Delek US Holdings, Inc. (DK) Q1 2015 Earnings Report, Transcript and Summary

Good morning. My name is Phoenix and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek U.S. Holdings First Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you, Mr. Keith Johnson; you may begin your conference.

Thank you, Phoenix. Good morning. I would like to thank everyone for joining us on today’s conference call and webcast to discuss Delek U.S. Holdings’ first quarter 2015 financial results. Joining me on today’s call will be Uzi Yemin, our Chairman, President and CEO; Assi Ginzburg, our CFO; Fred Green, our Executive VP and President of Refining; Danny Norris, our CAO as well as other members of our management team. As a reminder, this conference call may contain forward-looking statements, as that term is defined under Federal Securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify our forward-looking statements. You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations or results may differ materially from the results discussed in the forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. Today’s call is being recorded and will be available for replay beginning today and ending August the 4th 2015, by dialing 855-859-2056 with the confirmation ID number 29419413. An online replay may also be accessed for the next 90 days at the company’s website at delekus.com. Last night, we distributed a press release that provided a summary of our first quarter and 2015 results. This press release is available on our corporate website and through various news outlets. On today’s call, Assi will begin with a few opening remarks on financial performance for the quarter. Danny will cover additional financial details before turning it over to Fred, to discuss initiatives in our Refining segment. Then Uzi will offer a few closing strategic comments. With that, I’ll turn the call over to Assi.

Thanks, Keith. During the first quarter of 2015, we completed our expansion project and turnaround in the Tyler, Texas refinery, and made progress toward the loan [ph] transaction that was announced in April. In logistics we enter into our first pipeline development project and drop down two logistics assets during the period. While this should be provided growth going forward we did experience $79 million year-over-year decline in contribution margin at the Tyler refinery due to the downturn associated with the turnaround. With the completion of the work at Tyler we are approaching the end of a larger capital investment program in our refining segment, reducing our capital expenditure needs in the future. We ended the first quarter with $376 million of cash on a consolidated basis and $300 million of net debt. Excluding debt and cash at Delek Logistics we had a net cash position of $18.6 million at Delek U.S. Now, I will turn it over to Danny to discuss additional financial details.

