Delek US Holdings, Inc. Q1 FY2022 Earnings Call

Good morning. I would like to thank everyone for joining us on today's conference call and webcast to discuss Delek US Holdings' First Quarter '22 Financial Results. Joining me on today's call is Uzi Yemin, our Chairman, President and CEO; Reuven Spiegel, EVP and CFO; Todd O'Malley, EVP and Chief Operating 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 2 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 the 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 Uzi will offer a few closing strategic comments. With that, I will turn the call over to Reuven.

Thank you, Blake. On an adjusted basis, for the first quarter of 2022, Delek US had a net income of $42.9 million or $0.58 per share compared to a net loss of $80 million or $1.08 per share in the prior-year period. Our adjusted EBITDA was $172.8 million in the first quarter compared to $12.6 million in the prior-year period. I would like to highlight that during the quarter, the Tyler refinery inventory was retrospectively converted from a LIFO accounting basis to FIFO. This puts all our refineries on the same basis with FIFO inventory accounting. This is an opportune time to improve the communication of our results. In an effort to simplify messaging, we plan to discuss underlying performance on an adjusted EBITDA and EPS basis going forward. And we'll no longer highlight the impact of other inventory and hedging within our discussion of results. Moving to Slide 4, we provide the cash flow waterfall. In the first quarter of 2022, we had a positive cash flow of approximately $27 million from continuing operations, which includes a working capital detriment of $77 million. Please note the financing activities bucket includes $64 million shares purchased from Icahn Group in March. With that, I will turn it over to Blake.

Thanks, Reuven. Slide 5 highlights our capitalization. We ended the first quarter with $854 million of cash on a consolidated basis and $1.36 billion of net debt. Excluding net debt at Delek Logistics of $903 million, we had net debt of approximately $456 million at March 31 of this year. Moving to Slide 6, we provide first quarter guidance for modeling. Operating costs are forecasted to be in the range of $165 million to $175 million. Regarding the $64 million share purchase from the Icahn Group on May 7, this represented 4.7% of our shares outstanding. Given that the transaction occurred fairly late in the first quarter, the full impact of our share count will not be witnessed until the second quarter results. Finally, the planned acquisition of 3Bear places us well on track to achieve our longer-term midstream EBITDA target of $365 million to $395 million across our segments. This transaction should help transform DKL into a larger, more scalable entity with approximately 40% of pro forma contribution margin coming from third parties on a fixed fee basis, along with broader diversification within the Permian Basin and expanded product mix into natural gas and water. Collectively, these attributes should further propel DKL toward becoming a true stand-alone entity and enhance the underlying value of DK's interest in the company. With that, I will turn the call over to Todd to discuss operations and CapEx.

Thanks, Blake. During the first quarter, our total refining system crude oil throughput was approximately 272,000 barrels per day. In the second quarter of '22, we expect crude oil throughput to average between 280,000 and 290,000 barrels per day or approximately 94% utilization at the midpoint. With no major turnaround activity planned for the balance of the year, we are in a strong position to capture the elevated margin environment. On Slide 7, capital expenditures during the first quarter were $33 million. The full-year '22 capital program is expected to be in the range of $250 million to $260 million on a consolidated basis. This excludes capital spending associated with the planned 3Bear acquisition that is expected to close around midyear. Before turning it over to Uzi, I would like to highlight the significant growth being witnessed in our Permian Gathering system. Strong producer demand drove a significant ramp-up in volumes with a 20% increase sequentially, and we expect volumes to at least double from 4Q '21 to 4Q '22. With that, I’ll turn the call over to Uzi for his closing comments.

Thank you, Todd, and good morning, everybody. Adjusted EBITDA reflected a significant improvement, and we expect ongoing momentum into the second quarter based on prevailing margins and no planned maintenance. The 5% share purchase in March is proving to be a solid investment based on recent equity performance. As we generate free cash flow, we will continue to look for opportunities to enhance our balance sheet and return cash to shareholders. The increase in the payment activity is providing multiple benefits to our company. In our Legacy DPG system, we're seeing opportunities for organic growth. Not only does this provide an avenue for incremental earnings in our gathering business, but should ultimately lead to more attractive crude discounts in our refining system. Additionally, strong producer nominations gave us the confidence to pursue the announced 3Bear acquisition. This strategic opportunity will help springboard DKL to be more competitive among midstream peers and provides a platform for further growth into the future. After a challenging several quarters through the pandemic-led downturn, our company is firing on all cylinders and well positioned to capture opportunities that exist in the market. With that, operator, would you please open the call for questions?

