PBF Energy: Time May Be Running Out
Summary
- PBF Energy enjoyed a spectacular 2022 and 2023 as crack spreads have remained high, leading to terrific operating margins.
- PBF relies solely on its refineries for income. If crack spreads were to drop in the future, as predicted by the EIA, the good times will come to an end.
- Purchasing units when crack rates are high exposes investors to capital losses when rates decrease. With a lack of meaningful cash returns to investors, this could be significant.
- Larger competitors like Phillips 66, Valero, or Marathon provide a better risk vs. reward in the refinery space.
MichaelRLopez
Thesis
PBF Energy (NYSE:PBF) has had a fantastic 2022 and so far, crack spreads in 2023 look to continue that trend. The EIA, however, forecasts the crack spread to return to normal at some point in 2024. I believe making an entry point or expanding a position in PBF at this time exposes an investor to capital losses when crack spreads return to more historical norms. PBF may still have some left in the tank, but I believe investors should tread carefully.
Similar to buying an oil producer when oil is over $100/barrel, buying a pure refinery firm when crack spreads are well above $30/barrel is buying at the peak of the market.
I have written several articles on energy producers and even larger peer Phillips 66 with recommendations to buy even on falling energy prices. So why the change in heart? In this article I will evaluate the following points for why PBF may not be a good fit at this time.
- The shareholder return model is currently focused on share appreciation via buybacks, with a minuscule cash return. I believe this is indicative of management's desire to return capital on a one-time basis and not being committed to a fixed payout with a dividend when times get lean.
- Buying a pure refinery firm when crack spreads are well above $30/barrel (a decade high) is buying at the peak of the market.
- Larger peers like Phillips 66 or Marathon have other "legs" to their business such as retail and midstream companies to stabilize cash flows during downturns.
Shareholder Returns
At the onset of the pandemic, PBF suspended its dividend program, similar to what many companies faced with highly uncertain times. Now, with COVID mostly in the rearview mirror, PBF has begun to restore its dividend to 2019 levels with an initial launch of $0.80/share (roughly 2% yield) on an annual basis starting in Q1 of 2023. This is still not quite as lucrative as the level of returns in 2019, which rewarded shareholders with $1.20/share, good for roughly 4% yield if you owned the stock at that time.
The good news is that the current return model does include some equity growth aspects as well. Starting at the end of 2021, PBF's board approved a $500 million share repurchase program. Through the end of February 2023, the company has repurchased $188.8 million worth of stock. While beneficial to the shareholder base, I feel this is a one-time kicker the company is implementing while crack spreads are high.
I believe the company has taken this approach because it is a "non-committal" stance. The company is not obligated to repurchase any set amount of shares in a given quarter or even complete the $500 million program at all. To me this is a red flag and signals that we are near the peak for this stock. If you already own the shares at a profit, it may be time to consider an exit strategy. I also do not recommend initiating a position unless the share price to crack spread becomes significantly dislocated from where it stands today.
Financial Performance
2022 was a record year for most of the refinery industry and PBF was no exception. The table below shows the stark contrast between the lows of the COVID years and 2022. What this also shows, is how demand destruction can take this business from a cash cow to a cash burner.
| 2022 | 2021 | 2020 | |
| Net Income | $2,972.8 million | $315.5 million | ($1,331.2) million |
| Debt Reduction (addition) | $2,333.3 million | $254.2 million | ($2,542.9) million |
| Cash Balance | $2,203.6 million | $1,341.5 million | $1,609.5 million |
The chart below shows the crack spread for the last 7 years. You'll note that the average price, with the exception of 2022, was in the ballpark of $0.30 to $0.35 per gallon. More importantly, the EIA projects reducing crack spreads as projects come online in 2023 and 2024.
Using an average spread of $0.80 per gallon in 2022, PBF could face a reduction in revenue of roughly 50% if the crack spread returns to historical averages. In my previous evaluation of Phillips 66 (PSX), I assumed a slightly rosier, annual reduction in margins of 20% in both 2023 and 2024. Using this same thought process, 2024 Net Income would be reduced to $1.78 billion.
Crack Spreads (EIA)
Due to its lack of income diversity, PBF looks especially vulnerable here. In my previous article on Phillips 66, I highlighted the fact that its midstream business can help carry the enterprise should this forecast prove to be true. For comparison sake, Marathon and Phillips 66 generate roughly 20% and 40% respectively of their profits from their midstream business.
PBF does not have this same luxury. A drop in the crack spread has the potential to dramatically reduce cash flows for PBF and should cause investors to pause before initiating or adding to a position. It would be a mistake to assume this level of performance will continue for the long term.
