Delek US Holdings, Inc. (DK) Earnings Call Transcript & Summary

Thank you, everyone, for joining me this afternoon with this fireside chat discussion with Delek Holdings. We have Chairman, President and CEO, Uzi Yemin; and VP of Investor Relations and Market Intelligence, Blake Fernandez. Gentlemen, thank you for being available today for this call, and I hope you are having a good day with the conference. I think I want to just start off by giving the team here a couple of minutes to give their lay of the land as they see things right now, and then we can get into questions.

Yes. Thanks. Phil, this is Blake. I'll kick us off here. So the good thing or the bright spots that we're seeing in the market, thankfully, we are in the higher multiple businesses and that's primarily DKL and retail. We've really focused our efforts over the past few months here on DKL. I'm sure you've seen we've done 2 drops, the Big Spring Gathering business and then the trucking business. In particular, in the trucking release, we highlighted an outlook for improving distribution coverage and leverage ratios into the year-end that's going to be in line with the peer group. And we think that's critical because DKL is maintaining a 5% distribution growth while a lot of the peer group has actually cut their distributions. And so once we are able to deliver that and bring our ratios in line with the group, we really feel like that's a testament to DKL and should afford it to continue re-rating. Incidentally, DKL is the best-performing midstream company this year year-to-date, but we think there's still a lot of room to run there with 13% dividend yield, which is still well above the peer group. And so our feeling is as we deliver those ratios and net coverage, we see a real opportunity for DKL. And I would just remind you, DK owns 71% of DKL. So that's a big part of the sum of the parts value. I would remind you as well that as DK, the parent refiner, runs its system at, call it, 80% utilization, which is what we guided for 2Q. That's obviously going to benefit DKL in terms of providing a tailwind in that it's running above industry average and pushing additional volumes through the DKL system. So DKL is one the bright spots and we think a -- really a positive story going forward. In the retail side, despite the volume decreases that we've seen, margins have remained really sticky, and then we're seeing strong in-store sales as a result of some of the dynamics underway with the box stores in our markets. And so the bottom line is while there may be some changes in the composition of the earnings, we still feel very confident that, that business generates $40 million to $50 million of annual EBITDA. If you put a 10 multiple on that, that's $500 million of value, which we do not think is currently reflected in the DK market value. Phil, we had a sale of Bakersfield, which was something that kind of flew under the radar screen. It was a $40 million sale, but more importantly, it removed $14 million of expenses. And I think that's going to provide a real tailwind for us in 2Q. We've articulated an overall cost reduction of about $100 million year-to-year in both operating and G&A expenses, and I think that's going to give us good traction in kicking off those reductions, and that will be highlighted in 2Q results. But specifically on Bakersfield, one thing that was not in the release, we sold that to Global Clean Energy and they're in the process of converting that facility into a renewable diesel plant. And we have an option to participate in that with a 33% interest. That option is basically available to us today all the way through 90 days after the facility is operational. And there's no financial details we can disclose right now, but I think at the end of the month, there will be further SEC filings from Global Clean Energy. And that will highlight, I think, a very attractive entry point for us compared to the industry that is undergoing a build-out phase where it's a lot more capital-intensive. So that's something to keep an eye on. Like I said, the cost savings, we're reducing overall cost, $175 million. $75 million of that is CapEx. $100 million is actual cost reductions. And then we guided to utilization in the quarter of 80%. I think you'll know that, that screens very well compared to the peer group and should help us in terms of per barrel operating cost. So really, that's the opening remarks. I'll leave it to you with any questions, Phil.

Sure. Well, thank you for that overview. In terms of this renewable diesel opportunity, I know you don't want to give financials, but is there anything in terms of sizing of the facility?

We do have all the details. It's actually a very attractive option with -- you'll be surprised to find out how much the option is worth. But we want to honor our partners and they asked us to wait until they come with their full disclosure, and then we'll disclose. There are a couple of others involved in this thing, including the feedstock and the offtake agreement. So let's leave it to that. It's an extremely sweet deal for us.

Okay. Interesting. I look forward to that.

And in fact, the -- one thing that we wanted to avoid and hopefully we did, we were concerned about all this renewable diesel. We used to own one, as you remember, in California. We sold it [ to world fuel ]. The start-up process and the building process is extremely complicated because these are new technologies. I know that everybody should know -- these are known technology, but there are only a few plants that exist in the United States. So we wanted to avoid the pain of going through overruns and start-up. It's a set number of the option, and it's very clear, 90 days after the facility is up and running.

Got it. Okay. Well, maybe to step back for a second, like you were talking about the strength in the retail margins and we've heard similar messages from others. So any additional color you could provide there as well. Just in general, what do you see in your system from a demand perspective?

