Delek US Holdings, Inc. Q4 FY2020 Earnings Call

Good morning, and welcome to Delek's Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Blake Fernandez. Please go ahead.

Good morning. I would like to thank everyone for joining us on today's conference call and webcast to discuss Delek US Holdings' fourth quarter 2020 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President, and CEO; Reuven Spiegel, EVP and CFO; and Louis LaBella, EVP and President of Refining, as well as other members of our management team. The presentation materials used during today's call can be found on the Investor Relations section of the Delek US website. As a reminder, this conference call may contain forward-looking statements as that term is defined under Federal Securities Laws. In addition to reporting financial results in accordance with generally accepted accounting principles or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release, which is posted on the Investor Relations segment of the website. On today's call, Reuven will review financial performance. I will cover capitalization and guidance. Louis will cover operations and CapEx. And then Uzi will offer a few closing comments. With that, I'll turn the call over to Reuven.

Thank you, Blake. On an adjusted basis for the fourth quarter of 2020, Delek US reported a net loss of $204 million, or negative $2.77 per share, compared to net income of $9 million or $0.11 per diluted share in the prior year period. Our adjusted EBITDA was negative $138 million in the fourth quarter of 2020, compared to $65 million in the prior year period. The second paragraph of the press release highlights $38 million of after-tax headwinds, or $0.52 per share of items included in adjusted results. I would like to highlight the tables on page 10 of the release providing inventory hedging impact and page 14 providing other inventory impacts in the quarter. In the fourth quarter of 2020, we had a positive cash flow of approximately $117 million from continuing operations, which includes a working capital benefit of $243 million. Cash capital expenditure in the quarter were approximately $32 million. With that, I will turn it over to Blake.

Thanks, Reuven. Slide five highlights our capitalization. We ended the fourth quarter with $788 million of cash on a consolidated basis and $1.56 billion of net long-term debt. Excluding net debt of Delek Logistics of $988 million, we had net long-term debt of approximately $573 million at December 31, 2020. I would remind you that we expect a federal tax refund of approximately $156 million, of which $136 million is expected to be collected in the first half of 2021. Moving to slide six, we provide our first quarter guidance for modeling.

Thanks, Blake. During the fourth quarter, our total refining system crude oil throughput was approximately 229,000 barrels per day. In the first quarter of 2021, we expect crude oil throughputs to average between 165,000 to 175,000 barrels per day, or approximately 56% utilization at the midpoint. This reflects an accelerated timing of the El Dorado turnaround originally planned for 2Q. Weather-related downtimes at Big Spring and Tyler, and Krotz Springs continue to run at its current operating mode. Big Springs and Tyler are expected to be back to normal operations in March. We have no further turnaround work planned for the rest of the year. On slide seven, capital expenditures during the fourth quarter were $32 million, bringing full year 2020 spending to $240 million. This was $10 million below our revised capital budget and $85 million below our original 2020 budget. As a reminder, our 2021 capital program is expected to be $150 million to $160 million, including turnarounds, representing a reduction of approximately $85 million from the 2020 levels. Next, I turn the call to Uzi.

Thank you, Louis. Good morning everybody. Delek remains on track and well-positioned entering 2021 supported by cost and capital reduction initiatives. Recent industry downtime resulting from cold weather along the Gulf Coast should create improving product inventories and margins for the Gulf Coast region. Our 80% ownership in DKL continues to perform well, with the company outlining another 5% distribution increase in 2021. In renewable diesel, we have retained a low-cost option of $13 million to acquire a one-third economic interest in GCE Holdings acquisition, which indirectly owns and operates the Bakersfield California refinery. In our view, this approach to renewable diesel helps mitigate execution risk and is far less capital intensive. The retail business has served as a layer of stability and diversification throughout the year. We see strong growth opportunities in this segment and with returns well above other areas within energy. With that, I'll turn the call back to Blake.

Thanks. Before we conclude, we would like to address CVR's energies nomination of three director candidates for election to the board at our 2021 annual meeting. Delek is committed to maintaining a strong, independent and diverse board that serves the best interests of its shareholders, employees, customers and partners, and regularly reviews opportunities to create and deliver value. Our nomination and Corporate Governance Committee will evaluate CVR's nominees and make a recommendation in due course. We will not be making further comments on the nominations or our shareholder conversations at this time. The purpose of today's call is to discuss fourth quarter and full year 2020 earnings results, and we ask that you keep your questions focused on these topics. With that operator, can we please open the call for questions?

We will now begin the question and answer session. Our first question comes from Roger Read with Wells Fargo. Please go ahead.

