Vertex Energy: Mixed Messages

Summary

• Today, we take our first look at Vertex Energy, Inc., a refiner that has seen explosive sales growth thanks to a major acquisition.
• However, there have been some significant share dispositions by two insiders at the company recently and net losses in the second quarter were somewhat concerning.
• An investment analysis follows in the paragraphs below.
• Looking for more investing ideas like this one? Get them exclusively at The Insiders Forum. Learn More »

nantonov

What luck has gave you will probably leave you. - Amit Kalantri

Today, we put Vertex Energy, Inc. (NASDAQ:VTNR) in the spotlight for the first time. Vertex is a specialty refiner and marketer of high-quality refined products based in Houston with a market capitalization of approximately $620 million. This refining made a bold move to transform the company in May of 2021 when it announced it was purchasing the Mobile refinery in Alabama (90,000 bpd capacity) from Royal Dutch Shell (RDS.A) for $75 million with the goal of becoming become a leading regional supplier of both renewable and conventional products. The deal officially closed on April 1st of this year.

Management also said at the time it would spend an additional $85 million for the conversion of Mobile's hydrocracking unit which scheduled completion by yearend 2022. The current estimated costs of that conversion are now in the $90 million to $100 million range. The scheduled completion date of this facility to produce renewable diesel fuel is roughly the same, with start up now projected for the first quarter of next year.

August Company Presentation

To help financed this effort the company announced it would sell its 69M gal/year Marrero used oil refinery in Louisiana and the 20M gal/year Heartland used oil refinery in Ohio as well as other assets of its used motor oil collection and re-refinery business to Clean Harbors' (CLH) Safety-Kleen subsidiary for $140 million in cash one month later.

These assets would have generated more than $100 million in annual revenues for Safety-Kleen. At the time of the Mobile refinery acquisition, management stated once the conversion was completed it would give that facility the capacity to potentially generate at least $3 billion in revenue and $400 million in annual gross profit.

Unfortunately the Safety-Kleen deal fell through in late January of this year following regulatory review with the U.S. Federal Trade Commission. A few weeks later the company announced a five-year product supply agreement with California-based Idemitsu Apollo Renewable for 100% of renewable diesel produced as the soon to be completed conversion. Vertex's management stated it expected to generate $6 billion in revenues over the life of the contract. All of this 'news flow' has resulted in a very volatile five quarters for the company's stock and shareholders.

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Second Quarter Results:

On August 9th, the company reported second quarter numbers. Vertex disclosed a GAAP net loss of 98 cents a share, more than two bucks a share worse than expectations.

August Company Presentation

There were several items that made up all and more of the $63.8 million net loss for the quarter including a $46.9 unrealized commodity derivative loss, a $23.2 million loss on an intermediation agreement due to backwardation, and a $46.1 million realized commodity derivatives loss. The company had this to say about the Vertex's hedging program within its second quarter earnings press release:

Earlier this year, we entered into an inventory hedging program designed to mitigate financial risk, while positioning us to generate ratable cash flows with which to support our business for the first six months during the transition period. This program worked as planned during the second quarter, ensuring a ratable stream of cash flow into the business during a period of significant, planned capital investments. However, given expectations for a continued tightening in product supply and strength in refined product margins over the near-to-medium term, we intend to close out our remaining hedges in the third quarter, while maximizing our spot market exposure beginning in the fourth quarter 2022.

August Company Presentation

The company averaged just under 72,000 barrels per day of output. This is approximately 96% of capacity and above previous guidance of 69,000 to 70,000 barrels. Revenues surged to nearly $1 billion as the Mobile facility had its first full quarter of operations under Vertex. Adjusted EBITDA reached a record $71.3 million in the quarter, compared with just $4 million in the same period a year ago. The benchmark 2/1/1 Gulf Coast crack spread was $45.06 a barrel in the second quarter. This was just over an increase of 200% compared to 2Q2021.

August Company Presentation

Analyst Commentary & Balance Sheet:

The company's CEO sold just over 70,000 shares in his holdings on July 12th and then again on July 20th. This looks like it was just over 20% of his overall stake in the firm. A director sold just over 130,000 shares in the company in early June which appears to be his entire stake in the firm. This is the only insider activity in the stock so far this year. It also appears approximately 30% of the outstanding float in VTNR is currently held short.

