Delek US Holdings, Inc. Q2 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by. My name is Desiree, and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek Second Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the conference over to Robert Wright, Deputy CFO. Please go ahead.

Good morning. And welcome to the Delek US second quarter earnings conference call. Participants joining me on today's call will include Avigal Soreq, President and CEO; Joseph Israel, EVP Operations; Reuven Spiegel, EVP and Chief Financial Officer; and Mark Hobbs, EVP Corporate Development. Today's presentation material can be found on the Investor Relations section of the Delek US website. Slide 2 contains our safe harbor statement regarding forward-looking statements. Any forward-looking statements made during today's call involve risks and uncertainties that may cause actual results to differ materially from today's comments. Factors that could cause actual results to differ are included here as well as in our SEC filings. The company assumes no obligation to update any forward-looking statements. I will now turn the call over to Avigal for opening remarks.

Thank you, Robert. Good morning, and thank you for joining us today. During the second quarter, our adjusted EBITDA was $108 million. Despite a challenging market environment, we are managing our operations well. I'm proud of the ongoing progress our team is making. Turning to our strategic priorities. As I have outlined in our previous calls, Delek's key focus areas are safe and reliable operations; second, unlocking the sum of the parts value inherent in our system; and third, being shareholder-friendly and maintaining a strong balance sheet. I will now focus on each of these key priorities in detail. Safe and reliable operations is the core of everything we are trying to achieve. We have made further progress and achieved our highest throughput ever this quarter. Big Spring showed additional strong improvement and is on track to meet our previously communicated throughput and OpEx guidance. Joseph and Robert will provide more details on this. Next, I would like to talk about the progress we have made in our sum-of-the-parts efforts. We have announced a series of transactions that will allow us to further improve our position as a safe, reliable, and efficient refinery. On August 1, we announced the sale of our retail business for a total price of around $385 million. We are pleased with the transaction and the value it unlocks for DK shareholders. Our supply agreement with FEMSA is for 10 years. We are building a great relationship with the company and exploring additional strategic opportunities. We intend to use the proceeds from the sale to improve our balance sheet and return cash to stakeholders. I now would like to cover the transaction between DK and DKL. We executed an amend-and-extend agreement. We've also decided to drop our interest in Wink to Webster into DKL. These agreements are win-win for stakeholders of both companies. From DK's perspective, it will bring value back to DK refineries. And from DKL's perspective, it allows DKL to acquire high-quality assets without significant strain on its balance sheet. Today, we also announced several transactions for DKL. This transaction will enhance DKL's position as a full-service crude, natural gas, and water provider in the most prolific areas of the Permian Basin. DKL announced the FID of a new gas processing plant. The plant is synergistic, highly subscribed, and expected to exceed a 20% cash-on-cash return. We expect the plant to come online during the first half of 2025. On the M&A front, DKL announced the acquisition of H2O Midstream for around $160 million in cash and $70 million in convertible preferred stock. The transaction is immediately accretive to DKL on an EBITDA and free cash flow basis. Post-synergies, the transaction should be at an acquired multiple of around five times. This transaction puts us on a path to midstream independence and allows us to enhance the margin profile of our refineries and the asset quality of our midstream businesses. The overall impact of the transactions announced by DK and DKL is a cash infusion to DK of over $500 million on a stand-alone basis for little to no loss in EBITDA. For DKL, it’s a high-quality third-party EBITDA of around $70 million, making DKL a largely independent third-party midstream service provider. This transaction moves us closer along our path to midterm deconsolidation. We look forward to sharing with the market further steps we are taking on this road over the coming months. Next, I would like to highlight the progress we are making on our cost reduction efforts. When we announced our Zero-Based Budgeting effort, we had a target to reduce our cost by around $100 million. I am pleased to announce that we have completed this process ahead of time and are exceeding our regional estimates. Robert will provide more details around that. In addition, we are looking at ways to further increase the overall profitability of our company. The new project is not just about cost reduction, but it's about making Delek a structurally leaner and more profitable company. We look forward to providing you with more details in the near future. The final piece of our strategy is our commitment to shareholder returns and maintaining a strong balance sheet. During the quarter, we paid $16 million in dividends. On July 31, the Board approved another 0.5% per share increase to the regular dividend. Our quarterly dividend is now $0.25 per share. Before closing, I also want to highlight that this circuit overturned the EPA denial of the small refinery exemption petition under the RFS last week. Our petition has been sent back to the EPA for reconsideration. The case, along with the Chevron deference ruling, gives us important direction to the EPA as it reconsiders our request. We believe the EPA should grant us the exemption we deserve under the RFS rules. In closing, I would like to thank our entire team of 3,500 employees, especially our DKL Retail employees. On a personal note, I started my journey in Delek back in 2011 in the Retail division and have a special appreciation for the hard work and dedication of all employees. Now I would like to turn the call over to Joseph, who will provide additional insight on our operations.