Yes. Thank you. Good morning. How are you all?

Hey, Roger. Good morning.

I guess if we could release the renewable diesel. We've all been kind of waiting to hear what the investment side for you would be. Any more you can offer us in terms of timing of the facility coming online? Any thoughts on given that it's going to use a different kind of feedstock than a lot of the other facilities. How that's going out in Bakersfield and maybe thoughts on margin potential?

So, Roger, there's not a lot of updates besides what is in the slides. It's supposed to come online, January 22. We have a 90-day option once it's up and running. So there's really no benefit to us to execute that prior to this facility being up and running, and basically mitigating the execution risk. You rightly point out, they are potentially growing some camelina seed, and that could mitigate some of the feedstock risk. As we understand it, that could have a very low CI score. And that could be very interesting. But we're going to really defer to GCE and their disclosure. So at this point, we're basically just awaiting the execution and let them build the facility, and a 90-day free look, and as you see there, $13 million to participate. So not a lot of additional information aside from what is in the slide.

Thank you. As a follow-up, I don't want to delve into the activist perspective. However, some of the points raised resonate with thoughts from both sell-side and buy-side analysts, particularly regarding the value of the Krotz Springs unit when Alon was acquired. Uzi, there were concerns about whether the unit would remain operational, and currently, it is indeed idle. Setting aside other considerations, what do you believe is necessary for Krotz Springs to resume operations? Or should we view it as a potential candidate for terminal use or as part of future renewable fuel expansion?

Roger, that's a great question. Let me take it in pieces. First of all, Krotz wasn't idle. We took the time and did a three-time turnaround. It is finishing as we speak. In today's environment, including RINs, Krotz Springs is actually in positive territory. It's not making on paper. It's not making a lot of money. But in today's margin, it's a $3 million, $4 million, $5 million a month margin. So let's just call it $3 million or $4 million. That's including the RINs. We did take the time and enhance another project that we will be able to disclose over the next month or two that will add profitability to Krotz Springs. So we were in the waiting mode. But if margins continue to be where they are, $15, $16, with RINs at $1, then we may restart the refinery over the next two to three weeks.

All right. Thank you.

The next question is from Manav Gupta with Credit Suisse. Please go ahead.

Hey, Uzi. I want to follow up on Roger's question. I won't ask about a specific asset, but you're known for operating assets based on their ability to generate free cash flow rather than just for their capacity or other reasons. So, looking ahead three to six months, if there’s a refinery that you believe will struggle to generate free cash flow, would you have any hesitation in closing that asset and moving on?

Manav, we have to think of the ledger of the shareholders. Shareholders want us to make money, not to be big. Our commitment is to free cash flow. We are committed to operating profitable assets. You make decisions on assets, not in one month or two months or three months. You take a long-term vision. But absolutely to answer your question, it's clear that if we can't make money in an asset for a period of time, then we shouldn't operate it. We look all the time on optionality and changing different things. But at the end of the day, our commitment is to make money, not to have more assets.

That is perfect. And Uzi. Just on Big Springs very quickly. It's a very good refinery. It's done very well for you in the past. In the quarter, it looked a little lighter side. I'm just trying to understand were there any one-times? Because it's a very good asset. So for that asset to generate that kind of gross margin, something must have gone wrong. So if you could elaborate a little?

Yes, absolutely. Two or three reasons, if you will. First of all, Asphalt. In a rising market, Asphalt is lagging. And that's one thing. The second thing, we had a couple of hiccups in Big Spring. We still consider Big Spring one of the best refineries in the country. So it’s like this quarter it is, but I wouldn't read much into it. Actually, when we hear about different people, we get phone calls about that asset all the time. If we have any intent to do something with it? Certainly not. Especially in light of Permian coming back. So one or two quarters don't mean much. We had to freeze this quarter as well. But we will be back on March 1st. I think, Louis, with full slate. Big Spring is one of our best assets.

Thank you so much, Uzi, for taking my questions.

The next question is from Prashant Rao with Citigroup. Please go ahead.

Hi, Uzi and team. Thanks for taking my question. I just had one. I wanted to sort of ask about the balance sheet. The debt level is high. It is for a lot of refiners right now, given where we are in the cycle. But just wanted to get your thoughts on how you see deleveraging occurring? And if there's a target for year-end? And do you think that it can be achieved through free cash flow and some of these revenue initiatives? Or are other methods or strategies needed? Thanks.

