Delek US Holdings, Inc. Q3 FY2022 Earnings Call

Good morning, and welcome to the Delek US Third Quarter 2022 Earnings Conference Call. 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' third quarter '22 financial results. Joining me on today's call is Avigal Soreq, President and CEO; Reuven Spiegel, CFO; Todd O'Malley, EVP and COO 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 U.S. 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 our 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 as we are covering less segment and market information that is incorporated into the press release. On today's call, we'll begin with comments from Avigal. Then Reuven will review financial performance and capitalization. Todd will cover guidance and CapEx and then we'll turn it over to Q&A. With that, I'll turn the call over to Avigal.

Thanks, Blake, and good morning. We had another quarter of strong operational performance due to consecutive quarters of record refinery utilization and solid results, excluding inventory movement. Additionally, the outlook for the downstream energy industry is positive. I'm proud of the team execution and the focus on safety and reliability. Switching gears to talk about the priorities we laid out last quarter. First, returning cash to shareholders. We expect to repurchase $75 million to $100 million of our outstanding shares during Q4. We increased the regular quarterly dividend to $0.21 per share. In the third quarter, we exceeded our share repurchase guidance with a total of $14 million of buyback. Second, focus on capital allocation. We plan to retire between $100 million to $150 million of debt during Q4. This reduces our debt level and maintains a flexible balance sheet. Third, we started our initiative to unlock the sum of the parts value of our assets. We hired a head of corporate development and engaged a banker to advise us on strategic options. We will communicate our plan to the market once complete. After one full quarter in my role as CEO, I continue to be impressed with the depth of our team and the strength of our operation. I'm excited by the many opportunities we have in front of us to deliver additional value to our shareholders and remain focused on execution on our key priorities. I look forward to updating you over the upcoming quarters. With that, I will turn it over to Reuven.

Thank you, Avigal. Net income was $7.4 million or $0.10 per share. On an adjusted basis for the third quarter, Delek U.S. had net income of $1.1 million or $0.02 per share compared to a net income of $3.6 million or $0.05 per share in the prior year period. We had adjusted EBITDA of $136 million in the third quarter. This includes $225 million of inventory headwinds associated with FIFO accounting. Beginning in the fourth quarter, we will remove inventory impact from adjusted results. This should help put us on an equal footing with peers from an accounting perspective and make our results easier to analyze for comparative purposes. On Slide 4, we provided a cash flow order flow. Strong cash flow allows us to increase our buybacks and reduce debt. As Avigal mentioned, the Board approved a $0.21 per share regular dividend that will be paid December 2 to shareholders of record on November 18. Slide 5 highlights our capitalization. We ended the third quarter with $1.15 billion of cash. On a consolidated basis, we had $1.58 billion of net debt. Excluding debt at Delek Logistics of $1.43 billion, we had $146 million of net debt at DK as of September 30. In October, we had two noteworthy credit transactions. First, DKL extended its credit facility to $1.2 billion, including senior secured revolving commitments of $900 million with a maturity date in October 27 and a new secured term loan of $300 million with a maturity date in October 24. Separately, Delek U.S. expanded the asset-based credit facility to $1.1 billion with a maturity date of October 27. Before handing it to Todd, I would like to mention a key near-term initiative we have launched to evaluate our company's cost structure to ensure we remain competitive with peers. We have engaged advisers and are currently conducting this analysis. We plan to share additional information once we have concluded our work.

Thanks, Reuven. On Slide 6, we provide fourth quarter guidance for modeling purposes. Operating costs are forecasted to be in the range of $190 million to $200 million. This is a reduction from third-quarter levels, which is a result of lower natural gas and electricity prices and slightly lower utilization rates. G&A expenses in the fourth quarter are expected to be in the range of $82 million to $87 million. This is elevated relative to third quarter as the company typically accrues for bonuses in the second and fourth quarters of each year. Finally, interest expense guidance of $55 million to $60 million for the quarter reflects the consolidated impact of DKL debt. During the third quarter, our total refining system crude oil throughput achieved a new record of approximately 300,000 barrels per day. In the fourth 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. On Slide 7, capital expenditures during the third quarter were $81 million. The full year '22 capital program is expected to be approximately $300 million on a consolidated basis. Later this month, we will issue our third annual sustainability report. We are focused on making continuous improvements in our ESG efforts and we encourage investors to monitor our journey. With that, operator, will you please open the call for questions?