Thank you, Avigal. We haven’t discussed operational excellence in the past several quarters. Today, I'm very proud to share with you operating data results, which clearly reinforce our progress as operators and demonstrate improved capabilities of our assets. The bottom line for our second quarter is that safe, compliant, and reliable operations led the way to a record high throughput of 316,000 barrels per day and a favorable $5.02 per barrel cost structure for our refining system. In Tyler, total throughput in the second quarter was approximately 76,000 barrels per day. The production margin in the quarter was $10.11 per barrel, and operating expenses were $4.83 per barrel. For the third quarter, the estimated total throughput in Tyler is in the 74,000 to 77,000 barrels per day range. In El Dorado, total throughput in the quarter was approximately 85,000 barrels per day. Our production margin was $2.79 per barrel, driven by a low margin environment, increased vacuumization, and a relatively weak output market. Operating expenses were $4.12 per barrel. After successfully demonstrating our crude oil flexibility in the first quarter, the team is pushing forward initiatives on the product side, including product diversification and logistics to support new market access optionality. Estimated throughput for the third quarter is in the 79,000 to 82,000 barrels per day range. In Big Spring, the successful execution of the recovery plan is well reflected in our results. Total throughput for the quarter was approximately 74,000 barrels per day. Our production margin was $8.92 per barrel, and our operating expenses were $6.35 per barrel as we approach our $5.50 per barrel target range later this year. We successfully completed a benzene triple project at the Big Spring refinery, which supports consent requirements related to benzene in wastewater. We remain focused on people, processes, and equipment to ensure operational stability. Estimated throughput for the third quarter is in the 69,000 to 73,000 barrels per day range. In Krotz Springs, total throughput was approximately 82,000 barrels per day. Our production margin was $7.02 per barrel, and operating expenses in the quarter were $4.95 per barrel. Planned throughput for the third quarter is in the 79,000 to 83,000 barrels per day range. The team is in the final stages of preparations for our fourth-quarter turnaround. Our implied system throughput target for the third quarter is in the 301,000 to 315,000 barrels per day range. Moving on to the commercial front, improved challenged supply/demand balances in the Midwest have negatively impacted second-quarter growth differentials for products and upfront netbacks. For the quarter, we reported a $34 million loss for supply and marketing. Of that, approximately $17 million loss was generated by wholesale marketing, a $5 million loss was contributed by asphalt, leaving approximately a negative $12 million contribution for supply. In summary, after successfully addressing reliability gaps, our teams continue to focus on operational excellence while also advancing process logistics and commercial optimization initiatives for each one of our sites. I will now turn the call over to Robert for the financial overview.