Hey, good morning. Thanks for taking the questions here. I wanted to just start on the refining side. The 2Q volume guide that you provided looks quite strong. So I guess can you just talk a bit about how operations have been trending so far this quarter? And really, if you can run well at these utilization rates, where could you see cash flow or EBITDA power trending for the quarter given what we're seeing on the margin side?

Good morning, Carly, thanks for taking the time to ask us these questions. So we said all along that there will be no turnaround during this year, no major turnaround. We took the opportunity to fix a couple of things in the first quarter, the reason you see the 272,000 number. Actually, we are right now over 100% of our nameplate running for quite some time. Now I don't want to commit on behalf of our lead operator, Nithia Thaver, who just got nominated. I want him to beat the expectations, but it looks pretty strong right now.

Great, I appreciate that color. And then the follow-up was just kind of around capital allocation. You reduced some shares outstanding with the repurchase during the first quarter. So just wanted to get the latest temperature around potential for further capital returns from here, if you consider something sustainable or if the preference is to be more opportunistic like we saw in the first quarter?

I want to be open about our perspective. The margins we are experiencing now are unprecedented; in my long career, I have never witnessed margins like these before. The market has transformed significantly, and while we weren't certain that the margins would be this robust, we've strategically positioned ourselves without any major maintenance. We capitalized on the chance to purchase shares from the Icahn Group at around $18, and we've already seen a 35% increase on that investment. This is what our investors expect from us, and we are committed to delivering. We are considering both dividends and buybacks, which we plan to discuss in our meetings, targeting the second or third quarter to announce our second quarter results. If the current situation remains stable, we have no reason to believe we won't pursue both options. However, this depends on market conditions. Currently, the margins are strong and operations are performing well, so we are optimistic about returning cash to shareholders while also exploring other investments like we did with 3Bear. At this point, we don't have any acquisitions planned, so returning cash to shareholders is definitely a possibility.

Great. Thanks for that. And last I just wanted to congratulate Uzi on your retirement and thank you very much for all of the valuable perspectives over the years.

Thank you so much. Thanks for your kind words, Carly.

Yes, good morning Uzi, and I assume this is going to be your last major call with us. If so, then I offer my congratulations as well, although I know you're not leaving the company altogether.

Honestly, this will be my second to last call. My final one will be for the second quarter. I want this quarter to be like the previous quarter. So we'll see. Perhaps I'll do a victory lap over this quarter.

I have a couple of questions. Historically, Delek has maintained a relatively high distillate yield for a refiner, particularly among smaller mid-cap refiners. I'm curious about whether that yield remains consistent and how it's functioning within the system. Additionally, given the current environment, which differs significantly from what we would typically associate with Delek's earnings potential, I've noticed that this situation is driven more by crack spreads and capture rather than crude feedstock. How do you plan to adapt your operations to leverage this scenario?

Well, certainly, you saw in the past with crack spread in the $4 handle, when I say 40% and more, 41%, 42%, 43% for distillate with crack spreads being $80 per distillate or $70, we're pushing everywhere we can through the DHTs, the different DHTs in the different places. And gladly or luckily, we had some room for days like that, both in El Dorado and in Tyler. So we are trying to even buy some feedstock that you don't see in the numbers yet into these two systems. So absolutely, we're planning to be with the four handle, 40-something percent for the quarter. Obviously, higher than 42%, 43% will be just great achievements.

Okay. As we consider Big Spring, it seems to have a slightly higher gasoline content and a lower diesel content compared to the rest. Are there any adjustments being made there, or should we assume it will operate as is while we address capture issues?