August Company Presentation

Since second quarter earnings were posted, Oppenheimer has downgraded its rating on Vertex to Market Perform while H.C. Wainwright ($15 price target) and Stifel Nicolaus ($18 price target) have reiterated their Buy ratings on the shares. The company ended the second quarter with nearly $100 million of liquidity against net debit of nearly $300 million.

Verdict:

There a lot of mixed messages around trying to build an investment case for buying Vertex. Refiners are enjoying historical high crack spreads and there are moats around the business given we haven't built a brand new refinery complex in the U.S. since the late 70s. These factors have certainly have helped lift the stock of refinery giant Valero (VLO) since the beginning of 2021. Vertex's acquisition of the Mobile facility and its conversion project should lead to an explosion of revenues and one would hope profits.

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On the flip side, execution on several fronts by management leaves something to be desired and the deal with Clean Harbors falling through is a negative. The proceeds would have bolstered the company's balance sheet and help management focus completely on the Mobile facility, where the company gets the vast majority of its revenue and EBITDA. Leadership is still pursuing the sale of these assets, which it hopes to do by the end of the year. The large short interest in the stock and the insider selling of the shares this summer also are concerning to some degree. The economy has also cooled considerably in 2022 from where it was in 2021.

I think Oppenheimer's analyst had a nice summary around the company at this moment in time when he downgraded the shares in August:

"From an operating continuity perspective, Vertex's first quarter of integrating the Mobile refinery had several positives, including the refinery reporting 96% capacity utilization. However, hedging and energy markets volatility negatively impacted monetization of spreads, which have seen compression since quarter-end."

The Mobile acquisition is "transformative" for Vertex and still-elevated spreads as positive, "but given lack of visibility and management's outlook for continued volatility in removing prior guidance, we believe investors will need to see consistent EBITDA/FCF generation from the business to regain conviction," according to Kaye.

Therefore, I plan to avoid Vertex until it shows a bit more traction on its key initiatives.

Diligence is the mother of good fortune, and the goal of a good intention was never reached through its opposite, laziness. ― Miguel de Cervantes

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Comments

[Darp Research]

#1 short in sector

As of the close of business on Wednesday, 9/21, we captured the Top 10 Highest Short Interest % stocks within the Energy Sector.

The average short interest for stocks within the Energy sector stands at 2.81%. Therefore, the below stocks are showing a more pessimistic outlook than their peers within the respective sector.

VERTEX ENERGY INC (NASDAQ:VTNR) 33.05%
ENERGY FUELS INC (NYSE:UUUU) 23.31%
HOUSTON AMER ENERG (NYSE:HUSA) 19.61%
URANIUM ENERGY COR (NYSE:UEC) 15.96%
LAREDO PETE INC (NYSE:LPI) 15.69%
VAALCO ENERGY INC (NYSE:EGY) 15.03%
TELLURIAN INC (NYSE:TELL) 14.94%
SITIO ROYALTIES CO (NYSE:STR) 13.63%
KLX ENERGY SERVICE (NASDAQ:KLXE) 13.40%
CALLON PETROLEUM (NYSE:CPE) 12.95%

Many think short money is smart money, it is not. I have seen many 10+ baggers in heavily short stocks like PTRUF.

[qwerty11]

So Shell was just stupid to sell the refinery that low? Or is there more to the story?

[User 1111970]

@qwerty11 not really. Shell is a Deutsch company who is under a mandate by their country to reduce their carbon footprint globally by 25%. For a company that big, the only way to achieve this goal was to sell some of their refineries. Mobile was just one of those that they sold over the last few years. Shell also has agreement with Vertex to buy back some of the refined product. Lastly, Vertex had to purchase $173m of existing feedstock which was never really mentioned in any of the Vertex press releases when the deal was announced.

