Why I Sold Par Pacific Holdings

Summary

• Par Pacific was initially intriguing as a niche oil refiner with unheralded positions in Hawaii and Wyoming (and now Washington).
• The company wrote down its entire investment in Laramie Energy, and at March 31, 2021, liabilities were a steep 86% of assets.
• While the refining sector has improved, sector economics alone are not enough to rescue this company. 2Q earnings will be announced August 4, 2021.
• This idea was discussed in more depth with members of my private investing community, Econ-Based Energy Investing. Learn More »

Ammarin Amhong/iStock via Getty Images

Par Pacific Holdings (NYSE:PARR) is expected to report negative earnings when it announces second quarter results after the close of business August 4, 2021. This $986 million market cap company owns niche refineries in three states: Hawaii, Washington, and Wyoming and is the reason I originally invested.

But I recently sold my shares.

Despite the favorable June Supreme Court ruling on renewable identification number (RIN) costs which may benefit Par Pacific and other small refiners, the reasons for my concern:

• The company's total liability load is considerable with a very high 86% liability-to-asset ratio. Its debt is high-priced with some as high as 12.75% and some at +7%. Thus, Par Pacific already has less financial flexibility and is potentially exposed to higher interest rate costs as inflation ramps up.
• To pay down debt the company issued 5 million additional shares in March 2021. More equity issuances could further dilute current shareholders.
• The company's two largest refineries are in states that are hydrocarbon-unfriendly. The state of Washington is expected to implement cap and trade and low-carbon fuel standards, similar to those in California, which will likely mean higher costs and lower flexibility for the Tacoma refinery.
• Crude oil feedstock costs are high, labor costs (especially in Hawaii) are increasing, and margins could be squeezed.
• Hawaiian gasoline demand from tourism is temporarily limited now due to a rental car shortage. The company also faces competition from Asian refiners.
• The company does not pay a dividend, yet its capital appreciation prospects appear limited.
• Despite very high natural gas prices, Par Pacific is not benefiting from its 46% investment in Laramie. Indeed, the company has had to completely write off its Laramie Energy investment.
• In addition to dilutive stock issuance, Par Pacific stock ownership by a hedge fund and by a distressed-debt special situations fund could bring pressure to bear for financial or operational decisions not congruent with growth/return-oriented public equity holders.
• For those interested in refining companies, others provide more stable and potentially-lucrative investments.

Supreme Court Decision

The question before the court in HollyFrontier Cheyenne Refining v. Renewable Fuels Association was whether small oil refineries could use a compliance exemption in the Renewable Fuel Standard program if they had not received that exemption every year since 2011. The Supreme Court majority ruled in favor of refiners. However, opinions are mixed as to how widely the decision can be applied.

By the end of 1Q21, Par Pacific had about $125 million of RIN (renewable fuel) exposure. The decision may allow Par Pacific's applications for 2019 and 2020 RIN waivers to be granted, and to defer the 2021 exposure and application to 2023.

First Quarter 2021 Results

For the first quarter of 2021, Par Pacific lost -$62.2 million or -$1.15/share. This included $47 million of RINs mark-to-market expense related to the 2019 and 2020 compliance years, (which now could potentially be reversed due to the Supreme Court decision).

Operating cash flow for the quarter was -$82.5 million.

In the first quarter, by segment:

• Refining reported an operating loss of -$90.9 million;
• retail reported operating income of $49.4 million; and
• logistics reported operating income of $10.1 million.

Typically - and especially for Par Pacific with Hawaii reopening to Lower 48 tourists - refiners' second and third quarter results are particularly strong.

Brent Oil Prices

Brent oil price, $/bbl; Credit: Macrotrends.net

The July 30, 2021, NYMEX futures price was $73.95/barrel for WTI at Cushing for September delivery (triple the level of May 2020). The Brent futures price for October delivery - applicable for the Hawaiian refinery - was $75.41/barrel. The NYMEX RBOB price for September gasoline was $2.33/gallon while the price for heating oil/distillate was $2.20/gallon.

The graphics below illustrate Par Pacific's network.

Competitors and Laramie Energy Investment

Headquartered in Houston, Texas Par Pacific, Inc. owns four "offbeat" or smaller refineries, three of which are operating: a 40,700 BPD refinery in Tacoma, Washington formerly owned by US Oil; a small 18,000 BPD refinery in Wyoming; and the primary (and now only) Hawaiian refinery with a capacity of 93,500 BPD, oriented toward meeting the island's tourist jet fuel (and gasoline) demand. The company idled its second Hawaiian refinery, which had a capacity of 54,000 BPD.

The company thus owns operating refining capacity of 152,200 BPD, or 0.84% of the U.S. total of 18.1 MMBPD.

Par Pacific sells gasoline, distillate, and convenience store items at 123 retail outlets in Hawaii, Idaho and Washington. As shown above, it also owns logistics networks in Hawaii and the northwestern US.

Finally, the company owns 46% of Laramie Energy, which has natural gas operations and assets in the Piceance Basin of western Colorado.