That's another point that we want to highlight for the first quarter. And Nithi, I don't know if you want to say something about that. But we did take the opportunity to fix a couple of things on the DHT in Big Spring during the first quarter. So we can fill it up. Nithi, I don't know if you want to add anything to that.

Yes. We did some preemptive maintenance and the plant is running full now and reliably.

The DHT in Big Spring, you should look at the historic numbers running at full.

Okay. Great. And then just a final follow-up question on that. Is there anything that you'll change in terms of the crude you're running to put a higher distillate cut into the system or the downstream units enough for that? Meaning, is there any reason to search for a Canadian barrel or any other heavy barrel out there?

Roger, I'll be bold in this. During times like that, all you want is to run what you know is reliable. Everywhere that we can put through the system is very valuable. So we are not trying any new types of crude. What I'm going to tell you, though, is that because of our experience and because of the work we have done over the last few quarters, we do run, as I said, more than 100% utilization.

Loud and clear, thanks Uzi.

Good morning. I just want to say that I know I've been covering this space for about 10 years. I know people on the call who have been covering it for longer. But over these last 40 earnings seasons or so, I've always looked forward to your comments on macro and refining, Uzi. So I would say, post 2Q, the refining earnings season would just not be the same without your insights.

Well, I appreciate that, Manav. We know each other for a long, long time. Your support and others' support is just something that I couldn't do without. So really, really thank you for the nice words.

So Uzi, a quick question here is, over the last 10 years, let's go back a little. Delek was seen as a Permian refiner who was also trying to build its Midstream infrastructure to maximize the Permian crude usage and grow its earnings. Now as the company has evolved, particularly in the last two or three years, the perception is that now Delek is a Permian Midstream company that also happens to run Permian crude. So the picture has inverted a little, and your midstream earnings have continuously grown. So if you can talk about a little about how people perceive Delek today versus what they perceived it probably seven or eight years ago? And I'll leave it at that. Thank you, Uzi.

Thank you, Manav. Let me address that. We have consistently stated that Midstream is a crucial part of our strategy. With the acquisition of 3Bear, we believe we have reached our goal of $375 million in EBITDA. We plan to incorporate that into our system. It's important to note that we still have Wink to Webster at DK and not DKL, which will hold significant value, especially considering the activity in the Permian. We've actually seen gathering increase from 80,000 barrels at the end of last year to over 150,000 and growing with the combination of pipe and trucking. The activity in the Permian is definitely ramping up, and we will maintain our Midstream strategy going forward. You may have noticed that we sold some units, and the Midstream EBITDA is on the rise. At the same time, we aim to capitalize on refining. During the downturn, discussions about shutting down certain refineries arose. I believe that during downturns, it is best to tighten your belt and endure because, when the upturn arrives, it often comes with great force. Therefore, Midstream is certainly a major aspect of our strategy, but refining will definitely remain a key focus as we ensure it is the backbone of our company.

Thank you so much, Uzi.

Thank you. Good morning everyone. Uzi, I guess I'll add my congratulations. I didn't think you were retiring. I thought you were just becoming the Chairman. But maybe I got that wrong. But anyway, congratulations. I guess it's a long time since we first met back in 2004. So I'll put myself in that category.

Yes. 15 years now, Doug. We were both young and handsome. We're just now handsome.

One of us still is, I'm not sure which one. But I want to ask you a big picture question. Look, when we did meet, it was during the original Golden Age; it didn't last very long, I guess. It seems to us a lot of structural changes. So I just wonder if you could offer your perspective on how you see the U.S. as a generic refining center as you walk out or take a back seat? Do you think we've moved to a sustainable cost advantage with the capacity closures and gas and so on? I'm just curious on your view.

