Delek US Holdings, Inc. Q4 FY2022 Earnings Call

Good day everyone. Welcome to the Fourth Quarter 2022 Delek US Earnings Conference Call. My name is Jamie and I will be your operator for today's call. Please also note today's conference is being recorded. At this time I'd like to turn the conference call over to Rosy Zuklic, Vice President, Investor Relations. Rosy, you may begin.

Good afternoon. And welcome to the Delek US fourth quarter earnings conference call. Participants on today's call will include Avigal Soreq, President and CEO; Todd O'Malley, EVP and Chief Operating Officer; Reuven Spiegel, EVP and Chief Financial Officer; Mark Hobbs, EVP Corporate Development, as well as other management members. Today's presentation material can be found on the investor relations section of the Delek US website. Slide 2 contains our Safe Harbor statement. We'll be making forward-looking statements during today's call and actual results may differ materially from today's comments. Factors that could cause actual results to differ are included here, as well as in our SEC filings. With that, I'll turn the call over to Avigal.

Thank you, Rosy. Good afternoon, everyone. And thank you for joining us today. 2022 was the best year ever for Delek US. Market conditions were strong for refining and midstream, and we were able to capture opportunities along this. Full year adjusted EBITDA was $1.2 billion. During the fourth quarter, total results were strong. Adjusted EBITDA was $221 million, despite unplanned downtime, mainly at the Big Spring refineries. Third, we will provide more color on operations and the actions we are taking to ensure safe and reliable operation. As I said in the past, shareholder returns are a key priority for us. During the year, we returned $236 million to shareholders with $172 million in the second half of 2022, close to 10% of DK's market capital. We maintained the regular dividend this year, and we are pleased to announce an additional 5% increase in the quarterly dividend to $0.22 per share. Looking forward, we are very excited about our future. On the corporate structure, we are actively evaluating strategic alternatives for logistics and retail to achieve the sum of the parts objectives. On the operation side, we launched a zero-based budget to improve our competitive position on cost structure. We are proud of the Delek refinery team. The team finished the turnaround on time and on budget, and we are in the process of starting the plant. This marks an important milestone for Delek's turnaround story. We stated that we do not have any significant planned downtime scheduled until late 2024, so we are well positioned to capture market opportunities during that time. And now, I will hand it over to Todd to speak about operations.

Thanks, Avigal. Fourth quarter crude throughput across the system was approximately 258,000 barrels per day. The reduced rate was primarily driven by unplanned downtime at the Big Spring refinery during the fourth quarter. Unplanned incidents make us regroup and reassess. We take steps to improve when and where we see opportunities and focus on the areas of the business that we can control. This is a priority for us, not only for the wellbeing of our employees, contractors, and communities in which we operate, but because we know that a safe and reliable operation leads to financial stability and protects the environment. A good example is our Krotz Springs refinery, where our employees and contractors recently achieved a safety milestone of over 5 million man-hours worked without a lost time injury. As Avigal mentioned, we have just finished a significant turnaround at our Tyler refinery. The refinery successfully completed the turnaround with zero process and safety incidents on time and on budget in difficult weather. This is a fantastic achievement for Delek and I would like to thank our employees for their hard work and our contractors for their partnership. Our logistics segment performed extremely well this quarter. Our record earnings reflect this, and the big driver was the successful integration of the three Bear Delaware assets. While DKL sees benefits from its base business, we see continued growth opportunities in the Permian and Delaware footprints. Delek Logistics is well positioned to continue its strong track record of growth and to be a long-term, sustainable midstream player. With that, I will turn the call over to Reuven to go through the quarterly results.

