Delek US Holdings, Inc. Q2 FY2022 Earnings Call

Good day and welcome to the Delek US Holdings Second Quarter 2022 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’ second quarter ‘22 financial results. Joining me on today’s call is Uzi Yemin, Executive Chairman; Avigal Soreq, President and CEO; 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 could 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 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 than is incorporated into the press release. On today’s call, we’ll begin with comments from both Uzi and Avigal, then Todd will review financial performance and capitalization, and I will cover guidance and CapEx, and then we’ll turn it over for a Q&A session. With that, I’ll turn it to Uzi.

Thank you, Blake, and good morning, everybody. I would like to take this opportunity to thank the Board of Directors, our investors, and the employees for all their support over the past 20 years. I know many of you said goodbye to me on last quarter’s conference call, and I really appreciated those kind words. I look forward to remaining accessible and offering any strategic oversight in my role as Executive Chairman. Delek is in a strong position financially, and it’s an opportune time to hand the reins over to our new CEO, Avigal Soreq. With that, I’ll turn it over to Avigal.

Thank you. Thank you, Uzi, and good morning. I’m excited to rejoin the Delek family and reengage with old friends and colleagues. We reported a strong quarter, with record utilization rates and earnings. I’m proud of the team's focus and performance. Delek has a long history of returning cash to shareholders, and we are committed to continue. I want to highlight several things we have done to maximize returns. This year, we expect to return around $135 million through a combination of three avenues. One, a special dividend of $0.20 a share announced on June 21st. Second, we announced a $0.20 share regular dividend. And third, share buyback including $64 million completed in the first quarter, an additional $25 million to $35 million expected in Q3. On top of the $135 million, we are evaluating additional buybacks during Q4. During the quarter, we generated significant free cash flow and used the opportunity to improve our balance sheet by building our cash balance to over $1.2 billion. On June 1st, we closed on the 3Bear acquisition. I would like to welcome the 3Bear team to the Delek family. This is an important step in our strategy to make DKL independent and less reliant on DK. The transaction increased our third-party revenue, expanded our product mix into natural gas and water, and widened our footprint into the Delaware Basin. Finally, the macro environment for oil refining has improved, and the outlook remains robust. I look forward to meeting many of you in the upcoming months. I want to thank Uzi for many years of leadership and mentorship. And with that, I will turn it over to Todd.

Thanks, Avigal. Net income was $361.8 million or $5.05 per share. On an adjusted basis, for the second quarter of ‘22, Delek US had net income of $314.5 million or $4.40 per share, compared to a net loss of $33.9 million or $0.46 per share in the prior year period. We had record adjusted EBITDA of $518 million in the second quarter, compared to $46 million in the prior year period. The increase was attributable to the Refining segment, where dramatically improved margins, coupled with strong operational performance, allowed us to achieve record Refinery utilization rates and earnings. On Slide 4, we provide a cash flow waterfall. In the second quarter of ‘22, we had positive cash flow of $559 million from continuing operations, which includes a working capital benefit of $7 million. Regarding cash returned to shareholders, we declared a special dividend of $0.20 per share on June 21st that was paid on July 20th. Earlier this week, the Board approved the reinstatement of a regular quarterly dividend of $0.20 per share that will be paid on September 6th to shareholders of record on August 22nd. Finally, the Board increased the share repurchase authorization by approximately $170 million, bringing the total authorization to $400 million. During the third quarter, we expect to commence the program with estimated repurchases of $25 million to $35 million. Slide 5 highlights our capitalization. We ended the second quarter with $1.24 billion of cash on a consolidated basis. And on a consolidated basis, we had $1.57 billion of net debt. Excluding net debt at Delek Logistics of $1.51 billion, we had only $65 million of net debt at DK as of June 30th, 2022. With that, I’ll turn the call back over to Blake.

Thanks, Todd. On Slide 6, we provide third quarter guidance for modeling purposes. Operating costs are forecasted to be in the range of $185 million to $195 million, which reflects the ongoing impact of elevated natural gas prices, a strong utilization rate outlook, and minor maintenance expenses. I would like to highlight that G&A expenses were elevated in the quarter primarily due to bonus accruals for the annual incentive plan and closing costs associated with the 3Bear acquisition. The step change in bonus accruals was a function of a material increase in the forecasted profitability of the company for the year, and this expense is expected to normalize as reflected in our third quarter guidance range of $67 million to $72 million. Finally, interest expense guidance of $46 million to $50 million for the quarter reflects the consolidated impact of DKL debt, which reflects a full quarter impact from the 3Bear acquisition that closed in June. During the second quarter, our total refining system crude oil throughput achieved a record of approximately 295,000 barrels a day. In the third quarter of ‘22, crude oil throughput is expected to average between 285,000 and 295,000 barrels a day or approximately 96% utilization at the midpoint. On Slide 7, capital expenditures during the quarter were $60 million. The full year ‘22 capital program is now expected to be in the range of $290 million to $300 million on a consolidated basis. This factors in the earlier than anticipated closing of the 3Bear acquisition and additional growth in our Permian Gathering business, where we continue to see strong producer demand. With that, Operator, can you please open the call for questions?