So Vertex actually paid $248m for the plant with the feedstock, not $75m. Plus $90-100m to covert a portion of the plant to biodiesel. If you throw in the interest on the outstanding loan balance every quarter and the $30m it cost them to structure the loan, it was a very expensive purchase. They also borrowed another $40m in Q2. I assume they will probably borrow more in Q3 too.

From my calculations, they are somewhere in the $300-400m in debt. Their AR and AP nearly balanced out in Q2 and the had $98m in cash. Vertex will need several $100m profitable quarters to become debt free. Some say 2025 but who really knows.

Hope this helps.

[qwerty11]

@User 1111970 Yes helps greatly, thanks for all this info!

[CPA022784]

@qwerty11 Debt not nearly what is reported above. Half is inventory financing. There is also no compelling need to be totally debt free any time soon.

[User 1111970]

I would strongly suggest everyone reading the Risk Analysis found in #VTNR 10q filled with the SEC on 8/9/22. This management team is hiding a lot of information from shareholders. Vertex is closer to $400m in debt and climbing because of their inability to record a profit. The variable interest rate on their loans are also a lot higher at 10.25% as of 6/30/22. Also, the company must enter into a crack spread every quarter as it is part of their loan agreement. Hopefully they get it right in Q4. Lastly, Vertex admits that it will have to raise capital through a share offering resulting in dilution. Between this and the lenders 22m warrants which can be exercised anytime the stock reaches $15/share, this stock will experience dilution of at least 50% in 2023. Investors will not know the chances of Vertex being successful until their investor call in February 2023.

[grok42]

@User 1111970 Thanks for your comment which I thought was really important. Had not read the 10Q yet. I took a look at the 10Q risk factors on debt and have to agree with you that something is not right. Very negative tone on debt risk factors and very straightforward statement about needing to raise more equity. The 10.25% interest rate is way too high given the huge crack spreads. Something does not add up here.

Per the 10Q - "As of June 30, 2022, we owed approximately $81 million in accounts payable and accrued expenses, $173 million in connection with our inventory financing agreements obligations and $260 million, net of original issue discount "OID", under our senior notes payable". The $81m accounts payable should be covered by AR (Q2 was $91m) in the normal course of business unless they are going to lose a lot of money, which seems unlikely given the high crack spreads and ending of the hedges in 3 weeks. The $173m in oil inventory financing should also get paid off as oil inventory is turned into diesel and gasoline etc, assuming they are not somehow losing money despite high crack spreads. So that leaves us with $260m in senior notes, of which only $165m is the term loan. That is not much given they have $98m in cash and should be able to sell their motor oil operation for $90m to $100m (might be wrong on the motor oil amount - just from memory).

The hedging loss for Q2 was $46.9m, plus there was an accrual for the hedging loss for Q3 of $46.1m taken in Q2. Spreads contracted in Q3 so far and they expect to recover $23m of the hedge loss in Q3. They also had a "a $23.2 loss on an intermediation agreement due to backwardation" (think that is the oil inventory financing but am not sure). They also took a $40m hit from convertible bonds being converted to stock and had to recognize OID. If you add all that up, they took a $93m hedging loss + $40m one time OID interest expense which is $132m. They will recover $23m of the hedging loss in Q3 and should have no further hedging losses in Q3 or beyond, although we need to figure out the loan covenants requirements for hedging as you alluded.

Q3 could show a profit. If you add back the $132m one time losses to the Q2 -$63.8m loss they would have had a profit of $68.2m. Assume Q3 has the same profit and add back the $23m recovery on the hedging loss you end up with Q3 on the order of $91.2m. That is just a wild guess on my part and I need to drill down to the hard details and get a real number. But at first blush things don't seem anywhere near as dire as management seems to indicate in the debt risks section of the 10Q.

In looking at other refiners (DK for instance), they are making a huge amount of money. There does not seem to be any reason VTNR would not be in the same position once the hedges are gone in 3 weeks. Not sure what is going on.

Something feels very off on VTNR's communications.

[User 1111970]

@grok42 a lot of great points you made. Yes, the $23.2m loss was from the sale of the converted Shell feedstock. This was a result of the crack spread they entered into for Q2 and Q3. I will check and see if they can record a net positive in Q3 by recording an unrealized loss in Q2 for Q3.