Thank you, Todd. So with the fourth quarter of 2022, Delek US recognized an adjusted net income of $61 million or $0.88 per share. The net loss for the period was $119 million, or $1.73 loss per share. During the quarter, we also returned $104 million to shareholders in the form of share purchases pending. And on Slide 4, we highlight that we have adjustments this quarter of $243 million. The largest impact was related to FIFO inventory impacts, which is again adjusting for this quarter. We believe presenting this adjustment better aligns our EBITDA results with our peers. Adjusted EBITDA was $221 million after factoring in these adjustments. On Slide 5, we provide a waterfall of our adjusted EBITDA by segments from the fourth quarter of 2021 to the fourth quarter of 2022. This significant improvement period over the period was primarily due to higher results in refining. Compared to the fourth quarter of 2021, the Gold Coast market cracks were 76% higher in 2014, which primarily drove the lodgings. On Slide 6 we present the cash flow waterfall. We withdrew $313 million in cash during the quarter, largely driven by two events that occurred late in the quarter. First, we had $180 million unfavorable timing effects associated with the closing of the transition of an inventory intermediation agreement with Citi. This full amount resulted in a favorable cash flow in the first quarter. The second item was an unfavorable working capital cash flow impact associated with unplanned downtime at the Big Spring refinery. $60 million of this amount was a cash timing event and resulted in favorable cash flow in the first quarter of 2022. On Slide 7, capital expenditure for 2022 was $343 million on a consolidated basis. But during 2023 we have a capital program of $350 million. The timing of refinery turnaround is the single largest capital expense and makes up a large portion of the 80% of CapEx dedicated towards maintaining and sustaining the integrity of our assets. The remaining 20% is dedicated to both projects, primarily in logistics. The last slide covers outlook items for the first quarter of 2023. Before we move to Q&A, I wanted to give an update on our cost reduction and process improvement efforts. We're executing changes in the organization and expect about $30 million to $40 million of P&L improvements in 2023 and an additional $50 million to $60 million in 2024. Annually, we expect the run rate to be approximately $90 million to $100 million. These improvements may be lower cost or improved margins. I will now open the lines for questions.

Ladies and gentlemen, we will now start the question-and-answer session. Our first question today comes from John Royall from JPMorgan. Please proceed with your question.

Hi, guys, good afternoon. Thanks for taking my question. So maybe we can just start with an update on just a little more detail on how you're thinking about the some of the parts outlook. How do you kind of thread the needle between meeting steady streams of cash flows to pair with the refining business but potentially needing to separate out some portion of logistics and/or retail in order to realize that valuation output?

John, Avigal. Good afternoon and thank you for joining our call. Our number one consideration obviously is to be a friendly and investable company in shale. We demonstrated during the second half of the year with returning just over $170 million of cash to investors, of which is 10% of the market cap. And that's some policies as a subset of debt. So as we said, in the press release, we're evaluating opportunities in both retail and on the logistics side. Each one of those opportunities looks a bit different or should I say completely different. So we cannot go too much into detail, but we are obviously looking at how to manage the assets we need and to maintain the EBITDA we need and to sustain the cash flow we need. We mentioned that it is a good opportunity for me to introduce an important colleague here at the table, our EVP of Corporate Development, Mr. Mark Hobbs. Maybe you can say a few words?

Sure, Avigal. Thanks. And John, that's a good question. We've obviously been very vocal about focusing on some of the parts. Since I joined the company in October, my focus has been solely on evaluating and looking at options and opportunities across all of our business segments to unlock the value inherent in our businesses. I know Avigal mentioned midstream and retail, but what I would say is we're thinking about this in such a way that we want to ensure that whatever we do is additive across our businesses and positions our businesses across all the segments for future growth, to drive additional value for our shareholders. That's really the sole focus here.

At this point, we don't have anything to announce. But obviously, when we do, we'll be very transparent with everybody.

Thank you for the clarification. I'm interested in discussing capital allocation. It's good to see an increase in the dividend. However, I noticed there wasn't guidance on the buyback for the upcoming quarter. Should we interpret this as a sign that there won't be guidance moving forward? Or could it indicate that a buyback might not occur in Q1? How should we interpret this?

So we will elaborate on that just a little bit. Our intent, as part condition stays where it is, is to be balanced between debt reduction and buyback. Our goal for the remainder of 2023 is to be on the buyback between $75 million to $100 million. We demonstrated in the second half of the year that we could be prudent around that. And we did execute a buyback that we guided for with a total return of again, over $170 million. Our intent is to keep being friendly toward investors, and that's the benchmark that we put in front of ourselves.

Our next question comes from Neil Mehta from Goldman Sachs. Please go ahead with your question.

Yes, thanks, guys. Appreciate the time. Well, I'd just love some perspective on where you feel you are from a refining operational perspective? And maybe you can go through each of the assets, Tyler, El Dorado, Krotz, and Big Spring. And where do you think there are opportunities to continue to improve, capture, and drive profitability higher as the last quarter was a tougher one than I think people would have expected a couple months ago.