Thank you, Assi. For the first quarter of 2015, Delek U.S. reported a net loss of $16.1 million or $0.28 per basic share. This compares to net income of $33.7 million or $0.56 per diluted share in the first quarter of last year. During the first quarter 2015, we benefited from an $8.3 hedging gain, which included $12.5 million of unrealized hedging losses. This gain was offset by approximately $20.8 million of higher costs related inventory adjustments and approximately $4 million of expenses associated with professional fees, primarily related to acquisitions activity. Excluding the net effect of the unrealized hedging losses, higher inventory cost and professional fees our first quarter after-tax earnings would have been approximately $24 million higher than the reported results. General and administrative expenses increased to $32.7 million in the first quarter of 2015, compared to $31.6 million in the prior year period. This increase was primarily due to professional fees related to acquisition activity during the quarter. Depreciation expense was $28.3 million for the first quarter of 2015, compared to $24.6 million in the first quarter of 2014. This increase was primarily due to capital spending in 2014 related to the El Dorado turnaround, acquisitions completed over the past year and capital projects at Tyler. Finally, our income tax rate excluding the non-controlling interest income associated with Delek Logistics of $5.4 million was 27.1% in the first quarter of 2015. The rate on an adjusted basis in the first quarter of 2015 was lower by the loss at Delek U.S. We expect the income tax rate for 2015 to be 35% to 36% excluding the non-controlling interest. Turning now to capital spending, our capital expenditures during the period were approximately $90.7 million, compared to $114.3 million in the first quarter of 2014. During the first quarter of 2015, we spent $85 million in our refining segment, $3.8 million in our logistics segment, $1.3 million in our retail segment and $600,000 at the corporate level. Our 2015 capital expenditures are forecast to be approximately $226 million. This amount includes $173 million in our refining segment, $20 million in our logistics segment, $18 million in our retail segment and $15 million at the corporate level. This is an increase from approximately $218 million in our previous 2015 forecast. Now I would like to discuss our results by segment. A combination of factors decreased our refining segment contribution margin to $21.9 million during the first quarter of 2015 from $100.5 million in the prior year period. First, as mentioned earlier during the first quarter of 2015 the Tyler refinery underwent a scheduled turnaround and completed its expansion project, which lowered its performance on a year-over-year basis. This turnaround had a larger effect on performance, as compared to the turnaround at El Dorado in the prior year period. Second, the $8 million gain from hedging activity was lower on a year-over-year basis compared to $32.8 million in the prior year period. Finally, higher cost related to inventory adjustments in the first quarter of 2015 lowered performance. The discount between Midland and Cushing WTI, which averaged $1.98 per barrel in the first quarter of 2015 narrowed from $3.54 per barrel in the prior year period. This change was partially offset by crude oil future’s market that was in contango in the first quarter of 2015 by $0.68 per barrel, compared to backwardation of $0.16 per barrel in the first quarter of 2014. The Gulf Coast 5-3-2 to crack spread at average $14.99 per barrel in the first quarter of this year compared to $15.01 per barrel in their prior year period. El Dorado contribution margin was $29.2 million, compared to $21.8 million in the first quarter 2014. Our Tyler refinery contribution margin was a loss of $3 million in the first quarter of 2015, compared to income of $76.1 million in the same period last year. Now I would like to review our logistic segment, which is comprised of the results from Delek Logistics Partners. Our logistics segment contribution margin was $24.3 million in the first quarter of 2015, compared to $21.8 million in the first quarter of 2014. Results benefited primarily from acquisitions completed over the past year, improved performance from the Paline Pipeline due to the new contracts effective January 1, 2015 and higher volumes on the Lion Pipeline Systems. These factors offset a lower margin in the West Texas wholesale business, acquisition related expenses and lower volume at the Tyler terminal and under the East Texas marketing agreement supporting the Tyler refinery versus the prior year quarter. Moving on to the retail segment. Retails contribution margin was $12.3 million in the first quarter of 2015, compared to $5.9 million in the first quarter of the prior year. This change was primarily due to higher fuel margins and gallon sold combined with higher retail sales. Our same store fuel gallon sold increased 6% primarily due to improvement in our large format store category on a year-over-year basis. We ended the quarter with 64 large format stores out of our total store count of 360. I will not turn the call over to Fred to review initiatives in our refining segment.

Thank you, Danny. I’d like to discuss our first quarter 2015 performance at the refineries and the Tyler refinery turnaround and expansion. Our El Dorado Refinery processed approximately 76,700 barrels per day of mostly light crude and our asphalt yield was 10% during the first quarter 2015. This compares to approximately 37,500 barrels per day of crude in the first quarter of 2014, when the refinery underwent a scheduled turnaround. At Tyler we processed approximately 18,580 barrels per day of crude, compared to approximately 58,280 barrels per day reached in the first quarter 2014. During the quarter, the refinery was down for a scheduled turnaround from January 23rd and began its restart process on March 19th. While the refinery was down we completed the expansion project bringing the crude nameplate capacity at the Tyler refinery to 75,000 barrels per day. In addition, we replaced the SEC reactor with state of the art technology. Based on current market conditions, this project is expected to generate a significant return, using 15,000 barrels per day of incremental crude throughput; we believe that the annual contribution margin generated from this project should be approximately $65 million. In addition improved yield from the new SEC reactor are expected increase contribution margin by approximately $10 million on an annual basis. Now I’ll turn the call over to Uzi for some closing comments.

Thanks, Fred. We’re excited about the potential value that can be created from the agreement we reached to acquire 48% of Alon USA from Alon Israel. This presents a significant step in our growth and the assets fit well strategically and geographically with our existing footprint. It also provides a step forward doubling the size of our company which is one of our target to accomplish every five years. The combination of our strong balance sheet and using both debt and equity for this transaction allow us to remain in a conservative financial position. This transaction has received HSR clearance and is expected to close as early May 12. We look forward to working with Alon USA Board and management team in the future. With the completion of the Tyler turnaround and the expansion project we’re approaching the end of a large capital investment program that has improved the competitive position of our refining segment. As we move forward our capital expenditure needs are expected to decline through 2015 and into 2016, with our base and maintenance level capital expenditures required for our operations at less than $100 million. Depending on the economic for the refining industry, this created opportunity for increased free cash flow from our operations that can be allocated to growth initiatives and return to shareholders. Our financial position remains strong and we continue to focus on our capital allocation strategy to support growth of our businesses and return of cash to shareholders. With that Phoenix, would you please open the call for questions?

