Earnings Call Transcript - CLMT Q2 2022

Brad McMurray, Investor Relations

Good morning. Thank you for joining us today for our second quarter 2022 earnings call. With me on today's call are Todd Borgmann, CEO; Vince Donargo, CFO; Bruce Fleming, EVP Montana/Renewables and Corporate Development; Scott Obermeier, EVP Specialty Products and Solutions; Marc Lawn, EVP Performance Brands; and Steve Mawer, our Executive Chairman. Before we proceed, I'll remind everyone that during this call, we may provide various forward-looking statements. Please refer to the partnership's press release that was issued this morning, as well as our latest filings with the Securities and Exchange Commission for a list of factors that may affect our actual results and cause them to differ from expectations. You may now download the slides that accompany the remarks made on today's conference call, which can be accessed in the Investor Relations section of our website at www.calumetspecialty.com. Also, a webcast replay of this call will be available on our site within a few hours. With that, I'll pass the call to Todd.

Todd Borgmann, CEO

Thanks, Brad. Good morning all and thank you for joining us today. This morning, we shared two announcements. First, we reported second quarter adjusted EBITDA of $175 million, which is a Calumet quarterly record. We also reported that we've concluded a set of transactions at Montana Renewables that place the pre-commissioning enterprise value of $2.25 billion on MRL. These are game-changing accomplishments, and I thank our employees, customers and investors for the effort, commitment and faith you've demonstrated in Calumet. Honestly, a couple short years ago, many didn't believe that Calumet would be sitting here today. And the grit and determination of our employees is the fundamental reason that we are. It's fun to see that type of commitment rewarded with phenomenal results. Before we dive into the quarter, let's flip to Slide 3 and revisit our strategic plan to create and separate two independent leading businesses, our specialty products business and our renewable diesel business. As we highlight the quarter on Slide 4, I'll come at it through the lens of these two businesses. Let's start with specialty products. The second quarter demonstrates the upside power of our integrated specialty business. This business is unique, and it's been built one brick at a time over decades. We believe Calumet benefits from industry-leading flexibility and optionality and we have an unparalleled ability to provide a full portfolio of specialty products across a wide array of world-class customers and end markets. Our brand names are well known, and they are built on years of specific technical interactions with our customers to meet their specific needs. Our replicable asset base provides the ability to meet these needs at scale. And they have demonstrated the flexibility required to succeed in all business cycles. In tough times, we have the ability to scale back volume and target our production towards specific market niches with their business cycle agnostic, which was demonstrated during COVID. In a strong market like we're seeing now, we could run all out with a focus on generating as much product as possible, including the fuels that are made as byproducts of our specialty manufacturing process. We've talked before about the competitive advantage of integration, and we estimate the value difference between running specialty feedstock only and running our fully integrated system was worth more than $70 million in the second quarter. As you might expect in an integrated business, every product line and even business segment doesn't respond the same to changing market dynamics. Our Specialty Products and Solutions segment benefited tremendously from both the favorable market demand and the team's commitment to commercial excellence, as specialty margins not only kept up with the commodity supercycle but actually elevated to levels similar to the all-time highs seen late last year. Conversely, our retail business in the Performance Brands segment is seeing the effect of this market, as the rising material costs increase and the coinciding price increases are caught in the timing delay. Calumet as a whole is happy to make that trade as we sell 20 times more base oil and gasoline molecules in our system than we consume in Royal Purple, Bel-Ray and TruFuel. So we're seeing the high cycle results that we'd expect. And in a low cycle, as we saw a couple of years ago, we'll see the stickier pricing, higher margin side of our business carry a larger portion of the way. We think this dynamic puts a floor under our business risk, and we believe the favorable misbalance of upside reward and downside risk protection is something that sets Calumet apart. Next, let's talk Montana Renewables. Since our last earnings call, we've essentially completed the standing up of MRL. Production is expected within the next 60 to 70 days. Our renewable diesel and sustainable aviation fuel has been sold at commercial terms superior to what we expected in our financial models. Feed purchasing continues to progress much better than anyone expected. Cars have been arriving throughout the quarter as our tanks fill. And this morning, we announced the two transactions that complete the capitalization of Montana Renewables. The transaction highlights a free startup MRL enterprise value of $2.25 billion, which demonstrates why MRL is so transformative for Calumet and our unitholders. The transaction supports our hypothesis that this is the leading independent renewable diesel project in North America. I'll come back to Montana Renewables later this morning. But in the meantime, I'd like to hand the call over to Vince to discuss the quarter.