Thank you, Joseph. I will now move to Slide 10. For the second quarter, Delek had a net loss of $37 million or negative $0.58 per share. The adjusted net loss was $59 million or negative $0.92 per share, and adjusted EBITDA was $108 million. On Slide 11, the waterfall of adjusted EBITDA from the first quarter of 2024 to the second quarter of 2024 shows that the primary driver for lower results was from refining. The $64 million decrease in refining is primarily attributable to a lower margin environment in the second quarter relative to the first quarter. Logistics had another strong quarter, delivering $101 million in EBITDA. Finally, the lower expenses in corporate are primarily due to our cost reduction efforts. Moving to Slide 12 to discuss cash flow. Cash flow from operations was negative $48 million. Within this amount is our net loss for the period in addition to an outflow of $37 million related to working capital movements, including the Inventory Intermediation Agreement. Investing activities of $63 million are largely for capital expenditures. Financing activities of $15 million reflect the 2029 DKL tack-on offering, in addition to the timing of accruals. This also includes $16 million in dividend payments and $14 million in distribution payments. On Slide 13, we show the actual results of the 2024 capital program and the full-year 2024 forecast. Second-quarter capital expenditures were $71 million. Half of this spend was in refining, primarily addressing sustaining and regulatory projects. As for the full-year outlook for 2024, the original capital plan is on track at $330 million outside of the recent gas plant announcement. Net debt is broken out between Delek and Delek Logistics on Slide 14. During the quarter, we drew $96 million of cash and paid down $35 million of debt, ending the quarter with a net debt position of $243 million, including a cash balance of $658 million. Slide 15 covers outlook items. In addition to the guidance Joseph provided for the third quarter of 2024, we expect operating expenses to be between $205 million and $215 million, and G&A to be between $60 million and $65 million. Our third-quarter outlook for operating expenses and G&A is around $272 million. As Avigal mentioned, this exceeds our original target of $100 million in savings through our cost reduction efforts on a run-rate basis. As to other guidance, depreciation and amortization is expected to be between $90 million and $95 million, and net interest expense to be between $80 million and $85 million. We will now open the line for questions.

We will now begin the question-and-answer session. Your first question comes from the line of Manav Gupta with UBS. Your line is open.

Hey, guys, since you just spoke about it, I'm going to start with Slide 14 itself. I'm trying to understand here, obviously, there's a big difference between Delek's debt and consolidated debt. What more can be done this year? Eventually, how can we get to a situation where those two numbers start to converge and you’re not holding on to this additional debt? I'm trying to understand what more can be done to deconsolidate that debt.

Yes. Manav, thank you for joining us today. I will start by giving a highlights overview of what we are trying to do, and I will get exactly to the point you just mentioned. As you see in this quarter, we have an unwavering commitment to show investors both the DK and DKL the value of the sum of the parts and what we are driving to this target very aggressively. In the same quarter, we built, bought, sold, and dealt with a complex conflicted transaction between DK and DKL, all of that at the same time. That's a huge testimony to our commitment to bring that value to stakeholders along with strong execution to do all of that simultaneously. To be more specific, Manav, you remember I said during the last quarter that the availability of over $800 million we created during March and April earlier this year will create the ability to go to the next step. That's exactly what we did this quarter. From a DKL standpoint, we improved our cash balance. We have a minimal impact on EBITDA. What we did with DKL was an economic swap of assets, moving one asset from one company to another and vice versa economically, and putting everything in the right bucket to make ourselves deconsolidation-ready. That's significant. While doing all of that, we were able to grow EBITDA, increase third-party income, and have a seven-year amend-and-extend. In the future, you will see us taking additional steps towards deconsolidation. So that was a huge quarter for us with more to come.

Perfect. Sir, you mentioned putting the right assets in the right bucket. Delek has flagged that their EBITDA per barrel is less competitive versus some of your peers. Based on the transactions you have done with DKL, are some of those assets now going to fit within refining? Should we expect a better EBITDA per barrel now that the assets are in the right buckets?

Yes, Manav, you got it exactly right. We are bringing back value over time while growing DKL, and that's going to improve the DK capture rate in refining. So that's exactly what we have to do, and you got it exactly right. So DK and DKL are going to be deconsolidation-ready. You got it exactly right.

Okay. And sorry for the last quick question. On the small refinery exemptions (SREs), help us understand what your position is? Why do you feel you should be granted those SREs? And does it really matter if the retail price is $0.50 a gallon?

Yes. We were very pleased with the court ruling from 10 days ago on Friday. I think the court made the right decision, and that's something we need to get, and I hope we will receive it. But Mohit, why don't you give some more context around that?

