, this is your conference operator. At this time, I would like to welcome everyone to the Q1 Earnings Call for Delek US Holdings Inc. [Operator Instructions] Thank you.
I would now like to turn the call over to Keith Johnson, you may begin your conference.
Thank you, Laurie. Good morning. I'd like to thank everyone for joining us on today's conference call and webcast to discuss DK's first quarter 2019 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President and CEO; Assi Ginzburg, EVP and CFO; Danny Norris, CAO; Fred Greene, EVP and COO, as well as other members of our management team. The presentation materials we'll be using during today's call can be found on the Investor Relations section of Delek US's website.
As a reminder, this conference call may contain forward-looking statements as that term is defined under federal securities laws. Please see Slide 2 for the Safe Harbor statement.
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 comparable GAAP result, which can be found in the press release which is posted on the Investor Relations section of our website.
Our prepared remarks are being made assuming that the earnings press release has been reviewed as we are covering less segment in market information that is incorporated in the 1Q press release.
On today's call, Assi will give an overview results, Danny will review financial performance and then Fred will cover operations for the quarter, then Uzi will offer few closing strategic comments.
With that, I'll turn the call over to Uzi.
Thanks Keith. Great to be back that’s a great quarter.
We had a great financial performance this quarter as we continue to return cash to our shareholders while investing in our businesses. As Fred will discuss in few minutes, we completed the LT project at Krotz Springs and the turnaround at El Dorado in April.
As you can see on Slide 3 on an adjusted the basis for the first quarter 2019, Delek US reported net income of $121.2 million or about $1.54 per diluted share compared to an adjusted net income of $21.5 million or 26 per diluted share in prior year period. Our adjusted EBITDA increased by 126% to $237.5 million in the first quarter of 2019 compared to $104.9 million in the prior year period.
Now I will turn it over to Danny to discuss financial performance for the quarter.
Thank you, Uzi.
Delek US reported net income of $149.3 million or $1.90 per diluted share compared to a net loss of $40.4 million or $0.49 per basic share in the first quarter of 2018. Our consolidated contribution margin improved at $333.8 million in the first quarter of this year compared to $152.3 million in the first quarter of 2018. This was led by refining which generated contribution margin of $294.3 million compared to a contribution margin of $133.2 million in the first quarter of last year.
This increase was driven by more favorable Midland brand crude oil, price differential, lower rents expense, sustainable commercial performance, and the benefit from an active inventory management strategy during a period of rising prices. In the prior year period, refining results included approximately $90.9 million related to RINs waivers and $24.6 million of income from a biodiesel tax credit.
During the first quarter of this year results did not include any benefit from regulatory decisions on 2018 rents labors or the biodiesel tax credit. We continue to work with the government on both of these matters.
There was approximately $61 million on a pretax basis of inventory benefit net of the lower of cost or market adjustment in the reported and adjusted first quarter 2019 results. I do want to note that the inventory benefit and our reported and adjusted results was primarily offset partially offset by approximately $9 million on a pretax basis of costs related to an asset disposal and emissions allowance cost in the refining segment.
Our performance during the first quarter of 2019 generated approximately $133 million of cash from continuing operations as shown on the Slide 4. This cash flow combined with our solid financial performance supported investing in the business through cash capital expenditures of $124 million and returning approximately $67 million of cash to our shareholders.
Slide 5 highlights our capitalization. We ended the first quarter with approximately $1 billion of cash on a consolidated basis and $771 million of net debt. Excluding net debt at Delek Logistics of $700 million we had net debt of approximately $72 million at March 31 of this year. The financial flexibility provided of our balance sheet should allow us to fund our Midstream projects with 60% to 70% debt depending on our cash generation an alternate investment opportunities.
On Slide 6, I want to highlight our EBITDA potential from our current operations. We have used variations of this slide in our slide presentations in the past. Using a long-term average of $2.50 Midland discount to Cushing and the crack spreads highlighted on this slide, our current operations have the ability to generate approximately $900 million of annual EBITDA.
Please note that this includes the alkylation project at the Krotz Springs that is now operational and a benefit from commercial initiatives such as improved crude sourcing, and net backs across our refining system. It also includes a potential benefit from RINs waivers at our El Dorado and Krotz Springs refineries which we have consistently received in the past.