Vince Donargo, CFO

Thanks, Todd. Turning to Slide 6. Our second quarter results in our SPS business generated a record $123.5 million of adjusted EBITDA. Our team executed well in a strong margin environment as our specialty margin approached near record levels. The specialty material margin of $65.95 per barrel is exceptional for this business and a $25.67 per barrel in fuels material margin reflects a very favorable crack environment, as experienced by many other companies in the fuels industry. Operationally, our plants ran very well, as Todd mentioned. And even with the successful Shreveport turnaround in April, we were able to deliver increased volumes to take advantage of the strong margin environment. We mentioned earlier in the year that we were making what we thought were low risk, high return investments in Northwest Louisiana, focused on improved control, reliability of our plants in addition to increasing the level of integration. We've been very pleased with the results we've seen so far, and we expect to continue down this path. On the whole, we produced over 60,000 barrels per day of products. To put this into context, we have never produced the volumes experienced in the first half of 2022 with our current set of assets. Our ability to ramp up production when commodity markets are strong is obvious from the improvement in our results. On the commercial side of the SPS business, we have implemented over a dozen price increases this year as commodity prices have increased. The commercial team is doing a great job managing rising feedstock costs, our operations are performing exceptionally well, and external market factors are strong. It is this combination that is responsible for our strong performance. Slide 7 is a visual of some of the brands within our Performance Brands segments, including our new BioMax offering with Royal Purple. BioMax is a high performance sustainable lubricant and it's our fast and growing brand in the company. Moving to Slide 8 and quarterly results, we generated $3.7 million of adjusted EBITDA during the quarter. We have been increasing prices as quickly as possible. In fact, given a typical 90-day notice period, we're at the maximum level of price increases over the last few quarters, but we have yet to catch up. In short, the exact same market drivers that are supporting SPS margins are headwinds for Performance Brands. And that's a trade Calumet is happy to make given the favorable volume imbalance between SPS sales and Performance Brands purchases. We saw the opposite results in the declining commodities market of 2020, when this business was a key reason we were able to generate cash as an organization which again is part of the benefit of our integrated specialties business. What is critically important in our model is that demand remains strong as cost volatility will balance out over time. And we do continue to see strong demand for our Performance Brands products. Moving to Montana on Slide 10, we had a great quarter and generated $68.6 million of adjusted EBITDA. Naturally, the strong crack environment was helpful as we saw Rocky Mountain fuel margins return to seasonal norms. Further, asphalt margins stabilized as expected as we moved out of winter asphalt season and saw less price lag impact and experienced in the first quarter. In an environment like this, the most important thing is to operate well. It's a testament to the Great Falls team for staying focused on operational excellence, while dealing with the distractions and excitement of Montana Renewables surrounding them. The Montana site will be coming down for a turnaround this quarter. And when we come back up, we will have both a highly profitable specialty asphalt and niche fuels business and a leading renewable diesel business. In fact, we estimate that had we been operating the future smaller configuration this year, it still would have earned approximately $40 million to $50 million year-to-date. We are excited to get started. With that, I will hand the call back over to Todd for closing comments.

Bruce Fleming, EVP Montana/Renewables & Corporate Development

Hi, Manav. It's Bruce Fleming. The capital markets transactions were part of the evolution that we designed actually 18 months ago. We did run into some headwinds with the global conditions, just the whole sequence of things. And that's probably got us running a little bit slower than the original plan. But what the plan calls for is to take this step now. And as Todd said, to continue with our large equity process, which Lazard continues to run. So the details of the transactions, we literally finished at 7 o'clock this morning. So there's not a lot of meat in this deck. We will get you a lot of additional insights and an 8-K filing, which details the link to transactions that we've concluded this morning.

Scott Obermeier, EVP Specialty Products and Solutions

Yes. This is Scott Obermeier. So let me answer a couple of different ways. Overall, I'd say that we're cautiously optimistic as we look at the second half of the year. We're aware of a lot of the global market indicators tilting towards some downside risks from an economic perspective. Fuel cracks have regressed over the past couple of months, etc. But with all that said, we're overall very confident in the business. We've been operating in a highly volatile environment the past couple of years, and the business has been performing well. Todd mentioned during the earnings call that we continue to leverage our highly integrated business model and the flexibility and optionality that that creates. In addition, our customer base has been extremely diversified across both consumer and industrial markets and our broad product line allows us to drive growth in the business and minimize pockets of risk and demand, lower demand. So I'd say all that said, we feel good about the business and the resiliency of our specialties business.

Todd Borgmann, CEO

You bet. I'm happy to walk that. So the refinery is coming down, as we speak. And we have a sequenced commissioning of three things. It's a small site. Those that did join us for the tour will appreciate that visually. But there's a limit to what can be done, the size of the construction workforce that can be marshaled, etc. So what we're doing, we're coming down. Now, the hydrocracker catalyst gets changed out. We button it up and we start back up and we are in business making spec renewables. So that will happen in September. At that point, we're up. We're running railcars. The products are going out to our blue-chip customers. The next thing that happens is sequence right after that is we get the renewable hydrogen plant online. That's going to be plus or minus November at this point. And that is going to unlock full run rate. So we've got spec product at a part rate followed by full run rate when the hydrogen balance is addressed. And then what we sequence third is the feedstock pre-treater that opens the universe of any feedstock from anywhere. So all of that is in our financial model. We've generously given ourselves six months to learn how to walk up that curve. Certainly expect and hope that we'll do that quicker. But that is the short-term vision. So we're there. And the fact that we've got an excellent partner in Warburg Pincus and in Stonebriar that we're willing to underwrite a $2.25 billion pre-commissioning value tells you a lot about what the market expects from us.