Thank you. We will begin the question-and-answer session. Our first question comes from Carly Davenport with Goldman Sachs.

Hey, good morning. Thanks for taking the questions today. And great to hear you back on the call, Avigal. So just wanted to start out on the demand side. We’ve seen some noisy stats coming in from the weekly DOE data. So just wanted to get a sense of what you’re seeing from a real-time demand perspective across your system, particularly for gasoline, but commentary on the other products would be helpful as well.

First of all, Carly, great to have you on the call as well. So I will start and Blake will continue. We see solid demand on our system, both on the retail side and on the wholesale. We have no issue placing barrels, and we see robust demand. So Blake, maybe you can chime in.

Carly, good morning. So obviously, you see the same-store sales reflected in the press release up 5% or so in 2Q. I think what’s important to note is, some of the DOE stats here recently reflect a dramatic decrease. We are not at all seeing that in our system. Quarter-to-date, we’re actually seeing an increase year-over-year in 3Q. So I think part of that could be partially driven by the fact that we are Permian-centric, and the activity there is robust. But in our system, we are actually seeing increases on a year-over-year basis even into 3Q so far.

Great. That’s really helpful. And then the follow-up was just around capital returns. You’ve obviously had some positive updates here around the regular and the special dividend as well as increasing the buyback authorization. I guess as you think about the back half of the year and into 2023, do you expect the focus incrementally to largely be on the buyback? Or is there a potential to raise the regular dividend or even consider incremental specials?

So I will answer the question a bit more generally than that. And obviously, it’s too early for me to give a specific number for the second half of the year, but I would like to give some guidelines or highlights around that. So we need to look at cash holistically between cash return, dividend, buyback, and obviously, debt. And we, as you probably saw, have done the $400 million approval of the buyback for a reason, right. We believe that the Delek share is well undervalued, and we see much value in the some of the part, and we are exploring options and ways to deleverage debt.

Appreciate that.

Thanks, Carly.

Hey guys. All regions showed material improvement, but the noticeable improvement at Krotz’ capture – very good capture compared to – I mean, you have been showing improvement on a consistent basis, but this was off the charts. So help us understand exactly what you’re doing over there which is delivering these excellent results.

Yeah. Hey, good morning, Manav, it’s Todd. So a couple of things are happening at Krotz that you know we’ve done a good job over the last couple of years setting it up for the success that it’s having right now. One is, there were incredibly strong fuel margins on the Colonial Pipeline, driven by demand in New York, an undersupply out of northwest Europe into that market. As you know, we had a project a number of years ago to build an alkylation unit. Alkylation values traded at massive premiums during the quarter relative to alternate disposition, even in premium gasoline. We also have a pretty significant exposure to the distillate side of the barrel there via our jet make. In addition to that, we have our yield gain, where every barrel that comes in is actually yielding over 100%. So you put all those together, and that really makes Krotz Springs a powerful refinery during the margin environments that we’ve seen over the last couple of months and that we think we’ll continue to see on a go-forward basis, albeit slightly lower than the levels that we saw during Q2.

And the second question would be, we’re seeing E&P companies raise their CapEx. We are seeing people basically trying to grow – in the Permian. So I just want to focus on, not Brent – I mean, I want to focus more on the Permian versus Brent spread than Brent – than WTI versus Permian. And how do you see that spread between Brent and Permian crude widening as these additional rigs come in as production grows? And I’ll leave it there. Thank you.