As we complete our Midstream initiatives, we should have the potential to generate in excess of $1 billion of EBITDA before any IMO benefit. As we continue to develop our operations, our goal is to add less crack spread and crude differential dependent EBITDA overtime due to the combination of our midstream investments, the alkylation unit at Krotz Springs and our retail business.
On Slide 7, I want to provide some guidance for modeling in the second quarter of 2019. We estimate based on the forward curves that our realized Midland discount and our gross margin would be in a range of $1.30 to $1.50 per barrel which should help to continue driving cash flow generation from our operations.
I do want to note in the second quarter of 2019 we expect a $12 million headwind from the combination of rebuilding inventory levels following the El Dorado turnaround and timing of realized hedging losses.
During the second quarter of 2019, crack spreads have continued to improve averaging $16.30 per barrel through May 2nd compared to $13.02 per barrel in the first quarter of 2019 based on the 5-3-2 WTI Gulf Coast crack spread. In addition the Midland Cushing discount has widened for May and June crude oil purchases. This should benefit our refining operations in the third quarter taking in consideration and inventory timing effect.
Now I’ll turn the call over to Fred to discuss our operations.
During the first quarter our total refining system crude oil throughput was approximately 250,000 barrels per day. As shown on Slide 7, for the second quarter of 2019 we expect crude oil throughput in the refining system to average between 260,000 and 270,000 barrels per day. This takes into account the turnaround at El Dorado. Turnaround began on March 11th and was completed on April 24th. The refiner is now back to normal operations. Total capital costs for this turnaround was approximately $45 million.
During the second quarter of 2019, we expect the crude oil throughput at El Dorado to average between 50,000 and 55,000 barrels per day. This was a shortened turn around format that allowed work to be completed on the majority of the process units.
On Slide 8, I want to highlight our capital spending. Capital expenditures during the first quarter were $128 million compared to $70 million in the first quarter of 2018. Our 2019 capital expenditures are forecasted to be $394 million. This includes $223 million in refining, $12 million in logistics, $18 million in retail, and $142 million at the corporate level. The spending on the Big Spring gathering system is included in that corporate level number for 2019 is currently forecasted $131 million.
I'm pleased to announce that our new alkylation unit at the Krotz Springs refinery was operational in early April. Based on current market prices the expected annualized EBITDA contribution be approximately $50 million.
As a reminder, the alky unit should provide additional production flexibility across as it improves the ability to convert low value butane and butylene into higher value gasoline products. Our future EBITDA generated by the alky unit will also further reduce the portfolios dependence on crack spreads.
Progress continues on our Big Spring gathering project, during 2018, we spent $79 million and we expect to spend approximately $131 million in 2019. This compares to our previous guidance or approximately $80 million of spending in 2019. The change is due to a number of factors that include the addition of more production areas and an increased number of producers along with additional storage capability and connections to support future growth of the system.
Taking this into consideration, the total expected cost is approximately $210 million compared to our previous estimate of $170 million. This new business line has an expected annualized EBITDA on the range of $40 million to $50 million including accrued quality benefit in our refining segment which should be fully achieved by 2022. As a reminder, our capital expenditures for this project maybe further adjusted as we develop the system to support our producers growth plans.
Next, I'll turn the call over to Uzi for his closing comments.
Thanks, Fred, and good morning everybody.
This was a great start to 2019, operational improvements that have been implemented and continue to greet our EBITDA to our business. These initiatives including improvement in Krotz Springs refinery as well as commercial initiatives that continue to improve the refining system capture rate.
These were factors in our first quarter performance and should benefit us going forward. Also, WTI-linked crude system that we have built benefited from a widening of the Midland-Brent differential.
In addition to the initiative in place, which would benefit from the new Alky unit at Krotz Springs. As we entered the second quarter, market conditions have continued to improve. The crack spreads have increased and the Midland-Brent differential is currently at $11 per barrel. This remains an attractive environment for our business model.
The gathering system is progressing and we continued to walk with our producers to add acreage dedications. The increase in crude oil price since the beginning of the year should support drilling activity in the Permian Basin. During the quarter, we exited the proposed PGC Partnership. This allows us to explore more favorable options to participate in one of the announced long haul pipeline project.