Yes, Manav. I think from our company's standpoint, if you look at the recent ruling from the DC Circuit Court, it was a very positive move. From 2018 to 2020, nine petitions were denied for us. To meet the RFS requirements, we spent approximately $300 million during that time. We are still eligible to apply for more SREs after 2021, but we have not done that. Between 2018 and 2020, we spent $300 million to meet our obligations under RFS requirements. We don't know what's going to happen from here. The EPA can appeal more, but we think this court ruling is extremely positive.

So congrats on all the restructuring, and congratulations to Mohit on his new role. Thanks, guys.

Our next question comes from the line of Joe Leach with Morgan Stanley. Your line is open.

Hey. Hi. Thanks for taking my question, and congrats on progressing the sum-of-the-parts efforts here. So I know you touched on it a bit in the prepared remarks, but I'm hoping to dive a little deeper into the use of proceeds from the transaction. I know you mentioned allocating funds toward the balance sheet, how much is left to go on that front? Thank you.

Yes, absolutely. I will gladly touch on that. We have communicated in the past about our cash allocation strategy. Just to remind everyone, we have maintained a strong growing dividend throughout the cycle. We just increased our dividend again by 2% just a few days ago, so we are very proud of our ability to maintain, sustain, and grow our dividend. We have a balanced approach between improving the balance sheet and share buybacks. We see a lot of value in our share price, and we'll provide more details on that once transactions are closed late Q3, early Q4. Thank you for the question.

Thank you. Just a quick follow-up. How should we think about the tax implications from the recent transactions?

Sure. On the retail front, there will be some tax leakage, but it's not material. We are working on the structure to minimize that. As far as the related party transaction is concerned, the taxes are residual.

Right. Thank you, all.

Next question comes from the line of Neil Mehta with Goldman Sachs. Your line is open.

Yes. Good morning, team, and congrats on the announcement today. I guess the new corporate structure really helps to simplify things in a way that I think it could be easier to do larger scale M&A at the DKL level. I'd just be curious if this gets you one step closer to deconsolidation?

Yes, absolutely, Neil. That's the whole point of this deal. We are putting the right assets economically under the right ownership and rights structure. DKL is expected to show significant third-party income by the second quarter of 2025. That's a huge step in realizing full value for those assets. So the answer is absolutely. That's our intention. We have an asset in a premier location in the Permian Basin, and we are providing all products around crude, water, and gas; we are very proud of the clear strategy we have for DKL, and that value and M&A will reflect over time.

Thanks, Avigal. The follow-up is on Slide 9, where you show the margins by asset. There seems to be a lot of dispersion here. El Dorado appears to have had a tough quarter, while Tyler and Big Spring performed very well. What stands out to you looking at that spread, and how should we think about the future?

Yes, absolutely. There is extreme focus on El Dorado in terms of commercial improvement because the asset is performing very well operationally. But Joseph will provide more color on that.

Yes. Similar to our peers in the second quarter, we faced several headwinds. One was a low margin, including the lower capture that comes with it. Two is increased backwardation, which increased our acquisition price. Three is co-product weakness, which for us in El Dorado is primarily asphalt. Similar to our Midwest refining field, we faced an oversupplied Midwest market with the under-seasonal trends for a good list. On a strategic level, I want to clarify that we are pleased with our configuration. We believe it's healthy upstream and downstream, and we are doing a great job optimizing the plants consistently. Our opportunity is clearly around alternative market access when the growth is low. We have identified those strategic market destinations, and we are executing on the logistics and product offering aspect of that execution. I'm confident that in the next earnings call, we will be able to demonstrate actual progress and discuss our way forward. One last thing, we are five weeks into the third quarter, and the Midwest balances have improved, which we definitely see reflected in both the refinery and the wholesale margins.

Thanks, Joseph.

Next question comes from the line of Matthew Blair with TPH. Your line is open.

