Delek US Holdings, Inc. Q4 FY2021 Earnings Call

Good morning and welcome to the Delek US Holdings Fourth Quarter 2021 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, Senior Vice President, Investor Relations. 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' fourth quarter 2021 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President and CEO; and Reuven Spiegel, EVP and CFO; and Todd O'Malley, EVP and Chief Commercial Officer, 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. Please see slide two for the safe harbor statement. 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 posted on the Investor Relations section of our website. Our prepared remarks are being made assuming that the earnings release has been reviewed and we are covering less segment and market information that is incorporated into the press release. On today's call, Reuven will review financial performance; I will cover capitalization and guidance; Todd will cover operations and CapEx; and then Uzi will offer a few closing strategic remarks. With that, I'll turn the call over to Reuven.

Thank you, Blake. On an adjusted basis for the fourth quarter, Delek US reported a net loss of $44.9 million or a loss of $0.61 per share, compared to a net loss of $204 million or a loss of $2.77 per share in the prior year period. Our adjusted EBITDA was $58.2 million in the fourth quarter, compared to a loss of $137.6 million in the prior year period. The second paragraph of the press release highlights $6 million of after-tax tailwind or $0.07 per share of items included in the adjusted results. Page 14 of the release provides a breakdown of inventory hedging and other inventory impacts in the quarter. On slide four, we provide the cash flow waterfall. In the fourth quarter of 2021, we had a positive cash flow of approximately $161 million from continuing operations, which includes a working capital benefit of $110 million. With that, I will turn the call over to Blake.

Thanks, Reuven. Slide five highlights our capitalization. We ended the fourth quarter with $857 million of cash on a consolidated basis and $1.36 billion of net debt. Excluding net debt at Delek Logistics of $894.7 million, we had net debt of approximately $467 million at December 31, 2021. Moving to slide six, we provide first quarter guidance for modeling. Operating costs are forecasted to be in the range of $160 million to $170 million. This reflects the impact of elevated natural gas prices and assumes no impact from ongoing insurance proceeds. With that, I'll turn the call over to Todd to discuss operations and CapEx.

Thanks, Blake. During the fourth quarter, our total refining system crude oil throughput was approximately 279,000 barrels per day, reflecting some turnaround activity that was pulled forward at the Tyler refinery. In the first quarter of 2022, we expect crude oil throughput to average between 275,000 and 285,000 barrels per day, or approximately 93% utilization at the midpoint. The remaining turnaround work at Tyler was pushed to 2023, resulting in no major planned turnarounds for the Delek system in 2022. On slide seven, capital expenditures during the fourth quarter were $66 million. This reflects maintenance at Tyler and initial growth spending on the Permian gathering business. The full year 2022 capital program is expected to be in the range of $250 million to $260 million on a gross basis. This includes $112 million of spending on discretionary and business development projects, of which approximately $59 million resides in the logistics segment, largely associated with gathering in the Permian. Growth capital in the retail segment will be dedicated to a build-out of four new-to-industry locations and the ongoing rebranding of 7-Eleven stations. I'll now turn the call over to Uzi for his closing comments.

Thank you, Todd, and good morning, everybody. The macro backdrop continues to improve, and the lack of major turnaround activities on our assets in 2022 positions us well to capture the margin environment. We're optimistic on increasing activity levels in the Permian Basin and we see opportunities to grow our existing assets organically. The partial divestiture program of DKL units, announced in December, has been successful to date. This creates optionality to implement additional sale programs into the future. Over time, we believe these sales will underscore the underlying value of DKL units held within the DK portfolio. As we move into 2022, Wink to Webster should provide a positive contribution throughout the year. Finally, we continue to make progress on our ESG efforts with a 34% reduction target in our Scope one and two carbon emissions by 2030. We encourage investors to review our sustainability report for more details. With that, operator, will you please open the call for questions?

We will now begin the question-and-answer session. The first question comes from Manav Gupta with Credit Suisse. Please go ahead.