Thanks for the question, Neil. We're on a journey towards reaching our ultimate goals. As I mentioned earlier, success hinges on being safe, reliable, and environmentally responsible while operating our assets. We achieved some positive developments in 2022, which you and others on the call likely noticed through the improved capture rate over the year. We’ve implemented various initiatives across our fleet to enhance operations, and many of our facilities have shown progress. Measures such as catalyst reformulation have increased yields, particularly at Krotz in the fourth quarter. We're focused on ensuring that our assets remain sustainable and viable in the long term. Unfortunately, we faced a semi-planned outage at BSR, and we recognize that we didn’t manage that situation as effectively as we should have. We've learned from that experience and incorporated those lessons into our operations to prevent a recurrence. While I won't discuss specific details for each asset due to their proprietary nature, we are dedicated to optimizing product mix and fruit slate daily. The Tyler facility has set a high standard for turnarounds, and we recently completed a major turnaround there with no safety or process incidents, even under difficult weather conditions. The team's performance has been outstanding and provides a solid foundation for our future plans. It's also worth noting that we have no significant planned work until the fourth quarter of 2024, allowing us ample time to take advantage of the favorable macro environment we are observing.

And thank you, that's great perspective. And how much of the challenge around captures has been more operations-driven, as you talked about, versus market conditions? Because, as we think about the period where Delek's refining profitability was outsized from 2011 to 2018, a lot of it was about the middle and differential, which is now inverted. And so I think the investment community is trying to figure out what the mid-cycle refining environment looks like in an environment where the crude markets are less favorable. So we'd love your perspective on the go-forward crude markets and how that environment sets up for your kit. Thank you.

Yeah, no, thanks again, Neil. I'll take the first half of the question, then I'll let Avigal weigh in on market views. Look, I think we've demonstrated over the last year where Midland traded at a premium relative to TI, the earnings power of the company. So I think that's pretty well established at this point. Again, we've also done things throughout the system to improve yields, through catalyst reformulation. We've done some things throughout the system, looking at product mix changes that give us better netbacks. And will obviously continue to do that. But I think, given the synergies between our logistics system, the strength in the Permian Basin from a demand perspective, and how well albeit outside of Q4 we ran during the year, we're in a good place as we come out of the Tyler turnaround. I'll let Avigal comment on what our views are on the Midland differential on a go-forward basis.

So, hey, Neil, how are you?

Good, Avigal. Thank you.

So the Midland basin is obviously the most prolific basin in the world, not just in the U.S. And we have invested and demonstrated a lot of commitment to that. I think for the long-term, that investment was able to prove itself and will prove itself in the future. Today, Midland is around 5.7 million barrels a day of production rise, and we see a nice increase in our footprint of production. We forecast that that's going to go all the way to 400 to 600 this year. So it's going to put us at close to 90% capacity of the pipeline that we operate. Over time, the Permian Basin is going to respond and demonstrate the dry differential and fit to our configuration. We obviously have between 2 to 2.5 of our refinery, we have more optionality. So this is something we're always looking at in terms of improving the flexibility of our operations. But all the time, I think that the second half of 2023 and the beginning of 2024 will be pivotal years for the Permian Basin.

Okay, thank you, Avigal.

Our next question comes from Doug Leggate from Bank of America. Please go ahead with your question.

Hey, good morning, guys. This is Kalei on for Doug. So thanks for taking the question. My first question is a follow-up to John's question. I want to understand how you view the cash flow and the free cash capacity for DK Refining when it's fully burdened for all corporate costs. If you're able to walk us through those assumptions, I think it would help the street to understand whether the core business can stand by itself or not, and whether a separation of retail and/or logistics makes sense?

Thanks for the question. So it really depends on what the outcome will be, but we are not going to do any transaction that will put us at risk for the total cash flow of the company. So let's make it clear. We are not going to make any transaction that will jeopardize the mothership, we're going to do any transaction that we perform will be thought-out. We will think about different scenarios and will take into consideration downtime for the refinery business, which we know is a volatile business. So we're not going to make just any transaction to check the box. I've said that in the past, we're going to make the right one. Luckily enough, we're grateful to have the probably the one if not the best in the industry to perform those deals, and we are confident we can get one that you can all be proud of.