Well, I'm not the one to -- that's a great question, Phil. So first, the retail margin are enormous, as you know, because of the price of crude coming down. But that's not the spot price -- spot point here. That's the sweet spot here. You mentioned in our previous discussion, 18% retail, so jumped in May. And during this quarter -- and I don't know if this is sustainable or not. So far, it is. I'm not sure it will stay. For the quarter -- not May, I'm talking about April, May, June, the inside sales are something I have not seen in my entire career. And there are 3 -- far from anything that anybody expected, including myself. And there are, in our minds, 3 reasons for that: First, in the areas that we are in, the big boxes are not operating anymore 24 hours. Second, people don't want tomorrow to stand in line outside the boxes to get a couple of things. And third, people are afraid that they will be infected by the virus if they are in contact with a lot of people. So the combination of hours, impatience and fear of health caused our same-store sales to be something enormous. Now again, that is only 2.5 months. I don't have a clue if this will continue, but it's just something eye-popping. Every day, I look at it.

Interesting. Okay. Yes, we're definitely hearing strong metrics from several participants in the retail value chain. So how about just on the refining side? What are you seeing in your system there for gasoline and diesel demand as we try to compare notes across the companies and particularly your niche market operations that you've referenced many times?

Yes. So we -- I think the industry is running 71%. The guidance we gave, the middle point was 80%. I don't believe that there is any reason to believe that we won't come below 80%. That's the guidance that we use. And usually, these markets -- and you're asking about the demand, the demand in Arkansas is pretty much back to 100%. The demand of gasoline -- I shouldn't say -- let's be clear. The demand in Texas, West Texas is probably going to be in the single-digit reduction compared to last year by the end of June. So it's not going to be for the core single digit, but as we enter the third quarter, we expect this to be a single digit. Now I want to be clear. We are in rural areas. So I'm not sure we -- and we don't have good visibility to big cities like others do, New York, Chicago, Boston and L.A. or Houston. So we don't have good visibility around that. And I'm hearing from others that they are saying the demand is weaker than what we see. And honestly, we're in national -- the demand in national, we don't have any stores. But I hear from people, the demand in national is down. So many people here enjoy it. That was the case also in 2008. Maybe we enjoyed the location being in rural areas in some of our locations. So I don't know that I can give you good visibility of the demand in general. In our area, it's probably a little better than what you see in other places.

Okay. Great.

Phil, I would just add. It may be global, too. It's like the idea in the refining system is we're trying to match utilization with underlying demand. So even though we're running above the industry, we're not building product inventory levels. So I think you could look at basically our headline utilization rates as they come out and kind of understand that that's basically matching what the underlying demand trends are.

Right. And your guidance for the quarter was closer to 80% for all of the second quarter, if I remember correctly, right?

That is correct.

Has your run rate -- actually, if you look at June or July, is it looking above the 80%? Or has it been pretty consistent?

Well, over the last 2, 3 days, as you know, price points are -- have improved. So now we need to make a decision about July. We said it previously that Big Spring is pretty much running wide open, and that's our best refinery. So the other ones, we need to optimize it based not on demand, but sometimes, you have the demand but you don't have the margin. So you don't want to produce. So it depends on the margin. $9 is probably going to make July continue to be over -- above industry average. And we'll be happy to give you July when we do the -- our earnings call.

Sure, absolutely. What's your perspective on export markets to the extent you have a view in terms of what's happening there? Obviously, demand has been pretty weak to Latin America recently. But how do you think about that, the export markets and how they influence your areas of operation, if at all?

First, we don't have good visibility. So you probably can rely on others what they see in other areas. We did see Gulf Coast, as you know, and there are a couple of facilities, 2, 3 facilities, big facilities that are export facilities that are not running at capacity or even close to that. I think from what we read -- and we don't have good visibility ourselves. It's not that we have customers that called us and said, "Don't send us a barrel," just because our export is pretty limited. It's 5% of the production usually. So I do think that the weakness in the cracks and the fact that we saw this inventory is going -- growing are because of 2 things: First, Europe started to send barrels to the Atlantic Ocean and then barrels then leave the Gulf Coast to go to Latin America. That's just analysis of our research department, not something that we see firsthand. Just talk to traders, talk to other companies. We don't have good visibility. Sorry to disappoint you.

No problem. No, that's helpful. Let's move to talk about crude differentials for a little bit. Uzi, you always have views on -- especially on inland differentials, whether it's Brent, WTI or Permian spreads as well as some pretty good insights into what's happening on the ground in terms of crude production with -- especially with Big Spring. So maybe you could just talk about what you're seeing there, how you're thinking about differentials and what you're seeing in terms of barrels coming back and what it might mean for differentials moving forward.