Hey Uzi and team. I think what I wanted to focus on is, what is sometimes underappreciated is Delek's leverage to positive crude prices. You're probably the highest crude beta in the group. Higher crude prices bring inland rigs that help your differentials. They also increase the volumes on your midstream infrastructure that you have built. In fact, even your retail business tends to benefit when the activity is higher in the Permian Basin, given the location of the stores. Looking at what we are seeing today morning, the way crude is acting, can you help us better understand how this higher crude oil macro would overall play in your hands as we go ahead?

Good morning, Manav. I believe you captured everything quite accurately. I’d like to expand a bit. Reflecting on what occurred in 2015 and 2016, we can look to history for guidance. We all remember that Thanksgiving Day when the Saudis opted to flood the market, which marked the beginning of the decline in crude prices. Subsequently, when they adjusted their strategy, producers began to bring rigs back online, resulting in increased production. This set the stage for our strongest years in 2017, 2018, and 2019, particularly due to robust differentials of $10, $12, and $14. Currently, we're facing an overbuilt scenario of about two million barrels. Producers maintain they will exercise discipline, and I genuinely believe they will demonstrate more restraint than in the past. As a point of reference from our own producers, we wrapped up the year with 83,000 barrels entering our gathering system in the DPG system. As we exit the first quarter, we anticipate a 50% increase to over 125,000 barrels. In fact, as we speak, we are gathering even more. By the end of the second quarter, we expect to reach 150,000 barrels and aim to grow toward 160,000 barrels from existing producers with dedicated acreage. We’re effectively doubling our production from current operators, and it’s worth noting that we are in discussions with other potential producers outside our current portfolio, particularly given the shifts in pricing. The time we first engaged with them was when prices were at $80, which really sets the stage for a robust market when they approach $100. The developments in DPG are the first indicators to watch, as you will see immediate effects in the first quarter. Additionally, as production rises, we anticipate differentials to widen, although we don’t expect significant changes in 2022. Moving into 2023, we believe $80 to $90 would be very favorable for Delek, while $100 might be unsustainable and could see a decline after certain events. You’re right; these trends will affect the volumes from DPG and WTW, as well as the differentials, allowing us to shift back from WTI to Midland. Exciting times lie ahead for Delek.

Uzi, very quick follow-up here. We know in the past you have been given SREs for crops. Now, initially the position of EPS seems they might not issue SREs. But look the world has changed. Gasoline prices are high. So, there is a possibility they might actually give you the SRE to bring the RIN price down. But just in case they don't, would you actually be open to taking legal recourse for what you believe is rightfully yours? And I'll leave it there.

First, it's up to the government. I don't understand why the federal government would consider giving away a deferred tax of $0.18 while simultaneously taking $0.12. In the past, we have received these benefits every year, and we believe we deserve them, particularly at El Dorado and likely in Tyler as well. We are awaiting their decisions and are in communication with them, responding to their inquiries as they arise. Politically, I find it challenging to comprehend how the market accepts this unusual situation, but it is what it is. Regarding Delek, I am uncertain about their actions, but we strongly believe we deserve these benefits and are ready to take necessary actions to secure them.

Thank you so much, Uzi, for your time.

The next question is from Carly Davenport with Goldman Sachs. Please go ahead.

Hey, good morning team. Thanks for taking the questions. Wanted to just start on capital allocation. As we think about where refining margins have been trending, can you talk about your capital allocation priorities for the first half of the year? And then I guess what are you looking for or maybe what are the key gating factors in order to consider perhaps a reinstatement of some sort of capital returns program whether that's via dividend or buyback?