Good morning. Thanks for taking the time, Prashant. So let's go one by one. As you know, we have $156 million as we said, coming our way, hopefully over the next month, if not over the next three months. We're hoping to get this quarter. If not this quarter, I mean, first quarter. If not, it will be in the second quarter. We didn't commit to first quarter. So $156 million is coming our way. That’s on that side. Second, free cash flow. We said that all we need is another year of $270 million to $280 million to be free cash flow. That's the second thing. The third thing, DKL is doing very well. We just announced that we have another 5% increase in dividend with DKL. So that's an asset that is doing very, very well. We're not in the business of holding 80% in DKL. So that's another avenue of getting cash. So I wouldn't rule out one of these options. We feel very comfortable with our cash position. You saw in the quarter, we didn't burn any cash. We actually built cash. We feel that the first quarter and the second quarter will be similar to that. The balance sheet is not something that we're concerned about.

Okay. Thanks Uzi. And just a quick follow-up for us. So that we know we're on the same page. When you're thinking about debt level on the balance sheet, are you targeting sort of internally as your target a more debt-to-total-cap metric? Or you're looking at it more on a net debt-to-EBITDA metric? What do you guys think is the right metric or primary metric that we should be watching that you are targeting in terms of LNG?

That's a great question. Currently, DKL has a debt-to-EBITDA ratio of 3.8 times and no net debt. If we maintain our current course, that ratio should decrease toward three and a half, which we find acceptable for DKL. Excluding DKL, we have a net debt of $650 million. If we can reduce the DKL level to less than two times, we would be comfortable outside of DKL as well.

That's super helpful. Thanks, Uzi. Appreciate the time.

The next question is from Ryan Todd with Simmons Energy. Please go ahead.

Yes. Thanks. Maybe a quick follow-up on the refining side. Can you talk a little bit about any comments on RIN costs either what was the RIN expense in the fourth quarter? How you thinking about RIN expense in the first quarter? And maybe, refresh our view around the likelihood of potential reintroduction of small refinery exemptions under the new administration?

Well, I'll take the second one. Blake, I'm sure will want to take the first one so I may drink my tea here. So the second one, we are not counting on the Biden administration to handsomely give SREs. However, there is that Supreme Court ruling that is coming in I think a couple of months, and that may change things. I'm going to remind everybody that even under the Obama administration, Krotz Springs and El Dorado refinery got the exemptions. So we'll see what the court ruling is. And then if it's positive to refiners, I don't see any reason why these two refineries won't be eligible for that. However, our assumption is that the court won't rule for that. Now, we don't really know. But we can build our cash flow based on something that is not tangible.

And Ryan, on the first question. So, we have historically not disclosed what our RIN exposure or expense is. I will tell you, obviously Krotz with the FCC unit not running, that's a good chunk of our exposure right there. So that mitigates some of it. But historically, we have not disclosed it. I mean, at the end of the day, we do have some blending capability. But I want to be clear, we prefer not to have elevated RIN expenses. So we just kind of leave it there.

Maybe on a separate note. I mean, I guess, I appreciate that you can't say much about the Bakersfield plan. But outside of the Bakersfield investment, have you explored the potential to participate further in the RD business? Are there any of your facilities that you view as potentially conducive to conversion like Krotz Springs, or at this point is kind of the near-term focus just the capital-light plan there?

Ryan, you're asking a great question. We want to do it step at a time. Are we looking at it? Absolutely. We are concerned about the feedstock cost. And we want to do it. We play through GCE in one-third of that. We feel comfortable with that position. We do look at other opportunities, maybe to convert the entire refinery, maybe to convert some of the refineries. Just remember that we have four small refineries, which are relatively small, so they're all attractive to some degree in that area. But we are not in the business of investing right now, $400 or $500 million in something that may not happen profitability wise.

Okay. Thanks guys.

The next question is from Phil Gresh with JP Morgan. Please go ahead.

Yes. Hi, good morning. Thanks for taking the questions. First one just on the working capital trends, which looked positive in the fourth quarter. How much of that was just rising crude price effect and benefits that come from that versus maybe any inventory effects for Krotz Springs from running at a lower level? And just how would you expect working capital to progress from a cash perspective in 2021?

Phil, first, shutting down the refinery hurts your working capital and it doesn’t help. So shutting down Krotz didn’t help us; it actually hurt. Because if you remember, you pay for crude, and I'm sure you do, 20 days after the end of the month if you collect receivables in five days. So shutting down a refinery not running full slate, hurts your working capital and it doesn't help. Rising crude prices certainly helps. $60 now will help tremendously in the first quarter as well. I don't have the breakdown between inventory and rising prices on the receivable side or the payable side. I want to make sure that you understand though. We manage our cash on a daily basis and pay attention to our cash. So, at the end of the day, that's the most important thing, and we'll run our business like that.