That's a great observation, Doug. I read your note about the new Golden Age, and I would even refer to it as the Diamond Age. We're not entirely clear about our ages right now, you and I. When we discussed Rita and Katrina, we thought it was quite surprising, and it lasted three to four weeks. Now we're deep into this situation, with $80 distillate crack. Looking at the bigger picture, I don't believe the war in Ukraine is going to resolve itself overnight. Even if it does, it will take some time before there’s any recovery in Ukraine or Russia. Simultaneously, many refineries, including those in the U.S., have shut down. The crude market hasn't improved much due to the downturn and a lack of investment. I believe we will see producers maintaining capital discipline; however, at $100 per barrel, there will be days of discipline followed by a loosening after a week or so. This pattern is evident among smaller producers in our gathering. In the U.S., a resurgence in drilling is expected, which will lead to widened differentials. Additionally, we cannot ignore the ESG movement, which is quite significant. We understand that if you operate using LIFO with a build, your greenhouse gas emissions are considerably lower compared to running heavy sour crude. Therefore, there will also be momentum for this in the U.S. Overall, your timing in analyzing the industry is impeccable, and I believe we are positioned for a good 12 to 18 months ahead.

I believe it takes longer than that. I appreciate your comments, Uzi, as always. However, I must challenge your view on the stock over that time frame. The stock has fluctuated with the cycle, but it has mostly remained within a limited range for nearly 10 years. When I examine factors like industry costs, your general and administrative expenses account for about a third of Marathon's, while your company is about a tenth of Marathon's size. I'm curious about how you envision the future for Delek. Is the refinery's focus similar to your approach on lower 48 inline crude discounts, which have tightened somewhat? Do you think there is still a place for a $2 billion to $3 billion refiner, or do you see Delek potentially being part of a larger long-term consolidation trend?

Okay. So you asked two different questions. First, I'm going to challenge you back. If you take the combined operating cost, together with G&A, you will see that we not only were in line but screened better than others. And happy to share that data with you as we check it on a quarterly basis. We want to challenge ourselves on that, but I'll leave it at that. You're asking a much bigger question than the G&A, because the G&A is just allocation between the buckets. DK, and I said it, and I was bold in the past, DK as well as other small companies don't need to be stand-alone companies. And it's not a secret that during the pandemic with CVR buying shares, I thought that it's better to be together. You can't force somebody to merge with another company if they don't want to do that. I'm still saying that small companies, not only on the refining side, also on the midstream side, we see that the market favors the big names of Valero, PSX, and NPC. The market also favors midstream big guys, even though DKL performed very, very well. Like enterprise or EPD, Magellan, and other names, Kinder Morgan. So I think the industry, especially in light of these golden ages or diamond ages in the last 12 or 18 months, or, as you say, 24 or 36 months, this industry is ripe and should be consolidated.

Good luck, Uzi. Appreciate your comments.

Very good morning. Uzi, perhaps you or maybe the new CEO could talk about the outlook for your cash return structure. You talked on Q1 about $800 million to $900 million of EBITDA as being a mid-cycle view. You're obviously way above that. Are you planning to put some sort of framework in the way that so many other companies now have? Thanks.

Absolutely. Regarding capital allocation and returns, these are truly extraordinary times. There's no reason to doubt that over the years, as you have been with us for a long time, we have consistently increased the dividend on a quarterly basis. Given the current circumstances and our free cash flow, returning cash to shareholders is definitely something we are considering. To be candid, we even thought about doing it this quarter, but we opted against it for prudence and to see how things unfold. However, the way things are progressing, our Board views it quite positively.

Got it. Can you provide your usual overview? We understand that demand in your region may be different. We're interested in hearing about demand disruption and pricing levels. Given your location, some information may be misleading. However, could you discuss the macro situation and what you're observing on the demand side? Additionally, it would be great to hear your insights on the supply situation in the Permian. Thank you, Uzi. I apologize for not being too lighthearted, but I appreciated your comment about being old and handsome.

Well, the increase in Permian activity indicates that demand is definitely present. We're operating at full capacity right now with demand for our products at around 94%. However, I believe there will be some demand disruption due to current price levels. Nonetheless, the loss of 4 million barrels of refining capacity, along with developments in Russia, more than compensates for this disruption.

Yes. And presumably, you're still seeing strong demand through your system?

That is correct.

Just finally, sorry, for me. What's the year-over-year on that at the moment, at the same-store comp?

Paul, it's up 0.8%. If you look at the retail footprint on a same-store sales basis.