Debt
PBF used the record year of 2022 to dramatically improve its financial health. Debt was reduced to the point where they have a zero net debt position (more cash than debt on the books). To further that point, on February 2, 2023, the firm also repaid $525 million worth of their 2023 Notes. This certainly improves the long term viability of the firm.
I have to give them a plus for deploying the excess cash generated in 2022 in a very responsible manner.
Peer Group
We will also look at alternative investment options in the refinery space.
When compared to companies such as Valero, Marathon, or Phillips 66, PBF Energy fails to stand out in any major category with the exception of its debt profile. Its dividends and buybacks (as a percentage of market cap) are comparable or lower than either of the three companies mentioned so far in this space. Therefore I struggle to find a compelling reason to invest in PBF instead of the other larger cap companies.
Risks
The refinery market is experiencing premiums for its services thanks to a lack of supply. As the graph below shows, refinery capacity in the US has dropped since 2020, when total investment in the industry was severely slashed. Several companies (including PBF) are investing in renewable projects that will inevitably increase refinery capacity and thus have the potential to reduce margins due to increased supply. I believe that investors have 12-18 months of solid financial performance left in a pure refinery play like PBF, after that time the risks to profitability will weigh heavily.
U.S. Refinery Capacity (EIA)
However, if the projects slated to come online in the near term are delayed or do not perform to expectations, crack spreads may remain elevated. This would allow PBF to continue to generate cash at a hefty clip. This also would give the firm more ammunition to buy back shares and/or increase the dividend, both of which should bolster the share price.
The most likely scenario I see as a challenge to my thesis, is a combination of delayed and subdued performance for new refinery projects. Ultimately, this will only delay the inevitable for declining crack spreads. The image below shows the potential impact of renewable diesel production that is slated to come online.
It is also reasonable to believe that the high crack spreads, if sustained, will foster increased investment in the refining space. This will act to bring more supply online and potential crack spread compression.
Future renewable diesel projects (EIA)
Summary
PBF Energy is benefitting from the under investment in the refinery industry. This under investment is creating an imbalance in supply and demand, leading to high crack spreads. I believe this has the potential to last for the next 12 to 18 months, at which time, new project developments will lead to downward pressure on margins.
Because of its lack of complementary infrastructure, the business model does not seem favorable for a long term position when compared to other large refinery companies such as Marathon or Phillips 66. Additionally, the shareholder return model does not stand out from competing investments in the refinery sector.
Investors who have benefitted from the rise in share price over the last year should begin to consider an exit strategy before profits become challenged.
This article was written by
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.
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Comments (68)
Not that it matters as Danglinert has pointed out, but PBF is actually slightly lower than when my article was published. $42.06 on opening price on 4/6. It closed today at $41.79.Beyond that, all refiners stock prices have behaved in almost an identical pattern to PBF (Valero, Phillips 66 and Marathon). So again, nothing special here. Which in general, is my theme about PBF in this space.If you reread the summary, I do state the following:"PBF Energy is benefitting from the under investment in the refinery industry. This under investment is creating an imbalance in supply and demand, leading to high crack spreads. I believe this has the potential to last for the next 12 to 18 months...Investors who have benefitted from the rise in share price over the last year should begin to consider an exit strategy before profits become challenged."The main point of the article was to communicate:
1. I feel investors would be better served with Phillips, Valero or Marathon if one is to invest in the refinery space due to decreased downside if crack spreads retreat.
2. Under the premise that in 12-18 months profitability will decline, investors should identify an exit strategy to lock in profits and be cautious on starting a position at the peak of the market to prevent capital loss.If you disagree with those points or believe crack spreads will remain elevated for longer, that would be an appropriate comment for this space.
1. If all agree that crack spreads will decrease, we can all agree total profits will also decrease. What reason is there to believe that the stock price will go up on a company with declining profits.
2. The shareholder return model is generally a small dividend compared to its peer with a modestly sized buyback program (roughly 10% of its market cap at today's prices). This does not standout significantly from its peers
3. Its larger peers have a more diversified business to allow it produce profits on a more reliable basis that does not rely solely on crack spreads.Therefore I believe your investment dollars are better spent elsewhere. There really isn't anything "unique" about this investment other than its low debt profit and valuation compared to peers. Its valuation is lower because its profitability is less stable and less certain than its peers (see point 3).