Okay. So let's talk about different -- just a big question that I can probably give a lecture, which you don't want to hear. So you can...

Always appreciate your opinion. I always appreciate your opinion, whatever you have to offer.

I always want to tell my opinion. I'm not sure I'm doing the right thing by doing that. But that's okay. That's a different animal. Let's talk about the, first, heavy line differentials. We saw them coming in. They are coming in. And if you ask some of our peers what is their crude slate, most of them will tell you the first thing is Cushing or Midland, the second thing is domestic semi-heavy like Mars, then Maya and then Canadian. So that's the crude slate. That's a good diet for even the big refineries in the Gulf as we stand. And you can ask us of why is that the case just because of the fact that if you look at Mars today, Mars is $1 over Midland, so -- or $0.20, $0.30 over MEH. So that's the diet that they are taking. That's the short-term answer especially with Brent-TI being $2.50. Now I do think that the shock of the minus $37 scared everybody. We do see producers coming back, if you will. It used to be the -- in May, we were -- we gather usually 340,000 barrels. We gathered 260,000, 270,000. Now we are below 300,000, 300,000 and change. So -- and we expect July to be even stronger. Now the operating cost, and you know it as much as I do because you talk to all these producers, are independent in the 3 counties of Midland, Howard and Martin Counties. It's anywhere between $11 and, call it, $18, $19. That's the cash operating of the barrel. But most producers nonetheless -- I mean they said, "I'm not going to dilute my capacity by selling it so cheap. So let me wait until prices will go up and recover." So now that they are $37, $38, we hear that rigs have not -- didn't come back yet, but I won't be surprised if in July people bringing back rigs. There's 1 more thing that I'm sure -- you're aware of that and you know about it more than I do, which is the situation of the dollar. The dollar is -- was very strong in the middle of the shutdown, but it's getting weaker now, a little weaker. And that means that -- if you remember, in 2008, 2009, the dollar -- when the dollar got weaker just before the crisis, crude went to -- all the way to $140. At that time, there was no export. This time, you have exports. So if the dollar is weaker and traders and all these macro funds will go into commodities, then you're going to have a higher crude price against a situation that needed to be expected. Now this is too early to predict that. Maybe we're talking about something that will never happen, just something that we need to monitor. Lastly, Midland-Brent, even if you look at today's shipping -- and we spoke about that. In today's shipping, if you want to get from Midland to China, it's still around $6 even though it collapsed. So you -- eventually, this [ begins ] to clear the market. Now as long as domestic refineries, their diet is Midland, it doesn't need to go to China. But if you think that at one point something will come back from the import market, then it will open up. That was a long answer to a quick question.

Well, I gave you a several-part question. So you gave me a several-part answer. It's all good. Let's get to a couple of company-specific topics. First, in terms of -- Blake, you talked about the cost reduction efforts not only in operating costs, but there's obviously been capital cost efforts. So could you talk about how much of what you're doing you think is temporary actions versus permanent actions and how this might line up for a 2021 run rate based on how you view the flexibility of the business?

Yes. And Phil, just to be clear, are you asking more on CapEx or OpEx or both?

Both, both.

So on the OpEx side, I think the best guidance I can give you is if you look at the 2Q run rate and extrapolate that forward, that's probably a pretty good proxy. In other words, that won't get you to the full year guidance. To be fair, there's a variable component in there, where we're only running the system at, let's just say, 80% utilization. So in theory, as we flex back toward normal utilization, that variable cost should move higher. However, offsetting that is -- a lot of the steps we've been taking to reduce costs really are going to continue to set in, in the second half of the year and we think largely offset that upward pressure in variable cost. So that ultimately leads you to -- and again, I don't have hard guidance yet for 3Q, but I think something around the 2Q level that we guided to should be pretty indicative of the system going forward. On the CapEx side, we guided $250 million for the year. As you know, in 1Q, we spent $180 million, $190 million. So that leaves you with about $20 million per quarter. And the way we typically talk about the business on a sustaining, regulatory, turnaround basis but basically no growth is, call it, $180 million to $200 million a year. That being said, there's always opportunities to kind of push out and defer things short term. So we don't have a hard guidance yet for 2021, but I think that's the way I would look at it. $180 million to $200 million is kind of "keep the lights on" kind of CapEx and there's always some flexibility around that.

And I guess to your original point, with the renewable diesel, if you were to invest in that for your 1/3 stake, would that necessarily be in 2021? And also, could it be via a JV format like you've done with Wink to Webster?