[Operator Instruction] And your first question comes from Neil Mehta of Goldman Sachs. Your line is now open.

Hey, good morning.

Good morning.

So, can you talk a little bit about the strategic logic of the acquisition of that 48% of Alon and specifically what you see getting out of it is it the diversification of assets is the logistics upside is it the value of the equity that you are acquiring? Just could you talk about what drove you to the decision on what the opportunities are?

Well first of all it’s a great question. Let’s tackle each one of your topics. Let me just warn all of us that obviously Alon is a public company and I don’t know that I can make comments on their behalf, but I’ll certainly would be happy to make comments on our behalf. Our strategy all alone was to continue to increase and double the size of our company, we believe that two refineries are not sufficient enough to be in our business. Obviously, we are to the end of our investment or the capital that we invested into refineries and the free cash flow that is expected to come is very big. So we felt that with their footprint and the fact that they have logistic assets, they have retail, they fit very nicely with our assets. Now obviously, we haven’t closed the transaction, it will probably close as early as next week and then we will be able to talk about other initiative, but that was an opportunity that came across, the seller was a very big seller we know them very, very well they wanted a good transaction so we couldn’t go to a full Alon or they didn’t want the full Alon merger because they wanted that to close as quickly as possible because of their needs and that presented great opportunity for us and we took it.

And then Uzi the follow-up is I understand that there’re sensitivities around this, but is the end goal to ultimately acquire 100% of Alon, theoretically you can just take a controlling stake, but as I think about the DNA of Delek historically, you have been a company that has consolidated past acquisition and controlled a 100% of the entity.

We can talk on our behalf again we need to be careful here, but if you look at the 2011 acquisition of the El Dorado refinery. We bought initially 35% that was a private company at that time and when the time was right and we were ready we moved with the remaining 100%. I don’t see us at this point not thinking about the remaining shares we haven’t completed the diligence and see the initiative, but at this point eventually we will need to think seriously about buying the entire 100%.

That’s very clear. I will leave it there, thank you.

Thank you.

Our next question comes from Roger Read of Wells Fargo. Your line is now open.

Good morning.

Good morning, Roger.

Uzi, I would like to follow-up on the Alon question. Could you give us a little idea of kind of maybe how the transaction came together like as you said, it’s a group you know well and there was a lot of well I guess a lot of there were some leakage in the press and then the 8-Ks that were filed, I was just sort of wondering how long maybe the process had go on and how the negotiation sort of came together?

Yeah. I can give you a lot of stories around that. The first phone call I got was during the Super Bowl. So I thought I was scoring it touched down myself over there. But it took couple of months six weeks as a matter of fact, they wanted the quick deal which we really they wanted somebody with strong balance sheet obviously you know we have a strong balance sheet. So even though we were able to secure financing, we didn’t need to secure financing with the structure we’ve got and thus I was to move quickly and obviously we need the HSR, which we got this week. Now negotiation was directly with Alon Israel with not too much involvement of the company with one exception, the standstill agreement that we reached with the company as it was said in the 8K that’s a one year standstill, which in order to buy more than 50% we can go all the way to 50% and under certain circumstances we can go over 50% to protect our investment. But if we want to offer or buy more than 50% during the first year we will need to get the independent committee approval, which we have good relation with them. Now we have also great relationship with the Alon Israel people that’s a great opportunity for me to thank both the Alon management with Paul Eisman and David Weisman, but we have great relation with them and we feel that this transaction should be going very smoothly reality is that we signed this agreement two weeks ago and we are planning to close next week.

Okay, great. And then kind of the unrelated follow-up, if you could just talk in general what you’re seeing on the demand side in terms of product coming through the refineries in the retail component?

Yes. If you remember we said last call that was 9% we ended up with 6%. Actually the 6% is completely because of weather. If weather was nice in the South during the first quarter we would see, we continue to see great retail growth. I believe that some of it is us, but some of it is the market I think demand is - the customer really likes the 250 mark here in these areas and I think that people are driving more and I see a great summer ahead of us.

Okay, great. Thank you.

Thank you, Rodger.