Would you look at this as potentially a multistep process? So in the case for DK, they acquire something to get bigger through M&A. Would you consider selling some of the refining out back to DK Corporate?

Yeah, this is Mark Hobbs. Thanks for the question. We would look at things as a multistep process. But anything we do, as Avigal said, we have a lot of different options on the table for us right now. But anything we do, as I mentioned in my earlier remarks, will be done in such a way that it sets up all the different businesses to continue to succeed, and to operate effectively through the cycles. This involves moving strategic assets between our midstream company back to the refining company, and we're going to evaluate all the different options.

Got it. I appreciate it. My second question is regarding details on your cost-cutting plans, for example, how much from each bucket, the buckets being gross margin, optics, and corporate? And should we understand the cost cuts as being an EBITDA expansion, or are there any offsets to revenues?

So I think, let's talk about the OpEx budget. Do you want to take it?

No, absolutely. I just missed the last part of the question.

The second part of the question was, should we understand the cost cuts to be an EBITDA expansion? So for example, if you're talking about $100 million of cost cuts, does that translate into $100 million of higher EBITDA? Or are there any offsets from lower revenues because you're getting rid of certain cost centers that might be revenue-generating?

No, actually, as we see the plan right now, even though there could be one-time restructuring costs, we're going to see the $100 million projected to be sustainable. Just want to make it clear that it's on a run-rate basis. So we're going to recognize $30 million to $40 million this year, with a likely $50 to $60 million next year. And on a run-rate basis, around $100 million, which will be a direct contribution to EBITDA.

Perfect, and if I can just sneak in.

Sorry, Kalei, I want to clarify that it's not solely a cost that will come from the G&A line; it may take different forms.

I mentioned in the prepared remarks that it's both margin improvement and cost reduction.

Yeah, that's right. I just want to make sure Kalei picked up on it, because you specifically asked about costs. And so just to be clear, it is not just going to come out of the G&A line, it could be coming in the form of increased margins as well.

Got it. I appreciate that. If I could sneak one very last one in. Can you offer some color on the one-time items that hit cash flow this quarter? And which one of those items will reverse if they will or not?

Well, on the G&A, we had $17 million of one-time items, of which $13 million are already part of the restructuring costs that I mentioned to your previous question. That will allow us to be on track, and our goal for the fourth quarter is for the G&A corporate, I mean, company G&A to be in the mid-70s.

I was considering the factors that impacted cash flow in the fourth quarter. It appears that there was approximately $400 million involved.

Well, $240 million of them were a timing issue. And we received the $240 million during the, I mean, actually in January. The other $200 million were really the FIFO impact or the inventory impact. So if you compare all that together, that would have put us in a positive number.

Got it. I appreciate it. Thanks, guys.

Thanks, Kalei.

Our next question comes from Paul Cheng from Scotiabank. Please go ahead with your question.

Hey, guys, good afternoon. Can I just maybe go back into the earlier question? I think, will it be possible that you can separate out the $100 million by different major buckets? Like how much is on the headcount reduction saving? How much is on the margin improvement? And where the margin improvement do you expect that kind of separation?

Yeah. Hey, Paul, it's Avigal, how are you? So I would just say a ballpark number 30% to 40% of the G&A and 50% to 60% actually 70% in the OpEx ballpark?

So G&A is about 30% 40% and 60% 70% is in the OpEx or margin improvement? And how all these that, how do you reducing your headcount, and if you do by how many?

Well, we are not going to get specific around it. You probably understand that if they're sensitive discussions, but we want to have the most smart, efficient, and obviously a safe and reliable company. So we're not going to jeopardize safety on reliability on that. We're going to do it the right way. And we get advice from best-in-class once we have a great company going forward.

I have to apologize. This one wants to go back into the refining reliability. And thought if you look at where you are, do you think the reliability issues we see not necessarily is not just to Big Spring, but overall. Is it asset-based issue, means that you need to spend CapEx or just the process issue or cultural issue or that you're just not having sufficient of the timing or the skill set where that you may need to get some help from outside?