Hey guys, good afternoon.

Mr. Cheng, are you going to give me a hard time as you know now that I'm leaving?

Yes. I mean that just wish you have a wonderful time in retirement, but you're too young to actually fully retire. So I'm sure that we'll see you again at some form, but also that we should be able to spend a lot more time with your families in this world. So perhaps...

Certainly, there's somebody over there waiting for me.

Yes. Have fun with that. I have several questions. To start, do you expect to receive any insurance in the second quarter?

Hey, Paul, it's Blake. Yes, we are expecting some additional proceeds to come in. I think you probably noticed that in our 1Q, we have just under $10 million of business interruption. That is adjusted out of results. Hits the other income line item. And the bulk of what we expect to continue coming in will also be business interruption treated the same way.

I see. Just curious, now that everything is in FIFO, one of your competitors, CVR, treats the FIFO impact as a special item. Do you plan to do the same, and will that exclude it from your earnings going forward, or will it be part of the adjusted earnings?

Paul, our approach is that we will not adjust that out. The opinion of our SEC group is that we should include it in our adjusted results. Therefore, moving forward, our communication with you and your peers will focus mainly on what adjusted EBITDA will be, including movements in other inventory. This will fluctuate, but it will balance out over a full year. So, on an annual basis, the number should look quite similar to our peers.

And final question, Uzi, how important is the retail business? I mean you hear that the last several years have shifted the attention and the focus to midstream. And so yes, retail just like you just continue to run it? And at some point, if the price is good, you will try to exit it? Or that this will be considered part of the longer-term core holding?

As you know, Paul, when you look back at NAPCO, we are going to continue to invest in retail. But if the opportunity comes, then, for sure, that's something that I'm sure the new management will look at and say to themselves, am I getting the multiples and the returns from retail? As you know, building a store costs $6 million to be conservative. The EBITDA for that store is $1.2 million, $1.3 million, therefore it's 5 times. There are not a lot of projects that you can do that, especially with the free cash flow that is coming our way. But at the same time, if we can get a nice multiple and it makes sense for somebody else to take it, then for sure, we will look at that.

Yes. I think you've been saying that for some time, but you're saying that you need a certain critical mass before you will consider a sale. How big is the sufficient critical mass for you?

Well, if you remember, NAPCO, we had like 35 NTIs, the prototype, if you will. And these NTIs, as I said, generate $1.2 million. So you're talking about another $40 million, $45 million of EBITDA on top of the $50 million that we have right now. So if you're approaching $100 million, then you probably have a great chain that you can monetize if you decide to do so.

Thank you and congratulations and wish you the most fun in your retirement.

Thank you. Thanks so much.

Hey everyone, this is John Royall filling in for Phil. How are you? I want to quickly address the balance sheet. You should be generating significant cash as you come out of refining. However, it seems like capital returns are on the horizon, and there is an outflow for the acquisition. So, what are your current thoughts on leverage targets at a consolidated level? Additionally, do you have a minimum cash balance that you consider necessary to run the business?

That's a great question. Our midstream leverage will increase as we finance the 3Bear deal primarily through debt. However, we aim for a long-term leverage range of 3x to 3.5x for midstream. For our standalone businesses, such as refining, retail, and renewables, we prefer to maintain a leverage of no more than 1x. With our current EBITDA, we expect to be below that threshold, so we feel comfortable with our position. We previously targeted $1 billion but have adjusted that to $850 million now. We plan to strengthen the balance sheet while generating cash allows us to manage investments and return cash to shareholders simultaneously.

Okay. Thanks. And is there a minimum cash balance you guys operate the business with?

We used to think that $1 billion is a good number, and I don't think that we change that much.

Okay. Great. And then just a quick follow-up. I don't think you guys have gotten much into Midland differentials in this call. So it would be great if you could just give some color around your updated expectations there and your view on Permian production growth, I guess, over the...

Yes, I'll let Todd take that one.