Thank you, and good morning. I wanted to jump into the supply and marketing improvement in the second quarter. Could you talk about what helped you out there? Joseph, I think you touched on it a bit. It sounds like the outlook for Q3 is improving on the wholesale side. What about the asphalt side? Do you expect some tailwinds from lower crude prices in Q3?

Thank you for the question, Matt. We do see an improvement, but Joseph will elaborate further.

Yes. On the wholesale marketing side, when the Midwest market is not flooded, we have better options on pricing and moving the product, so you will see our results improving. As for the asphalt side, we had a rough start to the asphalt season this year due to wet weather conditions that made roofing and paving challenging. We expect conditions to return to normal ranges.

Sounds good. Regarding renewable diesel, has that plant in Bakersfield started up yet?

It hasn't happened yet, and I’ll let Robert, our Deputy CFO, to answer that question as he's closer to that.

Yes, it's something we are monitoring. We have ongoing dialogue with them, and today no decision has been made until they meet the requirements for the plant to come online.

Great. Thank you.

Thank you.

Thank you, Matt.

Our next question comes from the line of John Royall with JPMorgan. Your line is open.

Hi. Good morning. Thanks for taking my question, and congrats on the transactions today. I want to start with a high-level question regarding the sum-of-the-parts. It has been a flurry of announcements with retail and several incremental items. How close to completion do you think you are with this sum-of-the-parts effort after these deals are closed? You've mentioned more to do on the deconsolidation side of DKL, and presumably also on the third-party side to get that entity fully third-party. Can you talk about which inning you're in and what the next steps are?

Yes, absolutely. To complete all of those deals, you know too well that you're close to the story long enough, you need to ensure that the right assets are in the right bucket. We are starting to make those separations as we speak. While doing that, we maintain and grow DKL’s EBITDA to make it third-party dominant and ready for the next steps. All of those steps were completed, and we are ready for deconsolidation when the right opportunity presents itself.

Yeah, absolutely. Thanks, Avigal, and thanks for the question, John. The transactions announced at DK and DKL last week and today mark significant progress on our sum-of-the-parts journey. We are extracting the value of our retail operations, and through the DK-DKL announcements, we're reducing the interdependence between them. The Wink to Webster deal, along with the expansion of the gas processing capacity into Delaware and the purchase of H2O Midstream will all add substantial third-party business to DKL. We are in a much better position for future deconsolidation than we were prior to these announcements.

Great. Thank you. I have a follow-up question on the cost side. You've mentioned moving into Phase 2 of taking out costs after completing the $100 million early. Can you give us any details about that second phase? What might be some components of those savings? Will the order of magnitude relative to the first $100 million be similar?

We are taking that very seriously. It's going to impact more aspects of the business. We didn't provide guidance on that yet, but everything is in motion and we will be more specific around that very soon. So stay tuned.

Thank you.

Next question comes from the line of Roger Read with Wells Fargo. Your line is open.

Yes. Thank you. Good morning, and congrats on progressing the sum-of-the-parts restructuring. This question is for Joseph. You've been working hard to get Big Spring up. You had made comments earlier about some work around El Dorado. As we think about bringing the support pieces back into three of the four refineries, what's the right way to think about that in terms of enhancing cash flow or EBITDA generation of these units?

Are you asking about all refineries or specifically El Dorado and Big Spring?

I was more citing the progress at Big Spring. You mentioned El Dorado, but I was just curious in terms of deconsolidating DKL and bringing the assets back in, presuming that's also going to be margin enhancing. So, what progress have you made? What other changes or operational improvements are being made?

Yes, Roger. It is striking what fixed reliability can do not only for throughput but also for OpEx and favorable contributions. We have made substantial strides with our leadership teams in handling optimization opportunities for each of our sites. We have more octane capability, which enables us to drive more products from Big Spring to the right pay market. We can sell higher octane products, including aviation fuel from Tyler, and we can convert some of the diesel we make into jet fuel. This optimization will move us forward significantly. Mark, do you have more to add?