Our first question is from Roger Read with Wells Fargo.

I'd like to come back to the capital allocation, slide #3, and just understand partly because the share repurchase guidance for Q4 is well above what I was putting in my model. How are you thinking about the share repos? Are we going to be kind of going as we walk along here, margins stay elevated and so guidance will be more short-term like this? Or are you thinking on a longer-term basis of share repurchase magnitude? And I'll tie that in, I guess, to the strategic overview question. Are we essentially waiting for that before we get a more long-term guidance, I guess?

Roger, it's Avigal. So we said in the previous call that we're going to put shareholder returns for the company at the top of our priorities. We are walking the walk, not just talking the talk. If you remember, last quarter, we brought back the dividend. We had a special dividend. We increased the total buyback program to $400 million. And we exceed our buyback guideline to $40 million this quarter versus the guidance we gave of $25 million to $35 million. Obviously, this quarter, we gave the guidance of $75 million to $100 million and we are planning to do so. We are also planning to reduce the debt. We obviously had a perception study with the investors and that's what investors expect us to do. Going forward, Roger, we look at a very robust market and we see that the company is performing very well. With that said, going forward, we are looking to continue with the buyback aggressively well into 2023.

Okay. Appreciate that. The other question, just operationally, as you look across your system and you're selling gasoline and diesel, any thoughts, any specific numbers you can share in terms of what the sales look like compared to, say, prior quarter compared to pre-COVID period? Just how you're comparing on the demand side here.

Roger, it's Todd. I'll use our retail footprint, which I think is clearly pretty representative of what happens inside of our total envelope of refinery operations. And we're seeing same-store fuel sales kind of 7% up year-on-year. And obviously, we have a certain footprint of retail locations that are distillate heavy. We also have another subset that's gasoline heavy. So I think we're a pretty good representation across the Permian Basin. And on a year-on-year basis, again, we're up and feeling good. The demand is sticky here. And certainly, the lower prices recently have buttressed that view. So we feel good about where we are now and what the outlook looks like for '23 on the demand side of the barrel.

The next question is from Ryan Todd with Piper Sandler.

Great. I could follow up on that. I know it's a difficult question to address, but regarding the efforts you are making, including engaging bankers, to tackle the discount on the stock, could you discuss at a high level what might be causing this discount? Is it related to DKL's consolidated debt and the perception of higher leverage? Additionally, are there fundamental ways that you believe this discount can be better addressed? Looking ahead, do you anticipate any announcements on this in the next couple of months or within six months? Any high-level insights would be appreciated.

Ryan, it's Blake. I’ll give it a try. There are various factors that can lead to market dislocations, making it difficult to identify specific causes. One key factor you've mentioned is the perception of excessive leverage on a consolidated basis. We’ve discussed with investors the historical discrepancy between consolidated and deconsolidated debt, which has recently widened due to the DKL acquisition of 3 Bear. For a general portfolio manager reviewing our debt ratios on Bloomberg, we appear to be heavily leveraged. However, once the debt is deconsolidated, our leverage appears much lower. Additionally, another challenge is the limited liquidity and float at DKL, which we are actively working to enhance. We've gained some advantages by being one of the few remaining firms in the MLP sector as others have exited, resulting in increased representation within various MLP indexes like Alerian. This has boosted our trading volumes and presents opportunities for future growth. Another aspect to consider is that during the COVID downturn, we reduced our dividend as our refining operations were not generating positive EBITDA. We are now showing that these refining assets are very profitable and yielding significant returns, which should help instill confidence among investors over time as we prove that we have strong cash flows from these facilities. These are three factors contributing to the current disconnect in perceptions. Regarding timing, we haven't set anything specific; however, we are seeking to demonstrate progress. We have engaged a corporate bank and are looking to announce a plan in the coming months. It’s important to note that while we may announce a plan, the implementation could take time depending on the chosen approach. We want to keep the market informed of our advancements.

Great. That's very helpful. Maybe just as we look forward to 2023, you're spending $300 million in CapEx this year in 2022. Are there any large moving pieces that we should be thinking of in terms of next year's capital budget ballpark direction one way or the other?