Bruce Fleming, EVP Montana/Renewables & Corporate Development

Thank you, Roger. This is Bruce. I'll begin, and Todd may want to add some thoughts. As we gather more details to share, you'll find that Calumet still holds 100% of the common. This is why we are moving forward with the Lazard process. As we've mentioned in previous quarters, our primary focus for creating shareholder value lies in separating MRL into its own public entity. However, we've never set a specific timeline for this. This year may not be the ideal time to pursue that in the capital markets. We appreciate our partnership with Stonebriar and Warburg, both of which are patient investors, allowing us not to chase a particular goal within a set timeframe but rather to focus on maximizing value over time. That's the rationale behind continuing the Lazard process. We're also pleased with the interest Lazard has received, attracting a good range of strategic investors as well as some savvy financial funds. We look forward to seeing how this develops.

Todd Borgmann, CEO

There will be upside, Roger. The bill has to become law. It may or may not take its current form. But the support, the policy support for driving the energy transition economy has been rock solid or if anything is accelerating and strengthening. We're reading that, we're mapping that over to our particulars. There's definitely support in it for us if it were to pass in its current form. It's got a very substantive upside in our SAF capability, for example. So it's definitely top of mind. And none of it is in the base underwriting model, so all upside. I would like to remind you that we have already separated Montana Renewables from the parent company, which highlights the significance of the unrestricted subsidiary and Oaktree's support from last year. Essentially, we can sell anywhere from 0% to 100% of the common. We believe the optimal approach is to maintain a partner structure, which we anticipate will attract considerable interest from many investors. If a potential partner comes forward and requests control, we can accommodate that. Conversely, if it makes more sense to go public, we will manage that as well. We have numerous options available to us, and I believe the success of our core business will be a crucial factor in this process. Previously, we might have felt pressured to accelerate the timeline with MRL, but now we can pursue a more favorable timeline.

Carly Davenport, Analyst

Hi. Good morning. Thanks for taking the questions. I wanted to just start out on the quarter on Performance Brands. Can you just talk a little bit about how you see the supply chain constraints and the price hike impacts evolving here through the rest of the year? And then if your views have changed at all in terms of what the normalized earnings power of that business would be over time?

Marc Lawn, EVP Performance Brands

Yes. It's Marc Lawn here. So in terms of that, you've seen the uncertainties of the year as we're seeing them and Scott referenced sort of the volatility in the marketplace. At the moment, we're seeing supply chain has been improving. And we expect that to continue through the balance of the year. The teams have been very, very strong in terms of their progression around the price increases. As we mentioned, we're moving as fast as we can on that. And we expect ourselves to catch up as soon as the marketplace starts to normalize again. And then coming back to your question around the normalized run rate of EBITDA, we haven't changed our view of that at all. These were in exceptional circumstances that we've been working through in the marketplace at the moment. But when we look at the underlying trends, if we sort of model effectively freezing the marketplace, we see that underlying business looking the same as we've directed previously.

Todd Borgmann, CEO

The $40 million to $50 million figure refers to year-to-date performance in the current environment. If we consider everything that has occurred this year and assume we had the future refinery, the specialty asphalt refinery capable of producing 12,000 barrels a day, we would have achieved $40 million to $50 million in EBITDA year-to-date. This might be a bit confusing, as historically we've indicated that this smaller business would have a run rate of about $50 million as it caters to the local market with a focus on more specialized asphalt. It's purely coincidental that these numbers align. This year, if we annualize the performance of the small refinery, we're looking at $80 million to $100 million annually compared to the usual $50 million cycle.

Gregg Brody, Analyst

Hi, guys. I put myself on mute there and they took me off. So Jason answered a bunch of questions that I wanted to ask on the RD facility. Just one element there. Can you actually take cash out next year of MRL through distributions that can come up to Calumet or are there restrictions for doing that?

Bruce Fleming, EVP Montana/Renewables & Corporate Development

There are not restrictions. The Montana Renewables Board of Directors, which will include the Warburg member, will look at cash generation from ops. They will look at the capital allocations for the project, which I mentioned, and a bit of prudent rainy day probably to be held in the treasury. We expect to exceed all of that. So we do envision distributions. And that's part of how Warburg will get their floor return that you'll learn about as we resuscitate the deal team from overnight and get the 8-Ks out the door. But yes, this is a strong cash flow generator.

Brad McMurray, Investor Relations

Yes. Thanks everybody for your time and your interest. On behalf of the management team here in the room and really all of Calumet, we appreciate your ongoing interest in the company. So thanks, again, and have a great weekend.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.