What most don’t know is Vertex will be forced to enter another crack spread every quarter until their Mobile loan is paid off. It is part of their loan agreement and spoken about in their 10q filing. Hopefully they hired some experts to help with this. If they get it wrong again, I would say the company is in serious trouble and all shareholder confidence will be out the window.

If I was a betting man, I would bet they had to take out any additional $20-40m loan to stay alive in Q3 due to the crack spread revenue loss. We will see if I am correct on the next investor call which should be around Oct 9.

With the 22m warrants outstanding and the fact that a portion of these warrants can be exercised every time the stock hits $14-15, I believe this stock will have significant issues staying above $15 for the foreseeable future. This does not include any dilution by the company in an effort to raise capital without incurring more high interest debt.

A lot of things have to bd done differently for Vertex to be successful but there is definitely an opportunity if management makes better financial decisions in the coming quarters.

[CPA022784]

@grok42 I read the Q completely before, including the factors. Always recommend folks should. Have written more 10Qs and risk factors in my life than I can count. The factors all read like the end of the world for legal reasons, so they have to be individually considered in context. Otherwise, you would never invest in any company ever again. I saw nothing out of the ordinary for a small cap company on the verge of a complete business model change. No doubt the rate on the term loan is high, but my only concern was that it is floating with some onerous prepay penalties. P&I is easily manageable with cash flow. Net debt position is fine (and one can't include the inventory financing arrangements, but then exclude the actual inventory). Equity issuance language is boilerplate and not really applicable until 2025. They will have long since succeeded or failed by then. Warrant dilution is well disclosed, most are way out of the money and there is a lot of capital gain to get from $8 to $14. Operating cash flow is tough to isolate from just one quarter of operations due to the derivative items and working capital changes. It should be easier to tell in 3Q, but cash looks to be more than adequate. Ultimate disposition of the UMO business is perhaps as important a variable in the short term as the progress in the core refining operations.

[User 195396]

Mgmt incompetence on hedges=Q2 disaster, director insider sales=possible fiduciary violation; mgmt failure to provide forthright guidance=all negatives!

Avoid probably not strong enough, run the heck the other way! This company is fraught with negatives with mgmt incompetence compounding the problem, they are in over their heads!

[CincinnatiRick]

@User 195396 The concerns you allude to were already addressed in the previous commentary. Unfortunate that you failed to respond, in detail, to the cogent discussion, particularly that offered by CPA022784 and grok42. Hint: it's never too late.

[User 195396]

@CincinnatiRick I'm inclined to go with grok42 who clearly has misgivings about the mgmt ability to manage and communicate; his other factors are also persuasive, e.g. debt levels and payments. The many other negative comments on the operations of this company contained herein are also of prudent value.

BTW, td ameritrade reports consensus earnings estimate for Q3 is minus $1.72, that is negative $1.72, est report date of 11/07. Not sure if these are the same analysts who had Q2 as plus $1.24 with result of negative $0.98 so take that number FWIW.

As someone else recently commented, maybe a key indicator would be when bod member phillips buys back as an insider trader as he dumped 100% of his shares in early June when it would have been obvious to all that the hedges were blowing up or had already blown up.

[MerosTC]

I did work on this company a couple of years ago when they announced the Mobile transaction. For me, you can't own this stock unless you're comfortable (and knowledgeable) with the outlook for renewable diesel (RD) and the associated credits (such as RINs, et al) that make the industry viable. Without the various credits, the product is not viable, and further RD is 80-90% a California product. Other jurisdictions may have joined, I'm not sure. My concern a couple of years ago was that due to the favorable RIN structure, many companies were expanding RD capacity - far too many I thought. Capacity announcements of 3.8B gallons against a total market of 4B gallons ...nearly as much as the entire California market. And VTNRs small (200M gal?) unit was relatively small. The other players involved (P66, Marathon, Holly, CVR, DGD/Darling) have much larger balance sheets than VTNR. The company benefits from the current high refining margins industry wide, but this is not the future for the company. In other words, if you want traditional refining exposure, don't own this one.

[qwerty11]

@MerosTC Wow, so good to read some real life experience. And makes my (remaining) short position a bit less scary...