Okay, Carly, good morning. First, I appreciate your time and support. I'll address your questions one by one. Regarding capital allocation, we do not have any significant turnarounds planned for 2022. We took about 12 to 14 days of downtime at Tyler for a strike, which we are pleased about despite it costing us an estimated $14 to $15 million in lost profit. We implemented a similar approach at Krotz to ensure we remain on track throughout 2022. This was part of why this quarter was a bit weaker, as we likely left around $20 million on the table, but we avoided a major turnaround at Tyler. If the market conditions remain favorable—and let me clarify that we want to be cautious because differentials haven't changed and we are still in a backwardation situation with high RIN prices—we are observing positive shifts in demand and expect our earnings to improve. Should this trend continue, we have no reason not to evaluate our options closely, especially since we are returning to investing in growth, particularly in the DPG sector and other areas. We are also mindful of our free cash flow and the cash position on our balance sheet. Higher prices benefit our balance sheet just like they do for any other refiner, and we will monitor this closely throughout the year.

Great. Thanks for that. And then the follow-up was just on the midstream side and appreciate all the color you gave on the gathering business there. Can you talk a little bit about Wink to Webster, how that's progressing through the ramp-up process and kind of how we should be thinking about the contribution to earnings throughout the year?

We are currently in a ramp-up phase, and we're starting to see oil movement. I don't anticipate a significant impact on us this year due to the current differentials and our fee collection as we are still in startup mode. However, I expect that by the end of next year, we will approach full utilization. We believe we are already above the 15% threshold for that project. I also think the differentials will not remain as compressed, as we anticipate that producers will begin drilling more than what they have indicated so far.

The next question is from Roger Read with Wells Fargo. Please go ahead.

Good morning. Uzi, I think the big question I'd like to hit you on, I mean, granted Midland versus Cushing tends to have more of an impact on you. But if we look obviously in the last couple of days we've had a pretty big separation between Cushing and Brent. So Midland obviously discounted versus Brent more significantly. What does that mean in terms of how we should think about margin potential for you? And what are your thoughts? I know you mentioned earlier right capacity issues in the Permian and say we're not going to have any blowout differentials there. But I'm just wondering if you look across the US some of the issues with moving crude around as well as the export market how you think about the differentials going forward?

Okay. Let's take it step by step. Our general guideline suggests that in a scenario with a $15 crack spread, absent RINs and considering no backwardation or Midland zero-zero, we estimate an EBITDA in the range of $800 million to $900 million. This represents what we regard as mid-cycle performance. We evaluate this regularly and believe we are close to that level. As we analyze various factors, we observe that the crack spread is considerably higher. While RINs continue to pose a challenge for everyone, backwardation and the Midland discount remain substantial. The situation is fluctuating. We expect the crack spreads to widen until there is some change concerning RINs, backwardation, or Midland pricing. We have discussed this multiple times regarding Midland-Brent versus Midland-TI, and we see that spread widening. Over the past week, it has improved by approximately $1.50, which is encouraging. We have consistently indicated that we believe the company reached its lowest point a couple of months ago and is now on a recovery trajectory. Todd, do you have anything to add?

Yes. I mean, Roger, if you look at the Brent-TI obviously the phenomenon in the front-end market that prompt is being driven by what's happening over in Ukraine right now but that has had the effect of pulling the back of the curve wider as well. So if you look at full year you're kind of in that $3.80 range. So we think that's very constructive for us. The differentials have continued to be favorable on a relative basis. We think that's going to lead to even more incremental production on the DPG system ultimately benefiting the refineries, benefiting DKL and kind of working into the export market to the extent that there's excess.

And Roger, it's Blake. Let me just add one thing. I'm sure you know this. But from a sensitivity standpoint, if you assume 95% utilization of the system, that's roughly 100 million barrels a year. So if you just figure every dollar per barrel expansion in the spread that drops right to the bottom line. It's about $100 million. So I know you probably have that modeling but just a reminder to you.

That's helpful. Thanks. Follow-up question. Crude is kind of spiking around here and everything but just curious what you're seeing in the way of the demand trends across your system as we think about gasoline, distillate, and even jet fuel.

I believe demand is increasing everywhere, including jet fuel, as the pandemic subsides not just in the United States but globally. As I mentioned a few months ago, we anticipate that 2022 will be a very strong year, likely a record year in terms of various projects. It seems that things are recovering. The impact of the ongoing war on Europe and the U.S. is uncertain, but up to this point, demand appears to be very strong.