Yes. Ryan, it's Todd. I think $300 million this year, obviously, a lot of that was dependent on growth that we've seen in gathering and across the system. Again, we continue to see that as long-term strength. So we would anticipate that continuing through '23. The one outlier, I would say that we didn't have in '22 was a turnaround at any of our plants. We did some small surgical strikes but we do have the Tyler turnaround scheduled at some point during the first half, at least initially right now of '23. We'll come back and update the market more on that as we get a little bit closer to defining exactly what that timeline is. But I think marginally higher than that $300 million in '23 is probably a good target to set for yourself as we go into end of year and next year planning.

Next question is from Carly Davenport with Goldman Sachs.

Can you just talk a little bit about the efforts that you're making around the cost structure? Are there any numbers that you can put around the potential size of a program at this point? Or kind of any color you can provide about what kind of key areas you're targeting to drive efficiencies?

Carly, it's Reuven. Well, we're looking at both the G&A and the OpEx as part of the zero budget process that we have started. We have some initial thoughts and findings. I think we want to complete the work, which will be done in the next few weeks. Then we will have the whole structure around it. I don't have an exact number to give but we will communicate our goal once we are set on all the mini programs that will be under the zero budget.

Got it. Great. And then the follow-up was just kind of around the logistics side as you've had a couple of quarters here with 3 Bear under your belt. Kind of any key learnings that you would flag as you integrate those assets into the portfolio or any areas that have potential to surprise to the upside relative to initial expectations?

Carly, thanks again. That's a great question. When we spoke, we obviously discussed how it's a strategic debt acquisition for us, right? It's opened us not just from a geographic standpoint but also from a line of products that we believe in, by and large. As I mentioned on the call, we are very pleased with the integration, the numbers coming in line with our expectations, and we are very pleased. Going forward, we have a business to manage and we have a safe operation always to keep. We want to get the most out of those assets and the diversification we got.

Your next question is from John Royall with JPMorgan.

So just a follow-up question on capital allocation. Looking at your guidance for both the buyback and the debt paydown in 4Q, I'm assuming unless we have a major improvement in the macro that you're expecting to draw down some cash. If so, I think you're sitting over $1 billion today in cash. Is there a thought to working that cash balance down over time and maybe doing more on the buyback than you would see from your post-dividend free cash flow? I know you talked about being aggressive on the buyback. So is that a safe assumption that you may continue to draw some cash?

This is Reuven. Thank you for the question. I think if you look at the buybacks and dividend, these are done on cash flow we're generating, free cash flow that we're generating. When it comes to reduction of that, I think the way to look at it is a combination of the two because on one hand, banks are paying for deposits today but it's around 3%, 3.5%. On the other hand, since we have floating rate, we are getting increased rates on our loans. So we will use a combination of free cash flow and some of the cash that we have on the balance sheet to pay down the debt.

Okay. Great. That's helpful. And then just looking for your updated view on Midland differentials. Midland continues to trade above Cushing. What's your view on production growth versus takeaway in the Permian and the Midland differential going into 2023?

That's a great question. We are looking at the Midland production. And we obviously have a very close relationship with the producers in our area. We have seen the rigs in our area coming up very nicely on the DPG area. But being more specific about differentials, Midland is going to get full between 12 to 18 months from today, more or less. We are today around 5.7 million barrels a day. We've seen a nice increase of more than 600,000 barrels last year. So we are optimistic on that differential going forward. I think that we'll see more news around that front line in the next 12 to 18 months.

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

Do you have a target for your minimum cash balance? And is it reasonable to think that buybacks would be more than your free cash flow after dividend in 2023?

Matthew, I don't think we want to give a specific cash target per se. I think we've said historically that we need to maintain probably $500 million to $600 million or so to run the business. Obviously, we're comfortably above that. It is nice to have additional dry powder and potential recession scenarios and/or a potential M&A. So I think where we're trending right now seems to be pretty comfortable. As Reuven said, we may use a little of the cash to pay down some debt, which probably makes sense given the arbitrage between interest expense and cash benefits. In terms of '23, I think you were asking, are we going to basically use cash for buybacks. I think Avigal is of the opinion that we're looking to use free cash flow. I don't think we want to pinpoint anything specific. I think the robust buybacks that we're looking at right now are before the sum-of-the-parts scenario where we feel like the stock is really discounted. Once we finalize the sum of the parts scenario, we understand what the various entities look like. I think at that point, we're going to get more specific in terms of a formulaic approach.