Yeah, Paul, look, I think if you look at everybody in the industry, we all struggled during COVID. There were obviously cost cuts and rationalization on staffing across the industry, like we like everybody else are coming out of the back end of that now. I think obviously, we've just conducted a major turnaround at Tyler. We've done that successfully on time and budget in challenging conditions. So I think we really have the people in place; it's just really kind of playing catch up to some of the issues caused by COVID in terms of the poor margin environment. You look at what we did throughout the majority of the year, other than the Big Spring event that we had. And we ran the system very, very well, all-time record high utilization above nameplate capacity. So, I think you should treat this more as a one-off on a go-forward basis as opposed to something that's systemic in the company.

So basically that you believe if there's a reliability issue, yes. When it's just because during the pandemic, you guys may be postponing and delaying some of the maintenance activities such that now just playing catch up on that.

I think everybody's done industry experience. That's not unique to us. And I think I'll leave it at that.

Okay, and I think the final short one, this is probably for Reuven. Can you share what is the RVO on the balance sheet at the end of the year? And also if there is any meaningful impact on the fourth quarter result due to the mark-to-market on debt liability?

Paul, this is Robert Wright, Chief Accounting Officer. As you know, we don't disclose that level of information within our financial statements.

Can you tell us that is there any meaningful impact on the fourth quarter P&L due to mark-to-market liability?

Yeah, there was no impact beyond market rent price volatility.

Okay, we do. Thank you.

Thank you, Paul. You bet.

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

Hey, everyone. Good afternoon. Thanks for taking my questions. I wanted to ask the first one on the some of the parts unlock that you're going through? And the main question is, I want to understand if the contours of the kind of or the goals I should say are the same, which is really to deconsolidate DKL from DK. I know on the last earnings call, management suggested that was a driving force of why we want to do this some of the parts valuation unlock. Is that still the case? And additionally, on the prior call, there wasn't any mention of the retail footprint being part of the potential options that you're exploring. So did something change between that time and now we're now retail is in play? Thanks.

And thank you, Jason. So our end goal is to be a good shareholder and a good company for investors. As I've said in the past, there is more than one way to go about it. We obviously indicated in the previous call that we believe that with some actions around DKL, we can achieve that. And we still believe that's the case. We did put in the press release a comment about retail. Our belief in retail is either you go big all the way, or you're almost not relevant. So obviously, we're always thinking of what is the best asset base we should hold, and how to bring the best returns to shareholders. So you need to be very happy that everything is on the table. And we are certain that you will be very proud and happy with the deal we are going to end up showing you.

Okay. And then my follow-up. There's two quick ones, I'll ask them together. On cost cuts, the 60% to 70% OpEx reduction. Is any of that related to energy costs or is that all underlying? And then separately, last quarter, you guided to think $100 million to $150 million in debt reduction. Doesn't appear like that materialized this quarter. Can you discuss why that was and where you see gross debt levels going over the course of the year? Thanks.

Regarding energy, if there's an energy aspect to this, it's about consumption rather than the price. We're not going to claim we'll cut costs by $1 billion and rely on natural gas prices decreasing; that's not realistic. That's not what the market is indicating, and it's not something we can achieve independently. To clarify, we're aiming to be as transparent as possible with the information we share. If there's an energy component involved, it relates to consumption and not the price of natural gas. Let's set that aside for now. Reuven is very engaged with the debt reduction efforts and likely wants to share more insights on that topic.

So actually until the end of November, we were on track to execute both the debt reduction of $100 million and the buybacks of $100 million as a result of the unplanned events and the timing events that I've mentioned. It kind of disrupted our plan. We did end up doing the buybacks, but we had to push the debt reduction. We will go back and I think I mentioned it before, to focus on debt reduction and buyback as we go forward.

Okay, thanks.

Our next question comes from Roger Read from Wells Fargo. Please go ahead with your question.

Yeah, good afternoon. I'm going to beat the dead horse here regarding restructuring, but I'm going to ask the question with a little more detail. So I was curious as you're looking at the overall process and opening up value, how you see some other things such as the biofuels business and some of the equipment assets like Wink to Webster that are still inside of DK that were originally planned to be dropped down to DKL. Is that a complicating factor or an enhancement when you think about improving the overall value of the two entities?