All right. Thank you.

Thank you, Roger.

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

Hey good morning Uzi. Just one follow-up on the capital allocation front. I think in the past you've talked about your preference of dividend versus buyback. And then obviously it probably depends on your own share price. But to the extent you would consider something at some point in a strong environment do you have a lean one way or the other there?

At this point, we prefer to issue a dividend unless there is a significant opportunity arising from a dislocation in the marketplace; otherwise, we would favor the dividend.

Got it. Okay. And then just one cash flow question with the working capital tailwind in the fourth quarter. Was there anything unique about that that would reverse in '22, or is this kind of the right steady state to be thinking about for next year?

Hi, it's Reuven. Thank you for the question. Well, the impact was $110 million mostly because of a decrease in accounts receivable. There is a timing issue between quarters. So some of that will have an impact on the first quarter, but we still expect working capital to be positive in the first quarter. And with the events that are happening in the last 24 hours, if the pricing that we see is sustainable then that will have an uptick on working capital as well.

Okay. Got it. Thank you.

Thanks, Phil.

The next question is from Paul Cheng with Scotiabank. Please go ahead.

Mr. Cheng, good to hear your voice.

Thank you. Uzi, just curious that historically in the DKL you guys focus more on the oil. And I think that's a twice in Permian of reducing the faring and so correspondingly probably continue to have a big need on the gas takeaway. And so, is that a business that you guys want to get in or will be interested or that you want to stick to your core you know the oil and that would link to your integrated with new refining? So that's where the focus.

That's a great question, Paul. Our primary focus is oil. However, if there's an opportunity related to natural gas that complements our oil activities, we might consider it. Traditionally, we haven't taken that route. I believe we want to view DKL as an independent company in the long run; that’s why we are selling some units through the ATM program. As DKL operates as a standalone entity, there might be opportunities for them to explore.

Paul, I think the program was designed to initially test the waters and protect our investment in DKL. We've said publicly that 80% is definitely too high. We have not defined a specific target. But I think the messaging we're trying to deliver this morning is that we have appetite to do this program on an ongoing basis. Through the ATM, we're basically able to do about 1% per quarter. And I think the intention, of course, pricing dependent, but the intention would be to continue to implement this each quarter, so call it 4% a year. So I think that answers your question.

Okay. And Uzi, on the Wink and Webster, I was a little bit surprised you say this year and maybe even next year don't have much impact. I thought the project was backed by take-or-pay contract fully on the volume. So should you still receive the revenue, or was that I mean be able to book the cash, probably just the cash?

I want to clarify that the project is completely booked and subscribed, but there is a ramp-up period. During this initial phase, we need to be cautious because we have some shippers already committed, which are part of our existing business. In this ramp-up year, we expect to see a few million in revenue, but we won't reach the full expected growth of 15% to 17% that we had previously set as a threshold.

And Uzi, assuming that by the end of next year you would be operating at full capacity, what would your contribution be at that time?

We said that we are well above our 15% threshold and the investment is around $350 million.

Okay, and for the final question, maybe Reuven can answer this. Looking at year-end 2021, your current liability increased by about $1.2 billion compared to 2020. Is this rise solely due to the significantly higher crude oil prices, or does it involve your methods of managing working capital that enables more efficient funding of operations? What is driving that substantial increase in working capital, which, excluding cash, is currently about negative $1 billion, while at the end of 2020 it was around $300 million to $400 million?

Paul, I'm getting a bit technical, so we'll follow up with you. As you know from our journey at Delek and most refineries, when prices rise, we generally have positive working capital. You understand this. To determine where the cash will be by the end of the year, we need to consider everything and make assumptions about crude prices, independent of profitability, which does play a role. On a day like today, our cash could increase by tens of millions of dollars if prices remain steady. Therefore, predicting this is challenging without knowing the price of crude.

It's mostly the commodity price. But if you need more color on that, we'll get back to you.