Yeah. Sure, Manav. Obviously, you know right now we’re still in a situation where we have excess pipeline takeaway capacity. We believe that based on the growth that we’re seeing on our system and to your point, the increase in CapEx that a number of the producers are messaging during their earnings calls, that we’ll continue to see robust growth in the Permian. We don’t see a lot of new build projects, if any, coming to the table. So our view is that by the time we get to late ‘23, early ‘24, we should see that differential continue to widen. You know right now, if you look at the Midland-MEH spread in ‘24, it’s about $1.25, but Brent is trading significantly over that. So you know that spread is pretty robust and pretty wide. And we’re obviously ideally situated to take advantage of that with our ownership stake in Wink to Webster and the DPG Gathering System that we’ve built out over the last couple of years. So, we feel good about our position, and we think that as we move forward, we’ll have ample opportunity to reap the rewards of the hard work that we’ve done.

Thank you, guys. And all the best, Uzi.

Thanks, Manav.

Yeah, thank you. Good morning. And, Uzi, I missed my chance, I guess, in the last quarter. So I will say, thanks for everything over the years. And as you said, maybe a temporary goodbye, not a permanent one in terms of seeing you around. Maybe to just get into the call and to follow-up on Manav’s question about Krotz Springs, and my apologies to you, Uzi, for back at the time you acquired our friends, the view that Krotz should be shut down. I guess this pretty much proves the opposite on that. The question I have on the unit is, if we look at some of the dislocations in Q2, they were on the distillate side; Q3, on the Colonial, they seem to be on the gasoline side. So should we expect potential for Krotz to again outperform versus the rest of the Delek system?

Thank you for the question. We’re obviously very optimistic about Krotz. We think it’s well positioned with the high oil price and differentials. So the answer is, yes, we are very optimistic about Krotz.

And Roger, I would just add one thing, too. You know, we can’t speak for what peers are doing, but I think in the industry what has happened is, there’s a strong demand pull globally. And so a lot of barrels are being exported that would normally have flowed through Colonial, and that is allowing us to receive better netbacks through the system. So, I think that’s a contributing factor as well in addition to what Todd had mentioned earlier.

Okay, that’s helpful. And then this kind of asked earlier, but I’m just a little bit curious, as you look at the overall balance sheet structure at Delek, inclusive of DKL, is there an optimum debt structure? I mean, granted, you’ve taken a step up with the 3Bear acquisition, but is there a goal to take debt to a certain level of EBITDA, an aggregate level of debt? Just how should we think about that over time?

Hey. Thank you, Roger. Thank you for the question. And obviously, that’s a bit related to the first answer I gave. We look at the cash use and resources holistically between returned cash to shareholders, dividend, buyback, and obviously, net debt. And obviously, it’s a bit too early for me to give very specific numbers. But obviously, we are looking at that extensively. And as long as the refining outlook will remain robust and the economy will be stabilized, and we are optimistic on both, we’ll have more upside on that.

Well, let me ask it slightly differently. With the balance sheet that you have now following an acquisition, would you want to reduce debt before the next acquisition or a big step-up in CapEx? I’m just trying to kind of understand the overall corporate structure here on the balance sheet side, like any sort of broader goals.

Yeah, absolutely, Roger. Part of our goal is to reduce the debt level, and we’re going to do some of that in Q3 and then going forward later on this year. So the answer is, yes.

Okay, thank you.

Hey. Good morning. You’ve charted kind of a unique path here on the midstream side by still pushing distribution growth at a time when many of your peers are either not growing their distribution or even rolling up their MLPs. And looking at the yields, it doesn’t really feel like DKL trades at a premium. So I was hoping you could talk through that strategy. Do you intend to still continue growing the distribution of DKL? And what are the next moves there?

Yeah, sure. So, first of all, we see DKL as a growth engine, and we have seen that for years, and we have been able to capitalize on that over the years. We don’t have any intention to stop the dividend in the future. So we are optimistic on both of them. Blake, I don’t know if you want to chime in and give some more color around that.

Yeah. Matthew, you know you kind of alluded to the fact that a lot of the peers are rolling them up, and I think we’re a little bit differentiated and unique. We are 3Bear acquisition, and we are very third-party-oriented with about 40% of our EBITDA coming from third parties, and we’re looking to continue growing that. And so I think, obviously, there’s a leverage component where our leverage has moved up, but I do think we are experiencing free cash flow and we should be in a position to continue our distribution growth. We’ve committed to 5% growth this year. And obviously, we’re not in a position to guide for next year, but 38 quarters consecutively of increasing distribution, and I think that’s a long track record we’re looking to continue.

Sounds good. And then you had a nice improvement in the overall refining capture rate in Q2 versus Q1. Is there anything that we should be aware of for Q3? Or do you think you can hold on to these capture rate gains this quarter?

