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What is Western Refining Really Worth?

|Includes: HFC, TSO, VLO, Western Refining, Inc. (WNR)
The selling price of WNR is a bit more than 17 as of this week, but that's just the selling price. We want to know what it is worth.

I had an old finance professor at Drake that gave us a lot of different ways to calculate what a company is actually worth--if the price is higher than the value, you can expect the market eventually to figure it out and a correction will occur, and if the value his higher than the price, it's a buying opportunity.

At the moment, a lot of people would love to sell it,. The short sale % of float as of the end of February for WNR was 24%.

First, let's compute what it would be worth if it were an "average refiner".

The average PE ratio in this group, is about 14, per this recent calculation:

The forward PE, based on the analysts mean estimates for earnings for WNR is 9.1, so the calculation is like this:

Stock Price  $              17
Shares Out 88.3
EPS Est 1.86
Forward PE 9
Industry PE 14
Est Stock Price 26.04

So we already know one thing: at the moment it's undervalued relative to the rest of the companies in this group, or possibly more accurately, the value of WNR  is correct and the rest of the group is pricey, or even more accuratelythe value of the whole group could be incorrect. Anyway, that's one piece of information: The market is valuing this guy at less than its peers for some reason.

So maybe the value of WNR is some function of its ability to increase the wealth of its stockholders, that is, make money, as this old Professor used to say, and the market, whoever that is, believes that the company is not able to do so. We have a lot of information at our disposal on that, let's look at a couple of different calculations:

First the average, per Yahoo Finance, expects the company to make $1.86 per share in 2011 and even more than that in 2012. We all know that this is driven mainly by the crack spread, that is the difference between the crude oil price and the selling price of the products, which for WNR is about 56% unleaded, 40% distillates, and 4% other.

So we can reconstruct the WNR income statement working backwards from there, deriving a lot of this from their last quarterly report:

Forward PE 9.14
Earnings Est 2011 1.86
2011 Earnings per est  $        164,238,000
Tax Rate                          0.38
EBT  $        264,900,000
Interest  $        140,000,000
EBIT  $        404,900,000
STA  $        280,000,000
Gross Income  $        684,900,000
Retail Business  $          25,000,000
Gross Income Needed Ref Bus  $        659,900,000
Annual Throughput              51,739,480
$/bbl Net Margin 12.75
Conversion Cost 6
Crack Spread Needed @94% Util 18.75

Last year WNR had $35M per quarter interest expense, mainly on their long term debt, and about $70M in STA expense. We know their current refining capacity, and for the purposes of this calculation we'll make the assumption that they're really good, they ran the place at 94% throughput this quarter, that is about 7% higher than the rest of the industry. We will have to wait until their earnings call, about a month from now, to see just how good they were....

Using that information, and looking back to 2007, the last year they made enough money to pay taxes to get their tax rate, we can work back through to figure out their revenue requirements per barrel and to that add the conversion costs to get an estimate of what their crack spread needs to be this year to do it...

According to this, as long as they are producing at 94% and as long as their crack spread is more than $18.75 per barrel, they're on track to make their number.

So evidently the market believes that there is some risk, hence the 25% of the float that is short the stock. We're about to get the first data point, their first quarter earnings. Just for fun, we can work backward on that, too, and see how they're doing:

BPD at 94% Utilization 141,658
BPQ             12,749,220
El Paso Downtime                   894,600
Throughput             11,854,620
Actual Utilization % 87%
Crack Spread (actual $/bbl) 19.67
Gross Margin           233,180,375
Conversion Cost/bbl  $                     6.00
COGS  $         71,127,720
Net Margin  $       162,052,655
Retail Business  $           6,250,000
Total EBIT  $       168,302,655
Interest  $         35,000,000
STA  $         70,000,000
Pre Tax Earnings  $         63,302,655
Tax Rate 0.38
Earnings Available to Common  $         39,247,646
Shares 88,300,000
EPS after tax                         0.44
Analyst Est 0.27

We know per their press release that they experienced a week of downtime in their El Paso plant due to utility problems, and we also know that the average crack spread this quarter has been 19.67 per barrel, so even though it appears that they will fall below the high throughput we estimated, they will make their numbers, and if my estimates above are anywhere near correct, they're going to exceed them. Of course that assumes that they ran  at 94% the rest of the time, and that, which is what they were able to accomplish in the most recent quarter, 4Q last year.