Okay, great. Thank you for the clarification. One other thing, Uzi, you talked about in the last call, you had thrown buybacks out there as a discussion point, if cracks got to a certain level. Though it does sound like obviously, that the balance sheet is a key priority as well. So just your latest thoughts on buybacks versus balance sheet?

We feel confident about our balance sheet, especially with the upcoming $156 million coming in, which puts us in a strong position. DKL is performing well, and we’ll determine our next steps regarding that. Overall, the balance sheet looks good. We prefer not to initiate buybacks while we’re leveraging, so we’re looking for a few months of free cash flow first. Previously, we mentioned that $9 to $10 cracks were favorable, but RINs prices have increased from $0.20 to $1. I don’t want to set a specific target for cracks at this moment because other factors like the Midland differential and RINs could change. Once we see free cash flow, we will explore a balance between buybacks and de-leveraging.

Okay. Last question just on retail, you talked in your release about line of sight, the strong growth potential. So I thought I'd see if there's anything worth elaborating on there? Thank you.

So, Phil, retail, we see very strong organic growth opportunity within the energy complex. That's probably one of the strongest rate of return opportunities that we see. And so basically, that's what we wanted to highlight. Obviously, it served as an avenue of stability this past year. And once we do get back to a growth mode, we do see the opportunity to redeploy capital into that business, and we're basically above 20% rate of return on some of the investments that we're seeing. So retail is attractive and whether that sits with us or someone else, that remains to be seen.

The next question is from Matthew Blair with Tudor, Pickering, Holt. Please go ahead.

Hey, good morning everyone. Like to start on the refining side. It looks like Tyler's gross margins improved fairly substantially quarter-over-quarter, which is in contrast to most Mid-con segments that are falling margins. Is there anything you'd like to call out here?

Well, we did very well in Tyler vis-à-vis moving crude and capturing and capitalizing on opportunities in that market. The Delek trading and supply performed very well in Tyler. You probably saw the $7 and then jumped. I would say that this is maybe one or two times event. I wouldn't go and just say this is going forward. Because at the same time, as you know, we didn't perform as well as El Dorado, and these two are offsetting each other from time to time. So Tyler did great. But let's take some time before we celebrate victory here.

Makes sense. And then, on the renewable diesel side, it doesn't look like there's any existing LCFS fuel pathways for camelina. So I guess one, is getting that pathway is there any risk to getting that pathway? Or do you view that as pre-standard? And then two, Blake, I think you mentioned, you're expecting a pretty low CI. Are we talking something in kind of like the 20 to 30 range? Or could it possibly be even lower than that?

So, Matthew, we really want to defer to our friends over at GCE, since we're not even technically in the partnership at this point. I have read, and I'm sure you've seen industry commentary out there talking about 25, 30 CI scores. But I mean, again, we’re not even in that! So I don't want to comment for our friends. At this point, we just view it as a very attractive option. And again, to the extent that they can grow their own feedstock, I think that mitigates a lot of the risk in the industry, which we are very concerned about in terms of feedstock risk. So at this point, we really kind of just need to leave it there.

Yes. That's a good point. Thanks for the responses.

The next question is from Neil Mehta with Goldman Sachs. Please go ahead.

Good morning, guys. First question is on Delek Logistics. As you said, your stocks done really well here. And we've seen some multiple expansion. So how do you think about the potential for monetization there, given your large ownership, which accrues to your some of the parts? And then, in general, as you think about potentially right-sizing the size of your refining business, if you elect to do that. How do you think about the fact that DKL is very much tied to the refining system, recognizing there's a lot of third-party in there too?

Those are excellent questions. I believe there are three or four parts to address. Firstly, DKL has performed exceptionally well, and rightfully so. We have enhanced the leverage ratio and the coverage ratio. The Big Spring gathering system and trucking are doing very well for DKL. Additionally, we have other organic projects at DKL, and today we announced another 5% increase for next year. We are optimistic about DKL. The yield is currently between 8% and 9%, and we have been consistent in that regard. We are not aiming to own 80% as we have previously stated. Our approach will depend on whether we want to invest further or begin monetizing some of it, which is something we are assessing carefully. During the blackout period, our options were limited, so we should continue to evaluate this. We will consider the differences between DK and DKL and determine whether it makes sense to focus on DKL and then potentially purchase DK instead of executing a buyback. Increasingly, DKL is acting as a third-party provider rather than solely relying on refineries. I believe our Delek team is doing an excellent job of reducing dependency on refineries, which is reflected in the growing value of this MLP. So, yes, DKL remains on our radar. One final point regarding DKL and refining assets: as we incorporate more third-party business, the proportion of refining assets in DKL diminishes, along with its reliance on those assets. I hope I have addressed all your questions, Neil.