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

Hi, good morning everyone. This is Kalei filling in for Doug. Thank you for taking my question. My first inquiry is about the dividend, which has two parts. Would you consider reinstating it at the same quarterly level as before the cut? If not, could you explain your thoughts on adjusting that dividend, perhaps in relation to DKL? For instance, MPC's dividend is essentially supported by the distributions from MPLX. I'm curious if you would utilize your MLP in a similar strategic manner.

Good morning, and thank you for joining us. I want to clarify that we have maintained from the beginning that we will not be distributing dividends using borrowed funds. At the same time, we believe that our shareholders should receive dividends as soon as we emerge from the pandemic. We are gradually approaching that timeframe. We prefer not to revise our policy if market conditions shift, so we will proceed cautiously with our dividend plans. Our cash flow remains robust, particularly as we recover from the pandemic, and we want to be careful not to jeopardize that. MPC achieved profitability a couple of quarters ago and has done an excellent job returning value to shareholders. We will monitor the situation closely and likely aim to do the same.

Got it. It seems like it's still under a lot of consideration. My second question concerns maintenance capital. Clearly, the industry has prioritized cash preservation during the pandemic, which makes sense. You also postponed a major turnaround in Tyler from 2022 to 2023. Therefore, I'm curious if 2023 will be the year you return to normal maintenance capital levels, and it would be helpful if you could remind us what that number is. Thanks.

Yeah. Kalei, so going into 2023, obviously, what we've done is push out the Tyler turnaround from 2022 to 2023. So we will presumably have that turnaround activity there. And to give you the context, historically we've talked about maintenance capital plus turnarounds being somewhere in the $150 million to $200 million range. So obviously we'll try and finesse that. And we're not in a position to start getting into the fine-tooth combing of that yet; that's historically what we've said. And again, no turnaround activity this year opens up the opportunity for some growth. And then as we head into 2023, we probably will have that turnaround at Tyler.

The next question is from Dan Kutz with Morgan Stanley. Please go ahead.

Hey. Thanks. Good morning. Just wanted to follow up on the DKL unit sale program. So appreciate the color on the 1% per quarter at the market. Just wanted to ask is kind of like a larger structured sale on the table or an option that's being considered, or is the 1% per quarter as the market is kind of the plan as it stands now? Thanks.

Yeah. So look, we're carefully evaluating this over a long period of time. And like I said, the main objective was to protect our investment in DKL. Given the lack of liquidity and float, we felt the best option to benefit both DKL and the DK shareholders by not taking a big discount was to implement the ATM program. We're selling about 7,000 units a day and we're already starting to see some improvement in the trading volumes. I think what happens is, as that liquidity and float improves, that probably opens up additional opportunities for us to consider block sales. And we are not precluded from doing block sales with the program. So I think the answer is, yes, it’s probably appetite, but we want to make sure we're doing that at a time when there's ample liquidity and we're not taking huge discounts for the shareholders at the DK level.

Great. Thanks a lot for that color. And then just kind of switching gears. So we've been hearing about strength in asphalt prices. I wanted to ask kind of the extent that that would impact profits in your refining business kind of what trends you're seeing out there? And what your expectations are for that part of your business? Thank you.

Yeah. Excuse me, Dan, this is Todd. We're definitely seeing relatively strong prices. However, keep in mind that this is a seasonal business, right? And right now, we're in the winter fill season building inventories ahead of the paving and roofing season as we roll into the spring and warmer weather. When we look at asphalt prices, we do believe they're going to be robust as we go into that kind of end of second quarter, beginning of third quarter period. And we think we're ideally positioned to capture that market on a go-forward basis.

Great. Thanks a lot. I’ll turn it back.

Thanks.

At this time, there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Uzi Yemin for any closing remarks.

Thank you, Debbie. I'd like to thank my friends and colleagues around the table. I'd like to thank the Board of Directors. I'd like to thank, of course, you, investors and analysts for your confidence in us. This wasn't an easy year, but we have a bright future ahead of us. But mostly, I'd like to thank each one of the employees of this great company that makes it what it is. Have a great day. We'll talk to you soon.

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