Yeah. Sorry, Matthew, it’s Todd. Yeah, I think you know as we’ve talked about over the last couple of quarters, we’ve done a lot of proactive maintenance. We took the strategic strike in Tyler with a view that margins were going to be improved, albeit not to the level that they’ve reached in Q2. But we set ourselves up very well because of our view to be able to run to capture the margin environment that has materialized. We don’t have any major work planned in the quarter, and we feel very good about the levels that we’ve been running; obviously, you know up towards the upper end of our range historically. And as a result of that, we think that will continue on a go-forward basis.

Perfect, thanks.

Our next question comes from Kalei Akamine with Bank of America. Please go ahead.

Hey, good morning. It’s Kalei Akamine from Bank of America. Thanks for taking my question here. My first question is just a follow-up on WTI-Brent. So I’m wondering what you guys think about the current spread, whether it’s structural or a response to the SPR releases that are continuing through the turnaround season. And I suppose on a related note, can you give any color on whether the SPR provided a benefit at Krotz?

Yeah. Sure, Kalei, it’s Todd again. I’ll start in reverse order. When we looked at this most recent SPR release from August 15th through September 30th, we were involved in the bidding. But as we suspected, the values that cleared that market were well above what we would be willing to spend relative to alternative barrels. So, we weren’t a winner in that, and that information is public, obviously, at this point. So we think, though, the benefit is those barrels moving offshore give us access to barrels that are currently onshore, and we’re able to backfill without having to worry about some of the logistics issues that you see with the SPR. In regards to WTI-Brent, you know the spread has obviously blown out quite a bit. We don’t believe that’s a result of the SPR release. We actually believe that’s a result of some things happening in northwest Europe. We’re continuing to see incredibly high natural gas prices in the range of $55 to $60 an MMBtu. That, as a result, is causing European refiners to continue to shed very sour barrels in search of sweet barrels. That’s put a very significant bid into the dated to frontline market, which has been as high as a $7 to $10 premium relative to the Brent marker. So we feel like it’s much more of a pull out of Europe that’s causing Brent to perform versus WTI, as opposed to WTI being pushed lower because of SPR releases, which, again, are largely moving offshore. So, I hope that answers your questions.

I appreciate that, Todd. Thank you. And my second question is a follow-up on the buyback. First off, congratulations on getting back to this point. It’s been a volatile couple of years. But I want to try to understand your capacity to lean in. I saw the guidance for Q3 of $25 million to $30 million, but it feels like you could do more given the shape of the balance sheet, at least at the DK level. And it doesn’t appear like you guys have a lot of constraints here.

Thank you. I think it’s a great question, and that’s what the highlight I was trying to give in my first answer. We are trying to smooth the buyback program, not to make it on a one-time basis. That’s part of the reasoning that you have seen the approval that we got from the Board to go all the way to $400 million. So obviously, if the market continues as it looks like and the economy is still as we think it will, we will obviously continue with that buyback along the way.

Got it. I appreciate that. If I could sneak one more in here, it’s just a housekeeping question. Refining CapEx looks second half loaded. Can you just remind us of any planned work you have? And I’ll leave it there. Thank you.

Kalei, the bottom line is there’s definitely a ramp-up to get to the full year spending. So it’s roughly $100 million per quarter that you’re seeing. We have some minor maintenance that we’re doing in the second half of the year, but basically what we’ve indicated all along is that there’s no major turnaround activity for this year. So obviously, you can see the throughput guidance for 3Q, and we’ll give 4Q guidance once we have results next quarter.

Great, thanks.

Our next question comes from Jason Gabelman with Cowen. Please go ahead.

Good morning. Thanks for taking my questions. The first one is an open-ended one for Avigal. And I just wanted to get your thoughts as you step into the big seat from taking over for Uzi what your priorities are for the company and where you see the strategic path for it over the next few years? And I have a follow-up. Thanks.

So first of all, thank you for such a nice question. And my first priority as I stepped into the job around six weeks ago was, first, to learn to know the people better, to visit the assets. And I was extremely impressed by both dedication and the love that people have for the company and how much everyone wants Delek to be a successful and great company we are. So I was very encouraged to see many people visiting – or most of the assets, and it was great. Obviously, until we can present a holistic strategic plan, it’s going to take a bit of – a bit more time, but I will give one conclusion we have so far. We believe that the some of the part is not working, and we are exploring ways how to unlock the value there.

Okay. Understood. And then the second one is just on the Q2 numbers. It looked like OpEx for the quarter was a bit high; I think $45 million higher than where guidance was. Can you just discuss the factors that drove that and if you expect any of those to repeat in 3Q? Thanks.