Yes, sure, John. As I'm sure you're aware, the Midland differentials have been bouncing around kind of at a $0.50 premium to about a $1.50 premium. Right now, they're pretty much somewhere right in the middle of that at $1. As we go out the curve, because of exactly what you just mentioned, the fact that we see incredible growth in the Permian, especially around our Midland gathering system, we see that differential between Midland and the coastal markets widening out significantly. In addition to that, Brent-TI is also fairly wide on a recent history basis in the backs of the curve, so about a $5 differential. So we feel good about where we're at. We feel good that, as Uzi said earlier, differentials will continue to erode. That's a big tailwind for the refining system. And then in addition to that, with the incremental growth that we're seeing, that's a big tailwind for the DKL piece of the business as we start to load into Wink to Webster and also just on the Delek Permian Gathering system. So if you have any follow-ups, we can go deeper, but I think that covers it.

That's great. Thank you.

Hey, thanks. Uzi, just wanted to echo the comments that others have made. It's been great listening to your commentary over the years. I wish you all the best moving forward. The first question I have is on the 3Bear acquisition. And I was wondering if you could discuss some of the benefits, if there are any, that the acquisition brings not to the MLP, but to the C-Corp from an operational synergy standpoint. And then kind of more broadly, if there's the ability to deploy additional capital into midstream and the 3Bear acquisition, given there's going to be robust cash flow generation this year? Thanks.

You're actually asking three questions, Jason. I'll address them in the order you presented. Regarding 3Bear, we believed it was the right moment for the acquisition. We have been exploring several opportunities in that space. When we sensed a shift in the market, we decided to proceed. This is similar to our collaboration with the Icahn Group, where we took action when we believed the timing was right. We hope they are as pleased as we are. The decision was influenced by current developments in the Permian, prompting us to enhance our existing DPG system with another Delaware system. Secondly, given the ongoing situation in the Permian, we anticipate that producers will continue drilling and ramping up activity. Our entry into this business is motivated by two additional interests: natural gas and water. We see natural gas as a potential limitation in the Permian. Additionally, with the water shortage in the region, the industry is shifting from fresh water to produced water, an area where 3Bear excels. This transition will create opportunities for us to integrate these two business lines, which have relatively low entry costs, and potentially apply them to our DPG system and the current producers we work with.

Got it. Great. That's really helpful. My second question is just on the SPR release. And I'm wondering if you've seen any movement in the Brent-TI differentials or maybe across the U.S. more broadly as a result of the SPR release and if you're able to access and benefit from those barrels? Thanks.

Hey, Jason, it's Todd. I'll address that one. And if Uzi has any other comments, he can jump in on the back end. The most recent SPR portion of the release was about 30 million barrels. 27 million of it was sour. 3 million to 4 million of it was sweets. Those barrels cleared at quite expensive differentials relative to the benchmarks that they're marked against. The sweets marked against MEH. So the government was clearly looking at an export-type barrel. We saw quite a bit of volume actually loaded across the dock. So for us, we were involved in the process, but those barrels look relatively expensive to us. The benefit that we see is the fact that as those barrels come out of the SPR, we did see a couple of weeks after the fact when they started hitting the market that Brent-TI spread widened out. We saw Cushing differentials come off. Both of those are tailwinds for the business. In addition to that, we also saw the differentials come off, which I think is by and large a product of the fact that a number of those barrels out of the SPR release went offshore and satisfied some of that demand that left some of the inland barrels hunting for homes. So again, that was extremely advantageous for us, and that was our view. So that's how we expressed ourselves in the market.

Great. Thanks.

Well, I'd like to thank my colleagues around the table. With the new nominations of Avigal Soreq as our new CEO; Todd O'Malley as our COO; and Mr. Thaver as our President of Refining, I think we have a very experienced and very capable management team. I know all of them for many, many years, and I believe that they will do an excellent job for our company. Also, I'd like to thank you investors for believing in us, the analysts for asking questions. The Board of Directors, obviously, for sticking with us during the downturn. But mainly and mostly, I'd like to thank each one of the employees of this great company, who makes it what it is. Thank you. Have a great day.

Thank you. We will now begin the question-and-answer session. Our first question comes from Carly Davenport with Goldman Sachs. Please go ahead. Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.