Yes, Roger, regarding your question, Avigal has stressed earlier the announcements between DK and DKL are indeed an economic exchange of assets. The amendment of contracts brings clarity by extending them for up to seven years and removes uncertainties in the market. Importantly, these changes improve DK’s refining profitability going forward and enhance future capture rates as expected.

Okay. Appreciate it.

Did we answer your question?

I think it will take some time to see how it evolves, but I'll take it offline. Thank you.

Our next question comes from the line of Paul Cheng with Scotiabank. Your line is open.

Hi, good morning, guys.

Hey Paul.

I want to go back into the contract expansion. Can you quantify for us the lower fee that DK will pay to DKL on an annual basis? Also, did you disclose the price at which you sold the Wink to Webster pipeline to DKL? We saw in your presentation that the DK-DKL transaction net cash is $130 million. Should we assume that is the selling price? What is the EBITDA associated with the Wink investment that you're currently receiving? That's the first question.

Yes, Paul, thank you for the detailed question. You cannot assume that the Wink to Webster value is simply a one-off transaction between DK and DKL, and we provided the net number for clarity. The value of Wink to Webster is market-driven, and while we anticipate reducing the contract between DK and DKL in an order of magnitude of $60 million over time, that will allow for the building of additional EBITDA for DKL. Both companies will benefit from this move as the capture rate in DK looks to improve.

Okay. You're not going to disclose the actual selling price or drop-down price for Webster and the contract extension?

Unfortunately, I can't.

The second question is for Joseph. With Big Spring, you've been working on restructuring and improving optimization. As of now, are all efforts essentially done? Other than looking at new products or markets, have all the changes or operational improvements you've targeted already been implemented at this point?

Yes, so regarding the cost structure, we guided the market to a $5.50 target. This quarter, we were approximately $0.85 per barrel over that in Big Spring. We have several special programs ongoing for long-term improvements. As they conclude by year-end, we will hit the $5.50 target, which we believe will be sustainable. When you stop playing defense, you can start working on your offense. We have significant room for further optimization in Big Spring.

Thank you.

We do have our last question coming from the line of Jason Gabelman with TD Cowen. Your line is open.

Yes. Hi. Thanks for taking my question. I want to revisit what Paul just asked regarding the EBITDA contributions. If I look at the disclosed figures for the DKL transactions, H2O is $45 million of EBITDA, and the gas processing plant is roughly $25 million to $30 million. That brings you to that projected $70 million of EBITDA for DKL. It implies that the Wink to Webster divestiture offsets the DK contract amend-and-extend. Is that the correct math, or is there something off there?

Yes. Jason, I think this is a good opportunity to follow up with Mohit. We anticipate more value in the gas spend, for example, and there is more EBITDA that returns from DKL to DK. I said that to Paul, estimating around $60 million over time. It's not all realized on day one, and we didn't give specific numbers for each of the transactions, but we made sure the strategy is clear and that we're improving the capture rate while growing DKL. That's the holistic view we are seeking, and it's a vital step for all stakeholders.

Okay. When you say $60 million of value over time, how many years do you expect that to take?

We're not going to get into detail on that, but I encourage you to collaborate with Mohit for more detailed inquiries.

Understood. My other question pertains to the use of proceeds. Your interest expense seems quite high now, and that could be a focus for improving the cash flow of the parent company. Is that priority one? Why is there hesitation currently about discussing the use of proceeds?

The proceeds are aligned with our strategy. When we evaluate free cash flow, we consider it on a mid-cycle basis; mid-cycle free cash flow remains strong according to our expectations. We can accomplish all we need and provide good returns to our investors. We are confident about our position and looking forward.

Thanks for the answers, and I'll follow up offline.

Thank you.

That concludes the question-and-answer session. Mr. Avigal Soreq, our CEO, I turn the call back over to you.

Thank you for joining us today. I appreciate the management team's focus and execution around this. Thank you to our employees, the Board of Directors, and you, the investors. A special thank you to the retail employees for their longstanding dedication. Welcome to the H2O team that joins our family today. We'll talk again in the next quarter. Thank you.

This concludes today's conference call. You may now disconnect.