Hey, Jason. So for one, let me just mention, obviously, natural gas prices were elevated. So that was a contributing factor. The second piece is, we hit record-high utilization rates. So as you know, the more you run, the more you consume. So that’s an element as well. The final piece is, there was an element of bonus accrual that actually landed in OpEx as well. So we’re giving guidance for next quarter, which is in the slides. That does contemplate ongoing elevated natural gas prices. So, it does roll over a bit, though, as you can see in the guidance, $185 million to $195 million.

Great, thanks.

All right, thank you. Good morning, guys –

Hey, Paul. Good morning, Paul.

Good morning. Even though that we already said congratulations, so maybe let me add a final congratulations on the semi-retirement. I don’t think it’s a full retirement, right? So we well – I’m sure that we will come across and see you. You’re just way too young to fully retire.

I just told the guys that you are the one that took us public, Paul. So we know each other for 17 years.

Far more than that. You were IPO’d in 2006. So –

Yeah. So 18 years now.

So we’ve been known. Yeah, it has been quite a time, quite a time. So it’s been a great one. So we’ll miss you. And also let me congratulate Avigal that to be as the CEO for the first conference call in the company. I think, if I may, I have to apologize, first. I want to go back into the capital return framework, but it’s more on a high level. Some of your peers that have sort of a base formula or at least have somewhat of a long – medium or a longer-term target, whether you say 40:50 or 40:60 in terms of the cash flow will be returned back to the business. Is that approach, Avigal, do you think that may be applicable for the company? Or is the economic life cycle for DK much different than some of your larger peers, and so you don’t think that this kind of formulistic approach is the right approach? That’s the first question.

Okay. So, I will try to touch that point, but I’m glad that you asked it again. So we look at, Paul, as you know, on cash holistically between share repurchase and buyback, obviously, dividend. We have the regular dividend and the special we just announced. Obviously, the debt is an important part of that component. So we are looking at that holistically. We are not – I’m not ready just yet to give guidance for the second half, but I’m saying that, again, that as long as the market is going to be robust, and we believe it will, we will see more upside on that side.

No, I understand what you said. I think, Avigal, my question is that, some of your peers will say, okay, they want to return in the long haul or medium term, say, 40% or 50% of the cash flow and then the rest will be reinvested in the business. So I guess that’s my question, that do you guys think a formula-based or approach in the cash return on the cash flow is the right approach for the company? And if not, why not?

So Paul, this is Blake. Let me just quickly say, for one, I think we’re a little bit unique in terms of a lot of the companies that do have these specific frameworks are much larger, more mature companies. We’re a growing company. The second piece is that we have a huge midstream component compared to others. And there is a leverage component to that that is a little bit differentiated compared to refining. So we have not wanted, at least until this date, to box ourselves into a specific number or framework. Obviously, Avigal is getting settled and six weeks into the job. So we can evaluate these types of things going forward. But at this point, I think it’s a little bit unique for us compared to the peer group.

Okay. Two really short questions. One, you guys now that under the FIFO accounting, with the oil price lower versus the second quarter, will that from the accounting standpoint be reflected in the lower margin or at least an adverse impact on your reported margin? Or that the hedging and the inventory movement that you guys cite on the press release, other inventory movements, are those that’s going to fully offset that? And then finally, can you maybe share with us what is the Wink to Webster contribution in the quarter and when you expect that asset going to reach the full contribution to you and how big is that contribution going to be? Thank you.

So Paul, on the second piece, Wink to Webster that flows through the equity method line item. We aren’t disclosing specifics around that, just given the partnership nature of that, but it is progressively ramping up through, call it, the next 18 months or so. So we just want to make sure the messaging there is aligned with our partners. In terms of your question on other inventory and hedging, there is a table on the back page. You’re going to notice back there we had a benefit from other inventory of $40 million. That was much more than offset by hedging, realized hedging losses of $113 million. So technically speaking, if you wanted to strip all the noise out, our EBITDA would have been $73 million higher than what you see. But obviously, we’re trying to work from an adjusted EBITDA basis going forward, just to make sure all investors are clean and everything is much more straightforward.

All right, thank you.

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

Thank you so much for the call. Thank you to the investors trusting in us. The management team around the table that worked so hard for the best quarter Delek ever had. The Board of Directors trusting us and allowing us to manage the company the best way we can. And obviously, and mostly, our employees that make this company great every day. Thank you so much.

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