Mark can start, and then I can finish.

Yeah, sure. Roger, I really appreciate the questions. Mark Hobbs here, EVP Corporate Development. As we said earlier in the call, I mean, we're looking at all the options on the table. I am specifically across all our business segments, and looking at ways to unlock the value that's inherent in those businesses as well as to set all of our business lines up for success going forward. And so when you think about other areas for us to consider, whether it's on the biodiesel plants or whether it's decarbonization of our business. What we are evaluating as well around our business, just in general from a corporate development standpoint, is looking for opportunities where we can leverage our existing assets appropriately, where we have a competitive advantage in terms of location, configuration, etc., to seek opportunities, whether it's around decarbonization or low-carbon fuels in the future. And so that's something that we're constantly evaluating, and looking at organic opportunities around that. As we think about the midstream in particular and the Wink to Webster how that fits in the overall scheme of things. I mean, that's not a captive Delek US refining-related asset. It's more of a traditional midstream, third-party asset. So when we think about where assets should be longer term, and where the best value proposition is for those assets, that's something we're obviously thinking about as well.

Just to add to that. So every deal that we're looking obviously, we're looking to make it competitive to the cost of capital that we have. We are not trying to make a deal in the biodiesel back into just the 12% return or something like that. That's off the table. So every deal that we are exploring should be accretive to our shareholders. That's the main criteria.

We’ve kind of thought of Wink to Webster as generating roughly $50 million a year in EBITDA. I don't know if you're willing to comment on that, but is that a reasonable range at this point?

Yeah, Roger. It's Todd. Thanks for the question. Look, as we've said in the past, we don't speak for the consortium. Therefore, that type of information is not something we can disclose. I think suffice it to say that Wink to Webster running at planned rates means we get the benefit of distributions coming off that. But I think we'll leave it there.

Okay, understood. Thank you.

Thanks, Roger.

And our next question comes from Matthew Blair from Tudor, Pickering, Holt. Please go ahead with your question.

Hey, good afternoon. Hopefully, you can hear me okay. First question is, do you have an update on the potential R&D project in terms of timing, and there's been any sort of update on the EBITDA contribution, and whether Delek would be likely to invest in that project?

Hey, Matthew, it's Todd. As I mentioned in response to Roger, we are not currently invested in the project. We have an option for a little over $13 million to acquire a 33% interest in the physical plant. As we've noted in previous earnings calls, the company has filed some SEC documentation that suggests it probably won't be operational until the second half of this year. As Avigal mentioned earlier, we will assess the advantages of exercising our option in relation to our capital structure when the appropriate time comes. We will ensure you're well informed when we make that decision.

Sounds good. And then in the corporate segment at negative $60 million EBITDA this quarter. Was that pushed up by year-end comp? And if so, what's the good run-rate for corporate going forward?

A significant portion of that is the one-time cost that Reuven mentioned earlier in his Q&A response. We incurred around $13 million in restructuring charges in that segment, along with other one-time costs.

Okay, the one-time costs are still in the adjusted EBITDA figure?

Yeah, that's been clarified. The $60 million in the adjusted EBITDA number. But what we're really talking about is there that at year-end, we have the annual incentive plan, and so that's really the cost that you're seeing. That's why it's been elevated in the quarter.

We did the deal in the second and the fourth quarter. We did not do it every quarter. We're changing that going forward, but that's the way we did it in the past.

Okay, and so maybe like negative $40 million to negative $50 million a quarter would be reasonable going forward?

I would estimate it to be closer to 40 to 50. The distinction between the third and fourth quarters is mainly due to that accrual.

That is a bit higher than what they anticipate going forward, so I would guess, like $30 million to $40 million. So that's also a number that we come back.

Yeah, thank you very much.

Ladies and gentlemen, in showing no additional questions, I'd like to turn the floor back over to the management team for any closing remarks.

So I want to thank the management team around the table, to the investor to the sell-side, buy-side community. Thank you for believing in us and the big business with our strategy. Thank you for the board of directors of the company and first and foremost to our employees that are running and operating assets day and night, rainy and sunny. Thank you, everyone. And we will meet again in the next quarter.

If you have any questions, please feel free to reach out. Thank you. Bye-bye.

Ladies and gentlemen, with that we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.