As shown on Slide 9, the combination of these initiatives, along with other projects should help us achieve $350 million to $370 million in midstream EBITDA by 2023.
As shown on Slide 10, total cash return to shareholders was approximately $67 million in the first quarter of 2019. Over the last twelve months to March 31, would return $400 million or about 14% of our market capitalization.
Our capital allocation program balances cash to shareholders with potential opportunities for growth. Currently, we believe our stock is in attractive investment and we intend to repurchase $60 million of Delek stock in the second quarter of 2019.
In addition, our Board of Directors approved 4% increase in our regular quarterly dividend, which marks our fifth consecutive increase since the third quarter of 2018. We will remain focused on creating long term value as we balance returning cash to our shareholders investing in our business and exploring opportunities to develop the next stage of our growth.
With that, Laurie, can you please open the call for questions.
[Operator Instructions] Your first question comes from the line of Manav Gupta from Credit Suisse. Please ask your questions.
Good morning, guys and congrats on the big beat somewhere in the mediocre beat 1Q, we were all hoping there would be a big hidden beat or PSX like beat and I am very glad to see you guys deliver it. What was really good about this firm was also the fact that last quarter you had Big Springs and Krotz delivering the beat and this time it was Tyler and El Dorado. So the entire portfolio is working.
My question is more on the midstream side, Uzi, when we look at the Big Spring as we are doing project, management and investors both see to eye on it, right. It's a big project, everybody loves it. The views on PGC were all were little divergent. Delek management made a very strong case for it, but investors really never fell in love with it and that's why when it did not proceed, the stock actually outperformed.
What I'm trying to understand is how do we ensure that the next midstream project which replaces PGC looks more like the Big Springs gathering project or project which investors like right way versus management being forced to make an extra effort to bring investors on board. Any comments you could offer in that…
Well, first of all thank you Manav for the kind words. The team really work really hard here over the last few months to make these initiatives happen. So, and I am very proud of what we achieved vis-à-vis your question, the long haul strategy is something that we need to clarify and we probably didn’t do good job last time with PGC about the long haul.
Our intent all along is to use the access that we get form our gathering to utilize and to move these barrels both to midland and to some other places. Obviously, we don’t want to destroy our own market. So with our commitment and all in all which was our commitment that we will not enable new projects.
Also, we want to make sure that we are supporting our producers and the long haul projects should be at least five to seven times EBITDA and that’s on a fully fund project. Obviously, as
we mentioned in the past, we’re looking at for the financing as well, which if we do it at 60% or 70%, the return if you take the five to seven times EBITDA the return will be pretty healthy.
Lastly, I want to emphasize what we just said that there are several announced projects, we are looking at few of them and we will make a decision about them when the time give and we will notify the market.
Thanks for those and Uzi a quick follow up. DK leases spike from HEP and has an agreement with HEP that expires somewhere in 2020 if I am correct, any comments if you plan to renew it?
Well, the HEP agreement was something that we got from a loan. It expires I believe by the end of this year. We did work with several prospects, how to grow buyers and we are very, very close to make any decision to go with one option and we will notify the market once we do so.
Your next question comes from the line of Neil Mehta from Goldman Sachs. Please ask your question.
This is Carly on for Neil. Thanks for taking the questions. The first one is just on spreads. I think the expectation is so for Midland spreads. I think the expectation is so for Midland is to now as we move to 2019 as more pipes come online but we’ve see those widen more recently. So can you just talk about what you think has driven the recent moves in the diff and then how you expect are going to trend in 2019, 2020?
The diff in the second quarter and probably early third quarter, why, because we are balanced now and we get more pipeline, we expect the diff to narrow in Midland. However, I want to emphasize something here. That's all dependent on one big thing, the off-take capacity at Corpus. And I am not sure that the situation in Corpus as is clear and if the terminalling in Corpus and the [indiscernible] and Corpus are ready to take some of these barrels.
So we may see another wider depth going to the fourth quarter and the first quarter before beat was sold themselves out with the Corpus situation. The Corpus situation is pretty much, can’t believe the situation at this point with several pipeline trying to connect to very few active terminals that’s one thing.