2. The future earnings 2. Again - look forward, not behind. PBF Management has already discussed getting down to a "more normal" cash balance of $1 billion, meaning they're going to be returning ~$2 billion to shareholders in the intermediate future. They've already discussed a higher dividend, and we'll see another repurchase authorization soon.3. PBF again does own a midstream segment, but regardless, even if it had no midstream assets at all, that doesn't make it better or worse than peers - just a different risk/return profile. The part about low debt and valuation - that's a pretty big deal. Thanks again for the discussion. -FC
1. The current valuation
2. The future earningsWe have already discussed the cheaper valuation. You have no dispute from me there.The future earnings is the part where I am "stuck". You and I both have agreed to the point that future earnings will/should contract. If earnings are contracting compared to peers, (I will assume the multiple does not contract also), the implied price would also experience contraction. I think we agree the bigger midstreams will allow the larger peers to experience a lesser decline.I do not see a path for multiple expansion under a backdrop of declining earnings.I will not dispute anything you are saying on the "intent" of management to return capital to shareholders. This plan becomes harder (not impossible) to execute with declining profitability. There is just less discretionary cash to deploy to shareholders unless the company takes out debt.With that said, I will acknowledge that it is possible for everything you are saying to be true. My biggest point is that if I were looking to invest $10,000 today, I feel it would produce better returns else where. Not that you can't make money with PBF, but there just isn't anything "special" about PBF. All refiners benefit from the high crack spreads. If PBFs profits remain elevated, so do Marathon's, Phillip 66's, Valero's etc. If profits slip due to lowering crack spreads, the down side is lesser with the three I just mentioned because they have midstream and chemical related aspects to their companies.I think if you are more bullish on crack spreads remaining higher for longer, PBF would be the ultimate winner since it gets 95% of its earnings from the refineries (5% associated to midstream as you pointed out earlier).
2:12 pm ET April 6, 2023 (MarketWatch)
By Claudia AssisTop picks include Valero, PBF, MarathonU.S. oil refiners are expected to report "record" quarterly profits during a traditionally weak season, analysts at BofA Securities said in a note Thursday, calling it a "golden age of refining."The analysts on average raised their first-quarter earnings expectations for refiners by 9%, thanks to a "strong finish" for crack spreads, or the difference between crude oil futures prices and prices for gasoline and other refined products."We find a single trend for all names under coverage: record 1Q23 earnings for what is normally the lowest seasonal earnings of the year and a set-up we see potentially supporting continued strength in the run up to the driving season," the analysts, led by Doug Leggate, said in the note.BofA said refiners Valero Energy Corp. (VLO) and PBF Energy Inc. (PBF) continue to enjoy the "the best leverage to a robust refining environment."For its turn, Marathon Petroleum Corp. (MPC) offers the "most robust buyback program in energy, with more than a third of shares repurchased since 2021, with no slowdown in sight," the analysts said.Refined products have seen the highest seasonal demand in five years and for gasoline and jet fuel the highest absolute demand since the start of the pandemic, the BofA analysts said."With retail gasoline prices holding around $3.50/gal, we continue to expect the first 'normal' driving season since COVID, but with over 1mm bpd of net refinery closures increasing US dependency on gasoline imports, particularly on the US East Coast," they said.Refiner stocks have lost ground this week, reeling from Saudi Arabia and its OPEC+ allies surprising markets last weekend by announcing another round of production cuts, prompting a rally for crude futuresFor the last 12 months, however, the stocks far outperform an energy ETF and the broader equity market.Shares of Valero are up 28% in the period, while shares of Marathon gained 51%. PBF stock is up 56%. That compares with an advance of 12% for the SPDR Energy Select ETF (XLE), and contrasts with losses of around 8% for the S&P 500 index .-Claudia Assis
In the meantime, I hope PBF can hold $40 price.
...
For comparison sake, Marathon and Phillips 66 generate roughly 20% and 40% respectively of their profits from their midstream business.PBF does not have this same luxury"This isn't correct. PBF has 100% ownership of it's logistics and pipeline business. It used to trade as PBFX, and PBF bought out the remaining ~50% ownership last year. It was acquired at a $1.2B valuation (which implies 20-25% of PBF's market cap is the midstream segment) and produces around $150m of income a year. It's not as high as MPC ($59B cap with $23B, or 38%, being MPLX) but it's there.You don't discuss relative valuation of PBF versus the other refiners, which is pretty relevant. As far as crack spreads normalizing in 2024+, this is already well known by the market and why the major refiners are trading at 5-6x this years earnings (versus 3.5x for PBF) and 10x next years earnings (5.85x for PBF.) Then there's the cash story. PBF, after receiving the payment for ENI, will have around $1.5 in net cash (3B cash vs. 1.5b debt) on its $5.5B market cap. $2-4 natural gas prices makes NA refiners competitively positioned in the world. If we keep "good" crack spreads for another 4-5 quarters, PBF will cash flow its entire enterprise valuation. So if the ultimate thesis is "crack spreads are likely lower next year", this is already well understood by the market.
BD