In Hawaii and Washington, Par's refining division competes with companies on the US West Coast and in Asia who can profitably refine oil and ship petroleum products to Hawaii. In Washington state this includes Marathon Petroleum (MPC), HollyFrontier (HFC), BP (BP), and Phillips 66 (PSX). In California large refiners are Valero (VLO), PBF, Chevron (CVX), and Phillips 66 while Alaskan refiners include, Marathon, Flint Hills, BP, and PetroStar.

Asian refining competition from Singapore is also considerable.

In the Rockies (PADD IV), Par Pacific's small Newcastle, Wyoming refinery competes with HollyFrontier, Marathon Petroleum, and Phillips 66. Although the product markets are smaller and more isolated, so too is the crude supply, an advantage for Rockies refiners.

According to the company's most recent 10-Q, "During the year ended December 31, 2020, Laramie Energy incurred losses that reduced the book value of our investment to zero, and as of December 31, 2020, we had discontinued the application of the equity method of accounting for our investment in Laramie Energy. As such, the balance of our investment in Laramie Energy was zero as of March 31, 2021 and December 31, 2020."

So again note, despite its 46% ownership and the more-than-triple natural gas prices ($6.83/MCF in 1Q21 vs. $1.92/MCF a year ago), Par Pacific stopped recording any equity earnings or losses from Laramie Energy. In its first quarter investor call, Par executives noted that the excess cash from 1Q21 would likely go to paying down some of Laramie's considerable debt.

Although gas prices are much higher at the moment, from a long-term perspective, it is worth noting the Rockies gas market is generally a difficult, low-priced, low-margin sector. Moreover, Colorado regulators are limiting new drilling permits and thus future growth: other gas basins in the US are more economically and logistically attractive than the Piceance.

Governance

At July 1, 2021 Institutional Shareholder Services ranks Par Pacific's overall governance as a 1, with sub-scores of audit (1), board (1), shareholder rights (7), and compensation (2). On the ISS scale, a score of 1 represents lower governance risk and a score of 10 represents higher governance risk.

Insiders own 2.2% of stock. At July 15, 2021, shorts were 5.3% of the floated stock.

Chai Trust's (Sam Zell's) major holding of 21.7% (as of March 30, 2021) means it has a correspondingly large operational voice. Potentially somewhat allied with the trust are Rubric Capital Management, a hedge fund with only five clients, with 5.5% of the equity and Nut Tree Capital Management with 4.8%. Notably, Nut Tree focuses on special situations and distressed debt, which - together with the recent equity float and the nearness of the stock price to the one-year target - suggest any near-term common shareholder equity uplift may be limited.

Par Pacific's beta is 2.66, meaning its price is much more volatile than the overall market, as might be expected from a small refining company experiencing much-changing oil prices and refining margins in niche markets-especially Hawaii - that have varied between closed, partially open, and open.

Financial and Stock Highlights

Par Pacific will announce second quarter 2021 earnings after the close of business Wednesday, August 4, 2021 and will host an earnings conference call the following day.

Market capitalization is $986 million at a July 30, 2021 stock closing price of $16.38/share. The company's trailing twelve-month return on assets is -6% and its return on equity is -70%.

Par Pacific's 52-week price range is $5.91-$20.18/share, so the closing price is 81% of the 52-week high. A one-year target price of $17.60/share puts the closing price at 93% of that level.

Trailing twelve months' earnings per share were -$4.66. The average of analysts' 2021 estimated earnings per share is still negative at -$1.95 and turns positive only in 2022 at $0.98 for a forward (2022) price-earnings ratio of 16.7.

Data by YCharts

At March 31, 2021 the company had $2.23 billion in liabilities and $2.50 billion in assets. In June 2021, it paid down $85 million of debt. However, Par Pacific's liability-to-asset ratio is a nosebleed 86%. Long-term debt is $512 million.

Indeed, the company presented at Goldman Sachs' May 2021 Credit and Leveraged Finance conference.

Par Pacific Holdings does not pay a dividend.

The company's mean analyst rating is a 1.75, between "buy" and "strong buy," from four analysts.

A Note on Valuation

The company's book value per share of $4.59 represents a significant write-down from a year ago. It is thus about 30% of current market share price, meaning the market value of the company's assets is much more than its accounting base, a signal of positive investor sentiment.

Positive and Negative Risks

The biggest risk to Par Pacific is refining margin contraction from higher crude costs and inflation, which will increase nominal costs and make debt more expensive. The company may also face increasing costs from tightening environmental regulations in Washington and Hawaii. Because of its high debt levels, the company has far less flexibility than many others.

Recommendations for Par Pacific Holdings

I do not recommend Par Pacific Holdings to investors and recently sold my shares in the company. Par Pacific does not pay a dividend, its debt load is high (86% liability-to-asset ratio due in part to asset write-downs), its interest costs are expensive, its crude feedstock costs are rising in its major market of Hawaii (where it faces strong Asian refining competition), it has issued potentially-dilutive equity to pay down high-priced debt and could do so again, its investment in Laramie Energy is now at zero due to that company's losses, and the investment in its equity by a distressed/special situations fund suggests Par Pacific is exactly that.

Investors interested in oil refining should consider Valero or may want to further analyze a small refiner like Delek (DK).

Source: Par Pacific website

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CVX, MPC, VLO either through stock ownership, options, or other derivatives. 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.