I'll tell you how we look at it. The $40 million that we sold the asset, the Bakersfield, is not the real number. That sell price reflects in it the all-in option to buy into it based on their business model. So do not expect any 0 CapEx if we exercise the option. And as I told you, the option is in a very, very attractive price so that what we sold Bakersfield for reflected that idea.

Okay. That's great.

Phil, just to be clear, this is not anything like some of the peers that are spending hundreds of millions...

There's no $100 million and no $150 million and no $200 million and nothing like that, nothing. It's de minimis.

Yes, yes. Okay, okay, okay. Just in terms of where you see things today with the balance sheet and your dividend payout ratios, things like that, how do you think about -- if this were a lower-for-longer environment in refining, how do you think about the commitments you made and where your balance sheet stands right now?

Well, first, you are absolutely asking the right question. We always wanted $1 billion on the balance sheet. We ended the quarter with $800 million. We think that we need to go back to our $1 billion before we start deploying back cash to shareholders. I want you to remember one thing though and that -- you didn't ask that question, so I'll volunteer the answer regardless. We invested a lot of money in the midstream. Now you asked me that question in the past and I told -- and you asked me if it's going to -- are all happening in 1 day and I told you no, it's not going to happen in 1 day. Just one thing to remember that you need to expect DKL to continue, EBITDA continue to go up on investments that were already happening in the past, including Wink to Webster that the money they put in it already was invested. So the EBITDA for the midstream, we are confident that we can get to the $370 million to $390 million in 2 years now. But as you said -- I told you in the past and you asked me that question, the -- getting there is not over 1 day. You should see improvement almost every quarter now. So that will allow -- going back to your question, that will allow DKL -- because most of the debt is sitting at DKL, the vast majority, that will allow DKL either to improve the ratio within DKL and we said we expect this to be -- the leverage to be below 4 by the end of the year, or do something else with demand. So going back to your question, that's the capital structure that we built in order to maintain the balance sheet. That's -- I hope I answered that question.

Right. You did. And on the topic of DKL and to Blake's opening remarks, what do you feel like you need to do to get credit for the value of DKL for its growth rate with -- embedded within the value of DK?

That's a great question. I think time will give us that flexibility. We are still 13%, very attractive. We said that we will continue to grow it and, at the same time, get to coverage of 14%, 15% by the end of the year and also reduce the leverage. Why we're so confident about it? Because the money was invested. I think as these assets come online and people see that this is not just money that was burned, then hopefully, we'll get more and more credit. I don't see any reason why DKL won't continue to perform very well for us. And then if you are adding, let's just say -- today, DKL is a, call it, $900 million company and you have the GP, call it, $400 million. You take the combined entities and relatively -- relative value in it, it's $1.1 billion. So if you use $1.1 billion in this and another $500 million for retail, our refineries are not for free. They are negative. So that's okay. That happened in the past. The market fixes itself, and that will happen over the next 2, 3 quarters.

What's your perspective on the GP at this point?

We're looking at that. The GP is giving DK $40 million every year. So it's a substantial asset. And that $40 million are going away from DKL. If you add $40 million and you use, whatever, I don't know, 10x GP, there will be times that we will need to deal with it. But right now, we're comfortable where we are.

Okay. I think we only have a couple of minutes left. Uzi, this is usually an environment where DK likes to be involved in M&A at the bottom of the cycle and find good value. So how are you thinking about the M&A market right now? And obviously, there's been other companies that had -- appear to have had interest in you. So any comments on either side of that would be interesting in the last 2 minutes we have.

Well, the second part, I'll just ignore it so I'm not going to eat any time out of these 2 minutes. The first part, we are still...

I had to ask.

I had to answer that question. The first part, I don't believe the demand is coming back to 100%. We don't believe over the next 12 months. It won't happen. So there will be, in our mind, some facilities that will shut. If you remember, that happened in 2008. 13 refineries were shut between 2008 and 2013. You don't want to buy a refinery just because it's a cheap number and then find out that it's not sustainable. We will need to go into this thing over the next quarters to see who is valid and who is not. We know already that at least 2 refineries were shut and 2 more are on the bubble. So we think that we should wait a few more quarters before we jump into this pool of -- especially when our own 4 refineries are negative value. So if you took that and you say, "Okay, I'm going to sell DKL and I'm still going to sell retail," like what happened with MAPCO, when we go 14x, first, the numbers would be great for retail after this quarter. If you do that, then all of a sudden, you're a company that is negative value for refining. I don't think that any of our peers has negative value for their refineries.

Got it. Well, Uzi, I think we're out of time. You left it on an interesting note there. So we really appreciate you participating in the conference, as always, and we're looking forward to speaking again soon.

Thank you.

Thank you.

Thanks for taking the time, Phil.

Thank you.