So it's all about the crack spread, isn't it? We have known this for some time.

Here is a slide from WNR's presentation the other day at Barclay's conference:

In "their" opinion, the crack spreads will peak out in the second quarter at about where they are now, and back off toward 17 by year end. As of last Friday the 60/40 WTI crack spread, which was pretty close to their actual crack spread in the 4th quarter, was around 22.....

So the first thing you have to figure out is: What's the likelihood that crack spreads will continue at their current historically high levels. According to WNR's CFOin their Barclay's presentation, the high margins are traceable to the current unusual WTI/Brent spread, a condition which will continue for a couple of years at leastin their opinion.

The second thing you have to figure out is: What's the likelihood that the refinery utilization will be at least 94%. I used my little spreadsheet above to do a couple of "what if" calculations, and found that for every 4% lower utilization, for example 90% instead of 94%, they need an additional 50 cents of crack spread to make their numbers.... So clearly, crack spreads are the more important measurement but they would be doing themselves a favor if they can keep the plant running. In fact, one of the reasons they have a chance to do well this quarter is if they skipped their El Paso turnaround: According to their annual reports, they had turnarounds in 2005, 2007, 2008 and 2010, so it is not unusual for them to do one every other year, but keep in mind what happens when you delay needed maintenance in this nasty business: you get unexpected downtime.

Another way to calculate WNR's value: What's the value of their assets in the marketplace if you put the whole thing up for sale? We had some discussion in the following article:

We did a lot of calculations on Valero and Tesoro, and similarly can do it on WNR:

Ref Cap BPD                        227,700
Market Cap  $         1,501,100,000
LTD  $         1,090,000,000
Business Total  $         2,591,100,000
$ per BPD                           11,379

Note: Valero's value per BPD was $8500, and Tesoro's value per BPD was $9000 per BPD, So if you wanted to go into the marketplace and buy WNR to get its refining capacity, you'd be paying a significant premium versus both TSO and Valero, and we also know that there were a couple of other refinery transactions the other day. per my previous article at about $3100 per BPD, so WNR will not be bought out by anyone like Mr. O'Malley of PBF Energy because it's too expensive.

There is some additional information: WNR announced on March 30

the rollout of their long term debt to 2017 which will have the positive effect of about $10M per year on its income statement in the form of reduced interest payments.

In the Barclay's presentation they openly stated their desire to "monetize" i.e. "get rid of" their Yorktown facility that is now sitting idle, but if conditions happened such that they could restart the plant, weil will  have to revisit our spreadsheet. They also are toying with the idea of getting rid of their retail business, which they estimate brings $25M to the income statement per year, but which has some value in the marketplace allowing them to further reduce the long term debt.

Their Barclays presentation also mentioned a potential problem: They were cash-poor on the basis of their problems in 2009 and early 2010, and they anticipate that if the crude oil price exceeds $130 to $140 per barrel they will run into problems being able to buy crude oil because of cash flow.

I would also point out that per Yahoo Finance, during two of the last four quarters there were "negative earnings surprises" so perhaps some of the discount in the marketplace versus its peers may be due to this.

A final point for those who care: Since March 1, insiders of WNR have sold 580,000 shares, for whatever motivation known only to them, per Yahoo Finance:

From here, to reiterate, you have to decide two things: Are the current crack spreads in this business sustainable in any kind of way, specifically are they sustainable above about $19 per barrel because if not, these guys are going to miss their numbers.

The other decision is: You have to figure out whether they can run the equipment at something that approaches its nominal capacity, and if not, can the crack spread remain high enough to compensate, at the rate of 50 cents per barrel per 4% refinery utilization?

I should throw in, just out of respect for that old Finance professor, that the value of a stock is a function of its dividend yield plus its growth rate, but since there is no dividend, and the growth is really iffy since they are not imminently increasing capacity, he would be in utilities or zero risk T-billsand leave most of this group alone.....

Also, remember that for every transaction there are two parties that have exactly opposite opinions about future events, and of course, the world is chaotic, as we are being reminded every day, and there are no guarantees on anything.

Do with this information what you will....

Here's a link to their website, on which you can for a few days listen to the presentation:

Disclosure: I am long CLMT.

Additional disclosure: My old finance professor would be proud that I learned something: CLMT has a high growth rate and a nice dividend.