Yes, that's really good, Uzi. The follow-up is regarding your large gathering system in the Permian. Are you noticing any changes now that Brent has surpassed $65? Is there a return of production, especially from private operators? What is your perspective on activity levels when you speak with customers about Permian production? Furthermore, how do you believe this will impact Midland differentials, which are currently higher than TI? Part of this is likely due to production levels, but it also relates to the quality of the crude, which is superior to even a Brent barrel.

All these are great questions, Neil. I think that it will take time for production to catch up with the overbuild of the capacity. I think, as crazy as it sounds, the Biden administration may help the differentials because they won't allow building infrastructure, while the Trump administration allowed wide open building assets. Overall, I think that the differentials will go back to minus $5 over the next year or two? We don't think so. We don't build our budget on that, based on that. The level of activity is increasing. By the day you see it, more and more people will get comfortable. Remember, I don't think that Permian producers have seen $60 for a long, long, long time. Because when it was $60, WTI last time, the differentials were like $5 or $7 or $8. So I think a lot of people are rushing to do it. I think the demand if vaccine will materialize, as we see in Israel, where there's a 95% reduction in severe cases, then demand will come back in the second part of 2021 and 2022. If this is the case, then the outlook will be nice. The government put a note together thinking that Brent would grow even higher from here, I think $75. If that's the case, then production or level of activity will go up. I don't count. We do not count on further discount at this point.

The next question is from Doug Leggate with Bank of America. Please go ahead.

Yes. Good morning. This is Clay on for Doug. Just a couple of questions for me. So I know you guys have pulled forward the El Dorado turnaround. Want to know what the scope of that turnaround is? Whether the scope of that work is final? Or whether it could be augmented by perhaps the recommendation of the board?

So, hey, this is Louis. Yes, the scope of the turnaround for El Dorado is maintenance, general maintenance, and we are in the process of open cleaning and inspection. The scope is pretty much fixed. And due to the weather we had, the team was ready to execute and we pulled it forward so we can try to get it in and get ready for the rise in demand. The timing of that is expected to be back online basically beginning of April. So we should have a full 2Q effect.

My second question is also on renewable diesel. Will the execution of the renewable diesel project obligate you to the liabilities of the operators, such as any debt incurred?

Clay, that's something we probably ought to take offline. Maybe we can huddle up on that offline if that's all right.

The next question is from Jason Gabelman with Cowen. Please go ahead.

Thank you for taking my question. I have a couple of inquiries regarding the Global Clean Energy project. I would like to know if work has commenced on the project and whether the facility will feature a pretreatment unit. Additionally, concerning refining, it appears that El Dorado operated at a relatively high rate in the fourth quarter, and the entire system seems to be running well, yet margins are still quite weak. It seems like the optimal strategy might be to operate at lower rates. Could you explain the reasoning behind the decision to maintain relatively high operating levels at El Dorado despite the negative margins? Thank you.

So, Jason, on the renewable piece, we're really going to have to defer to our folks over there at GCE. At this point, it's not 100% clear what the pretreatment situation is. So, again, I'm sorry to not give you an awful lot of information, but we're basically on the sidelines on that. Sorry.

And regarding El Dorado, as I said, if you look at Tyler, Tyler is very, very strong. You probably want to think about offsetting factors here between Tyler and El Dorado. We do believe that in today's market, today's environment, El Dorado is certainly in the green in all areas. When I say green, I mean RIN, EBITDA, and RIN net income. So we'll see once we come up how it plays, but I wouldn't read much into one quarter. If you look at Tyler, Tyler is $7 and El Dorado is minus $4. So they offset each other.

Got it. Thanks.

This concludes our question and answer session. I would like to turn the conference back over to Uzi Yemin for any closing remarks.

Well, I'd like to thank everybody for their interest in our company. 2020 was a tough, tough, tough year, and 2021, at least the second part of 2021 looks a little better. I'd like to thank my colleagues around the table here. I'd like to thank investors for their confidence in us. We don't take it lightly. I'd like to thank the Board of Directors for their vote of confidence. But mainly I'd like to thank our employees for making this company what it is. Have a great day. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.