[PBRM1]

Thank you for the writeup. I've been waiting for someone's perception of the company going forward after the Q2 results. I bought at just under $7 a share and planned to hold but got spooked after the recent downdraft. It's hard to know the direction going forward after bad Q1 guidance, sales falling through, director's suspicious insider sales. But I think based on the nature of the sector currently they'll have no choice but to make money. I'm getting back in when I can.

[The Insiders Forum]

@Seeking Mammon Sounds reasonable. Best

[Seeburto]

@Seeking Mammon I took profits after a double and jumped back in shortly after the fall in price. I think low 60s by the end of 2024. Just ignoring my shares for until then. Kind of like our potato field.

[Joeyh72]

@Seeburto we will never see $60 with current assets. Will never even see $30 with currents assets

[JackCr]

Long VTNR - patience is a virtue......

[CPA022784]

Poor superficial analysis. CEO had almost 7 million shares - selling about 1% each time under 10b5-1 plan. High short interest is mostly due to convertible bonds. Quarter losses were all related to derivatives prudently placed for a brand new operation and would not have caused losses if not for extraordinary spreads, which have since normalized. Limited hedges going forward. Did some nice capital structure cleanup actions in quarter. Possible retention of the previously AFS businesses which are generating nice returns and would only add to EBITDA. Currently inexpensive at EV/EBITDA multiples.

[grok42]

@CPA022784 Useful and accurate comment! While I agree with your views on the mitigating factors, I found management's communications and previous forward guidance pretty bad. Management put out huge forward guidance and then delivered exactly the opposite results with, I think, very little to no interim updates. Management also appeared to have muffed the sale to SafetyClean. Makes me wonder if they are in over their heads at this point. Having said that the refinery performance was solid, which is good and they did hire some new exec talent with refining experience.

The second thing that is not discussed much is the notion that refining is a commodity business and eventually margins will revert to long term low margin levels. It seems to me an analysis of the factors driving the high crack spreads need to be examined and some notion of how long they will last is needed. The refining story in Europe (Russian strangle hold on NG prices) is going to drive high refining margins for awhile. The problem could extend past the end of the Ukraine war as Europe would be really dumb to depend on Russian gas in the future. So we may see higher crack spreads until Europe can establish reliable alternative NG sources. On the other side, the rapid growth of EVs will reduce demand for gasoline and diesel. But I am just guessing here as to how those factors play out as I do not have much background in refining. Would be really useful to see a professional analysis of the supply/demand macro situation for refining.

The biodiesel initiative should be a winner, particularly with the passage of the IRA act with its incentives for green diesel. For the next year or two profits at the refinery should be quite large. I think the stock market underestimates the win for that. VTNR should be able to reduce or eliminate their debt, buy back stock, etc with those outsized profits. It also seems to me the stock market is ignoring the fact that the hedges will be gone in a month and that VTNR already took a reserve for hedging losses for Q3 in Q2. A lot of the Q2 loss is one time and Q3 should see material profits, if I understand the financials correctly.

Anyway, thought you made an insightfull comment!

[Joeyh72]

@CPA022784 lower crack spreads might lower hedging loss but it wouldn’t add to the bottom line any. The loss represents where they sold the inventory at market price minus the hedge price. Market price going down would have resulted in lower top line and same bottom line unless the market price fell below the hedges. Bottom line is this was a rookie mistake and even an amateur sitting in the cheap seats would have known it was a terrible idea.

[CPA022784]

@Joeyh72 That is one possible perspective with perfect 20-20 hindsight (that could further be applied to almost every energy firm that has hedges). Another alternative view is that they only hedged 50% (or so) of a brand new operation to prudently protect and control the potential cash flow from the new venture as it is needed for further operations and build-out cap-ex. Their hedges did not work out due to extraordinary market conditions that are highly unlikely to be repeated but, in any case, they are letting the hedges roll-off. The CEO then freely admitted their mistake and discussed the issue extensively in the conference call (in contrast to companies such as EOG which had billions in hedging losses in the 2Q and didn't feel it necessary to mention it in their release, presentation or conference call).