Now it doesn’t change the fact that in our mind in the long term that’s our strategy. In the long term the situation of being closer to barrel and as we know the gathering system in Big Spring and we saw how good it’s been this quarter, the gather system in Big Spring would allow us to enjoy the quality of the barrels and by the end of the day all these barrels need to be exported not to the Gulf but somewhere in Europe or Asia. So by the end of the day, the diff that we're looking at is much more impacted by the Midland-Brent versus Midland WTI.
And then the follow up is just around cash flow, looked quite strong this quarter. Just wondering one, if there was any working capital impact to call out in that number and then also just wondering if you can talk about views on capital returns for the rest of the year following another strong quarter on both the buyback and the dividend here.
First I'll start with the cash flow, there was some headwind to the cash flow rebuild roughly 800,000 barrels of inventory in the Tyler refinery. So that was basically offsetting the great cash flow in the quarter. Without being said even with that it was a very strong quarter for Q1.
As of capital return as you know it has capital to return excess cash to shareholders and this quarter was no different. As results came stronger than even what the market anticipate materially stronger, we're up the buyback this quarter to 60 million and on top of it we also increased the dividend so no change in our direction there.
Your next question comes from the line of Phil Gresh from JPMorgan. Please ask your question.
Couple of follow-up questions or I guess clarifications, one would just be on the long haul pipeline. I know it's already been asked about. I'm just trying to think a bit maybe mathematically about this. In your slides you're implying $150 million of Midstream EBITDA improvement about 50 or so of that is the Big Spring gathering. So it will be 100 million I think still embedded in there for the long haul pipeline. You mentioned a five to seven times build multiple, but you're also talking about potentially getting in on an existing pipeline. So it would be your expectation that you'd still be able to achieve something like that and would that be the order of magnitude of cash we should be thinking about you also mentioned project financing so I’m just trying to tie this altogether?
Good morning Phil, there is one missing point and one missing point in your question which is the growth in the gathering system. We just need to remember that the gathering system continue to grow and we have the EBITDA this quarter to $40 million to $50 million slightly, but we have more and more producers coming to us and more and more acreage dedication. So I wouldn’t assume that the EBITDA coming from gathering system was stick to $40 million to $50 million.
That’s one thing. We see more acreage and more barrels coming our way than we expected. By the way the growth in the Permian Basin is little better than what we expected to being of day we thought 700,000 barrels would probably I think now closer to 800,000 barrels this year maybe even little more that’s one thing.
Second about the long haul, the long haul we were very clear in the past and we said not more than five to seven times EBITDA. And that’s without project financing obviously that’s fully funded and we still need to make couple of decision here how we go about this because we certainly don't want to enable new part like. And also we want to make sure that we are picking the right people to go with.
And second question on the quarter. Obviously very strong quarter, if I look at El Dorado for example the gross margins there we're just well in excess of our expectations. And in your press release you talked about being able to run full amounts of Permian barrels despite the downtime there. So was there an element of reselling Permian barrels in the quarter I'm just trying to make sense of such a strong result despite the downtime?
So, first as we enter into the quarter we did manage our inventory slightly different going into the turnaround in the El Dorado refinery. We basically lifted some of the hedges around the J-1 agreement and as prices come up throughout the quarter we hedged them internally. So there is a profit taking there from managing the inventory as we mentioned on the cover of the press release.
Second, we did sell during the quarter products that we produced in the prior quarter and that provided I will say a tailwind to the quarter and as Keith suggested during the script with Keith and Dennis selected during this script. Some of which will be reversed in the next quarter roughly 12 million.
But overall, if you look at the amount of crude we’ve add in the quarter, almost of the majority of it was WTS Midland and local crude and we bought basically no WTI which we supplement sometime the refinery. So that was the ability to run fully and utilizing all of the 200,000 barrels a day that we have across the system.
So I can’t say that we sold barrel we just render on the right barrels, enjoyed inventory benefits and of course, a very lower reason why I meant as you know, the prices of RINs came down to at least the ethanol RINs to almost $0.12, $0.14 RIN towards the end of the quarter, which have really benefited the refinery.
Your next question comes from the line of Matthew Blair from Tudor, Pickering, Holt. Your line is now open.
Assi, it sounds like there is a few moving parts from the inventory picture you had LCM benefit of $52 million, you sold some inventory for $61 million but I think there might be a third portion here. What about the FIFO benefit at El Dorado, Big Spring and Krotz, was there a positive tailwind here on margins in the quarter and if so, can you break out the FIFO versus LIFO impact there? Thanks.