Your next question comes from Ed Westlake of Credit Suisse. Your line is now open.

Yes, good morning and congrats on the deal. The independent committee approval process say you were looking to increase your stake presumably, there would be some price that gets determined and that price would be I presume based on ALJ standalone prospects. How do they, or do you have any idea of how people think about little bit the large synergies and in terms of whether that should be included in the purchase price so from the merger of the two?

It’s too early to speak about specific number Ed, but we know what the market history is. And obviously it’s a balance between okay should we move quickly and maybe enjoy the synergies again I can’t be specific around that or if we want to be patient. It depends on the market conditions at that time, obviously if we look at the Alon situation versus Delek situation, we can rather check or we can borrow the money and rightly check. Today if we want to subject to their approval obviously, so there is no financial restriction if you will, if we want to do the right thing. Now, our history shows that we usually with El Dorado if you remember I am sure you are, or you do. We went in and lend the company and when the time was right and we moved on and talk about how to take over the 100%. Obviously here the situation is different this is a public company we have much more knowledge on this company versus what we knew with El Dorado, so when the market conditions are right we will look at this very seriously.

And then you mentioned constraints and not having any obviously that’s going to be a function of the debt and equity mix smart way of doing the first deal we would have to see what the second deal looks like. But is there any sort of debt to EV kind of metric or net debt to EV metric which you feel is a little bit stretched talk us through how you might fund the potential or additional move?

Again, great question. We always said that we don’t want to stretch the balance sheet above two times. I actually think that if we can get and if you look at the balance sheet it’s very clear that the one-time maybe one and half times is very achievable. So I wouldn’t expect on a net debt situation be above one and half times at any given moment obviously if you look at that and do the calculation that implies a lot of flexibility between all debt to some equities.

No, I have my spread sheet right in front of me. Thank you very much, Uzi.

Thanks, Ed.

Our next question comes from Jeff Dietert of Simmons. Your line is now open.

Good morning.

Good morning, Jeff.

I know it certainly on Tyler post fee expansion, but I was hoping you could talk a little bit about what kind of throughputs you are seeing at Tyler and how it’s running relative to expectations?

Obviously the first month as you said it’s early, the first month was the first time that we run we looked at production tried different things Fred can talk about that. As I am just going to give you the news that Tyler has reached during the month and is running now 75,000 barrels. So during the month we tried different things we went up with production, we went down to see the constraints we didn’t want to push the system, but as we entered May we are at 75,000 barrel. Fred, do you want to add to that?

Yeah, the only thing I would add Jeff is that each of the units that was revamped or expanded in the process we’ve tested the design capacity and everything has been achieved that we were looking for. So far so good we are very happy with the performance of hardware.

Got you. And so expectations mid to low 70s for the full second quarter and kind of ongoing through the end of the year?

Based on what we see right now there is no even not to assume that.

Okay, good. And secondly, you talked about with the Tyler refinery being down consuming some of your inventory during the first quarter. How do you expect that to influence second quarter results?

The first around 2,000 barrels that we produce would go back to inventory to rebuild the historical LIFO layers there may be some positive impacts on the financial as a result of that the prices have come up, but in general we finish the turnaround with almost no product inventory in our tanks.

Thanks for your comments.

Great. Thank you, Jeff.

Thank you, Jeff.

Your next question comes from Brad Heffern of RBC Capital Markets. Your line is now open.

Good morning, everyone. Just going back to Alon, I was wondering if you could talk about if there would be any changes to either business with you controlling or with you having the 48% stake rather than having a control stake, is there anything that you can do in the near-term with crude sourcing or any other synergies that maybe you could recommend based on your position on the Board?

Well first of all let me clear what the position on the Board would be, so there would be five us joining the Board with me being the Chairman. So together with me there would be four of my colleagues. So we will have significant presence on the Board. Second, obviously I am not going to comment on Alon’s behalf they have a CEO actually we think that he is a very good CEO. So they will need to decide what they want to comment on their direction. We - what we want to bring to the Board is our expertise and our way of doing business and we’re hoping that that can help move along forward, but for specific changes you probably need to ask Paul or somebody else on their behalf.

Okay, understand. And then shifting gears over to the couple of announced pipeline projects DK was involved in. Can you talk about the benefit that you are expecting at the DK level from those from a crude sourcing standpoint?