Sounds good. And then is there any update on your R&D investment in terms of when it's expected to start up and when the contribution might flow in through to Delek?

Yes. Matthew, I think the best thing to do is look at the Global Clean Energy filings. The last I believe we have seen is that they had deferred the start-up to March with, I believe, a 90-day option to extend. So just to be conservative, maybe you're looking at a mid-year next year kind of start-up. And of course, we have a 90-day option after that. So it's probably feeling like a late second half of the year type of scenario, should we enter the project.

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

This is Kalei on for Doug. My first question is a follow-up on the oil basis. So WTI Brent has widened here modestly. Just hoping that you can give us an updated view on how you see this trending post the SPR releases and noting that the compression in U.S. to EU gas spreads also helps the economics on sell recruits.

Yes. Kalei, it's Todd. Thanks for the question. So I think you watch the markets as closely as anybody out there. We've kind of seen the Brent-TI in the dead prompt settle around that 7-ish range out the curve. We are kind of mid- to high 5s to maybe low 6s on any given day. We firmly believe that due to what Avigal was commenting on earlier in terms of the dynamic between growth that we see in the Permian as well as no incremental takeaway capacity being built that Brent-TI spread is going to continue to remain wide and roll up to that kind of 7-ish level on a go-forward basis. As we truly reach that kind of like 80% to 85% utilization rate of existing takeaway capacity, that's when we think we'll start to see the Midland do the work and Brent-TI probably hold in at those wider levels. So I think that's what we're looking at, in 10 seconds.

I appreciate that, Todd. My second question is on basis on gas. So prices recently dropped to zero because takeaway there is very tight and it won't get fixed for another several quarters. So wondering if you can talk about how this benefits the OpEx and hydrotreating costs at Big Spring.

Yes. We don't obviously break it down into individual plant levels from that perspective. I think what we can say is that we are obviously keenly attuned to what's happening in the Waha area. We think that's going to continue, to your point. And every day, we are working on the commercial side of the ledger to increase our exposure to Waha gas. I think it's safe to say that Big Spring is 100% exposed to that market. We are, again, actively looking at different projects, some of which have kind of come to fruition through the acquisition of 3 Bear and the inclusion now of natural gas in our gathering and processing portfolio and using that to leverage into potentially capitalizing on accessing Waha for some of the other facilities. So I think there's more to come on that and we'll continue to update the market as and when necessary.

The next question is from Paul Cheng with Scotia Bank.

I have two questions. First, I would like to discuss the hedging. Can you explain the nature of the hedging you are implementing? Are you planning to reduce your activity in the future, increase it, or keep it the same? Second, regarding your current strategy, you mentioned that if you proceed, it would be in the second half of next year. What is your latest outlook on this? Additionally, do you have a biodiesel plant or branding facility? Are those generating profit in the third quarter?

Paul, it's Blake. Let me handle the first two and defer to Todd on number three. So on the hedging piece, as you know, we don't disclose specifics but I will say this. I think as we said in the script that we're planning going forward to begin adjusting out the other inventory impacts. And with that being said, I think that allows us the opportunity to then minimize the hedging because, historically, those two should be offsetting each other. But if we're able to adjust out the inventory, then it really makes sense to reduce our hedging exposure. So our plan going forward is to probably minimize or reduce the amount of hedging that we've done historically. So I hope that answers that. That's really all we can say from that level of disclosure. On GCE, it's $13 million for us to participate in a 30% interest. So I don't want to overcommit to anything that we're going to do in the future. But I think most would view that as a fairly small amount of capital to participate in renewable diesel to get our foot in the door and dabble. So I think it's likely that we would participate. It tells an interesting story. It allows us to kind of understand the market. And so I think I'll probably just have to leave it there. And then I'll give it to Todd for the biodiesel plant.

Yes. Thanks, Blake. Paul, just to clarify, we actually have three biodiesel facilities that exist inside of our footprint. Those three facilities are indeed profitable and are, I will remind you, to a certain extent, exposed on the upside to LCFS obviously as well as what the D4 RIN does and a mix of various different feedstocks. So those are profitable and we continue to believe that they will be profitable on a go-forward basis, but not in a material way that would impact results for the total corporation.