Sure. So let’s start with the effects. We had inventory benefit on the actual results not the adjusted results of $112 million, of that $52 million was LCM, lower of cost or market which we adjusted out, so we left with roughly $60 million of FIFO gains, FIFO or LIFO gains across the system and we actually called it out in the press release on the second paragraph.
So the loss – we are benefited basically from 60 – the adjusted result from $60 million on inventory and basically, historically, all of Delek inventories were hedged. At El Dorado, Krotz and Big Spring with J-1 Towards the early Q1 of this year and late last year we lifted some of those hedge with RINsJ-1 and then we put them back, close the year as we manage our inventory. So that was a very good benefits and that’s part of what we call the inventory management.
I will point out though that even when you take out the $60 million, results are still extremely favorable and as we mentioned in our bridge in the slide, commercial did an excellent job during the quarter by basically getting better netbacks across the board, buying a cheaper barrels across the board and on top of it we’re able to renegotiated some intermediate products that’s really benefitted our quarter.
And you can see we allow customers saying that in a much different environment today, I will say less crack spread, lower midland diffs, we can generate closely $900 million of inventories. So I think the missing part is actually how commercial exit this quarter.
And then the $61 million I guess, inventory gain, are you able to split that out by refinery?
We had them between the refineries but I think it's better that we’ll report it separately. I don’t want to go into a specific detail this quarter at this point.
Your next question comes from the line of Doug Leggate from Bank of America. Your line is now open.
This is Kalei on for Doug. Just I have one question on the Permian Basin. Obviously demand there for fuels is very strong. Wondering if you can talk about their supply/demand balance for that market and whether any impact is expected as peers extend their reach into central Texas?
Are you talking about the product balance or the crude balance? I assume product.
Yes, the product balance.
Yes, it continues to be very strong and as we know our couple of companies or actually one project is more then out to explain to bring I believe 20,000 barrels or something like that 25,000 barrels to the region that will happen in some time in 2020, middle of 2020.
We are not yet concern and I’ll be clear why. Still bringing it to the – from the Gulf is $0.09, so at any given moment, any circumstances or even somebody signs take or pay or T&D and you look at it as a some cost, there is the other portion of the pipe that people need to pay $0.08 to $0.09 to bring it up.
So I do believe that we will continue to see very strong margin because we basically have long term agreement with different peoples, we have wholesale branded system over there that we don’t expect people to change and if anything that we need to be accountable with is the Big Spring netbacks.
Your next question comes from the line of Brad Heffern from RBC Capital Markets. Please ask your question.
Uzi, just wanted to beat the dead horse a little bit more but on the pipeline, can you just clarify what exactly the opportunities set us for that. You mentioned that you don’t want to support another new built pipeline and so. Are you talking about buying into one of the projects that’s currently in flight or are you talking about buying into an existing pipeline that’s already online?
We had several options and since we are in the middle of – thinking about that I would leave it to the comments we made earlier. I am sure it would be – it will clarify trough over the next few months.
And then you guys talk last quarter about progressing a new DKL drop with Krotz Springs assets. Can you give an update on that and maybe more broadly just you are thinking on MLP in general?
Assi, do you want to take that one?
Sure. For the crops dropdown we continue to look into the net weight to do it and taking into consideration the agreements and the type of the assets and we’ll probably be able to discuss it with the market or at least on our decision sometimes next quarter, we still think we’ll be able to accomplish drop by year end.
As of the MLP market, you know the market is still not as favorable. With that being said, we were very encouraged by the ability of our PL to access their capital market in the last few weeks. So we do see some I will say strength and appetite from investors to buying to those units.
[Operator Instructions] There are no further questions at this time. I will turn the call over to the management. Do you have any closing remarks?
Thank you, Laurie. Wanted to thank my friend along the table here, you analysts and investors for supporting us over the last quarter. I would like to thank the Board of Directors of Delek US Holdings for helping us making happen and by the end of the day without your support we couldn’t do it but mainly I would like to thank every employee of this great company that contributed to this another wonderful quarter that we just had. Delek US has a bright future. We’ll talk to you soon. Thanks.
This concludes today's conference call. Thank you, everyone for your participation. You may now disconnect.