Yeah, this is Mark Smith. The Tyler pipeline joint venture with Plains will basically allow us another inlet to the other El Dorado refinery; right now as everyone knows we get most of our pipeline crude through Sunoco mid valley line. And so this line will actually help us increase our ability to gather more crude in East Texas and potentially bring more crude from Cushing and Midland into the El Dorado plant. The RIO pipeline in West Texas is actually in an area of the Delaware Basin where it is right now are not very well served with pipeline gathering systems. So this will actually help us increase our gathering abilities in the Delaware Basin, which will allow us to buy that crude directly from the producer instead of having to buy it from other third parties at the market center.

Okay, great. I think that’s clear. And if I could sneak in one accounting one here, can you talk a little bit about the allocation of the hedged losses and inventory affects across at your refineries?

Sure. Most of the inventory impact is actually at the Lion Oil facility; because most of the inventory was there and then the hedging basically you can assume one third Tyler two third Lion.

Okay, thank you.

Your next question comes from Tee Chao [ph] of Tutor Pickering Holt. Your line is now open.

Thank you. Given the Alon transaction, how are you thinking about additional cash allocations at this point towards dividends and buybacks and specifically any thought on special dividend going forward?

That’s a great question again. First of all since we’re to the end of this capital program and we mentioned that our cash generation will increase significantly. We will need to think about how to finance if we decide to move forward with the remaining 52%, how to finance it. And also to look at the balance between Alon price and our price. So that’s something that we will look - we will watch the market very carefully. In terms of the regular dividend obviously we have the regular dividend, we didn’t declare the special dividend this quarter it doesn’t mean that we are not going to declare special dividend in the future, but as we look at our capital structure and the need of the different entities we will probably get back to the market with these ideas in the next quarter or two.

Okay, great thanks. On retail Delek appears pretty much as the only refiner I think we’ve seen with an integrated retail system that show any meaningful same story gasoline volume growth in the last few quarters, you mentioned it earlier that you think it’s mostly the market, but we’re not seeing that through your competitors, so can you talk about the programs that you are implementing and how big of a driver do you think that is on the volume growth?

Well thank you for giving us some credit, I am not sure we deserve everything you give us though. We have - let’s talk about the two programs we have specifically, we have one program that we have loyalty card we give $0.03 discount and since we are integrated the entire system and we have determined all in the pipeline ourselves then we have competitive edge on our competitor. So that’s the one thing very well known, also building the mega stores and then starting to mature have a great deal, they actually perform very well we’re going to continue to build this mega stores and look at other areas. As we look at so far we were in the Southeast, but we may need to look at other areas in the future to complete the entire system, if we look at the system being integrated into next few years. The combination of the mega stores and the loyalty program gives us boost versus the marketplace. However I do believe that the industry is changing dramatically and if people want to enjoy the growth in the marketplace what they need to do is to go to this large form of stores versus the four MPDs traditional stores that’s existed years ago. By the way just as a side comment our retail contribution margin in the last 12 months is the highest ever for our company, we can give you the exact number, but it continues to grow and we feel very comfortable.

Great, thanks. One last question on asphalt, could you talk about your asphalt margins in the first quarter and how that’s trending so far here in 2Q?

Obviously asphalt margins are coming down. Big part of the hit in the inventory that you saw in the first quarter came from asphalt as we mark down the asphalt based on the wholesale prices. Now usually wholesale prices in the winter time are down and then they bounce. We are in the marketplace if you look at different publications, retail asphalt is going up, the season is started it’s looking better, it came down from a year ago obviously with the price of crude is coming down, but now it’s coming up and are the layers that we have in our inventory as we mark down our inventory in the first quarter are relatively cheap. So we need to see boost from this business in the next two quarter.

Okay, great. Thanks Uzi, appreciate it.

Thank you

[Operator Instructions]. There are no further questions in queue at this time.

Well, I’d like to thank you Phoenix for hosting us this morning. I’d like to thank the management team and my colleagues around the table for the great work that they’ve done around the Alon acquisition and the expansion of Tyler. I’d like to also thank the investors for their confidence in our company, but mostly I’d like to thank our employees for everything they do and the great results that they give for this company. We’ll talk to you soon.

Ladies and gentlemen this concludes today’s conference call. You may now disconnect.