Great. Can I ask a simple accounting question? Since you are using FIFO accounting, why does it still have the LCM?

Paul, let us come back to you offline on that. I think it's a small amount compared to the LIFO peers. But I think it's a more detailed accounting question that it would be better just to take offline if that's all right.

The next question is from Dan Kutz with Morgan Stanley.

I just wanted to ask, I guess, kind of a broad high-level question in terms of what you guys are seeing from a demand perspective across your system and kind of what your outlook is moving forward, maybe parsing it out by the different product market.

Yes. Sure, Dan. This is Todd. As I mentioned a little bit earlier on the call, we're seeing sequential growth in our retail footprint year-over-year, kind of running, let's call it about 7%. We think that's pretty representative of what is happening inside the Permian Basin, both on gasoline and diesel demand. We have obviously, in the last quarter, seen pretty robust product markets in the New York Harbor area and in the Chicago land market. New York based on limited imports and some maintenance. Chicago based on the unfortunate incident that occurred one of the refineries there in Toledo. Obviously, those are shorter-term. But by and large, we see demand continuing to be robust in our footprint as well as elsewhere in the United States. Certainly, lower flat prices have continued to help make the consumer resilient. And I would say the last kind of shoe to drop that we've seen is on the jet fuel side of things where we are effectively now back to kind of pre-COVID levels and obviously can take advantage of that inside of our system. So I'll leave it there.

Building on Todd's comments, the supply side is significantly impacting the situation. It's the first time in refinery history that we've observed such a considerable drop in production. The supply side is just as crucial as the strong demand side. Therefore, we remain very optimistic about our business and the sector as a whole.

That's really helpful color. And then I guess I just was hoping that you could refresh my memory or let me know if there's any updates on kind of what your mid-cycle EBITDA outlook is appreciating that the backdrop kind of supports above mid-cycle earnings for the foreseeable future here. But just wondering with the 3 Bear acquisition and a lot of kind of strategic projects underway if you could share the latest on your mid-cycle outlook?

Yes. That's a great question and I can follow up on that later on if you guys wanted. But we didn't give specific guidance regarding the mid-cycle. What I can tell you that when we look today, everyone is basically in a budget season as we speak. We see a more robust market and we think that the mid-cycle is higher than we thought before. And on top of that, we see a strong demand coming from our customers. So going forward, we are very optimistic about what we see from a downstream demand and supply.

I want to first ask about the debt reductions that you discussed. And historically, I think you've carried both a high cash balance and high debt levels as well but overall though, low net debt levels. Can you talk about why now is kind of the right time to reduce that debt? And what may be a gross debt target is for the business, excluding the MLP, if you have one? My second question is on the strategic initiatives that you're exploring. Thanks for talking us through some of the considerations on that front. One that you didn't mention was just the size of the parent business. And I wonder, as you explore options to enhance value if you think the DK parent is at the appropriate size or if there's any consideration in growing the business?

Yes. I would like to address two questions. I want to be as specific as possible. We are focused on reducing debt, taking advantage of the current market conditions due to the disparity between borrowing and deposit interest rates. Our strategy of maintaining a significant cash position on the balance sheet remains unchanged. We still intend to keep substantial cash reserves to prepare for unforeseen challenges and to seize opportunities quickly. We are making some adjustments, with some coming from free cash flow and others from our existing cash reserves. Regarding your second question, we recently completed an acquisition on June 1 with 3 Bear, and we are pleased with the results so far as we integrate it into our operations. Our commitment is to pursue growth through acquisitions only if it adds value for our shareholders. We will not engage in M&A simply for the sake of it, nor will we focus on growth without a solid rationale. Our goal is to ensure that our investors see worthwhile returns on their investments. I hope this provides clarity on our future actions.

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

Yes. I want to thank first and foremost our employees that we're able to have a record quarter from a utilization standpoint and operations. Very proud of the team performance. I want to thank you, the investors, for staying with us and believing in Delek. I want to thank the management team here in the room for running this company and guiding it to fulfill the potential we can. Thank you for everyone, and we'll meet again in the next quarter. Thanks.

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