Par Pacific Holdings, Inc. Q3 FY2022 Earnings Call

Thank you, operator. Welcome to Par Pacific's third quarter earnings conference call. Joining me today are William Pate, President and Chief Executive Officer; Richard Creamer, EVP of Refining and Logistics; Jim Yates, EVP of Retail; and Will Monteleone, EVP and Chief Financial Officer. Before we begin, note that our comments today may include forward-looking statements. Any forward-looking statements are subject to change and are not guarantees of future performance or events. They are subject to risks and uncertainties, and actual results may differ materially from these forward-looking statements. Accordingly, investors should not place undue reliance on forward-looking statements, and we disclaim any obligation to update or revise them. I refer you to our investor presentation on our website and to our filings with the SEC for non-GAAP reconciliations and additional information. I'll now turn the call over to our President and Chief Executive Officer, William Pate.

Thank you, Ashimi. Good morning to our conference call participants. We're pleased to announce the second consecutive quarter of strong financial and operating results as all our business segments had strong profitability. Third quarter adjusted net income was $2.88 per share and adjusted EBITDA was $214 million. Our organization is excited to return to a growth posture with our recent agreement to purchase ExxonMobil's Billings refinery and related logistics assets for $310 million. As previously noted, this acquisition will double our mainland refining capacity and significantly boost our logistics business. We expect to fund the acquisition next spring with cash on hand. This quarter, both our Retail and Logistics business segments reported record quarterly adjusted EBITDA. The Retail unit benefited from declining crude oil prices during the third quarter. Retail price declines also partially reversed a portion of the demand destruction that we experienced in the spring when gasoline pump prices spiked to very high levels. Our Logistics profitability continued to improve due to increasing throughput and sales throughout our system. Strong operational reliability, a high exposure to distillate markets and falling crude prices benefited our Refining segment, despite refined product cracks that softened from record second quarter levels. While gasoline cracks have dropped significantly, distillate cracks remained strong due to high natural gas prices and significant incremental demand from gas to oil substitution in Europe and elsewhere. Prompt distillate prices are approximately $40 a barrel above gasoline prices in Singapore. Forward distillate cracks remain at high levels through the end of 2023 due to rising global demand. The profitability of our business has boosted free cash flow over the past two quarters, bolstering our balance sheet. With over $400 million of GAAP net income generated during the last six months, our book equity is back to pre-pandemic levels. Over the near term, we will focus on successfully closing the Billings transaction and integrating that business into our organization. We expect the Billings operation to be immediately accretive to our earnings and cash flow. We're also making progress on several renewable energy projects. We have a small co-processing investment in Tacoma scheduled to be operational in the first quarter, and our joint venture with Hawaiian Airlines to explore sustainable aviation fuel is advancing quickly. The Hawaii SAF project looks very attractive based on the renewables market outlook and current levels of government support. While we are cautiously assessing our feedstock options and mindful of potential government policy changes, we expect to make a final investment decision next spring. We believe this timeline would permit us to break ground next year and commence operations during early 2025. We believe we can complete this conversion project at less than $1.50 per gallon of annual production capacity. Collectively, these two projects in conjunction with our blending operations would generate enough RINs to fully cover our obligation for all units other than D3s. We're also working on a green hydrogen project at our Washington refinery that would be highly competitive with a low all-in cost of energy and a low greenhouse gas emissions profile. I'll now turn the call over to Richard to discuss our refining and logistics operations.

Thank you, Bill. Our three refineries worked hard to maximize operational availability in the third quarter, achieving an average of 96.6% availability. In Hawaii, we experienced unplanned rate reductions, which pushed rates below our guidance for the quarter. Third quarter throughput was 80,000 barrels per day and production costs were $5.14 per barrel. The refinery is running well in the fourth quarter, and throughput is expected to be 80,000 to 82,000 barrels per day. The reduced throughput in Q4 is related to planned maintenance activities on one of our gasoline conversion units that we expect will reduce capture rates as we are increasing purchase products and exporting secondary products. In Washington, we operated extremely well and captured peak margins related to West Coast salvages during the quarter. Production costs were $3.43 per barrel and throughput was 40,000 barrels per day. Fourth quarter throughput is expected to be 40,000 to 42,000 barrels per day. Our investment to debottleneck heavy crude capacity during our 2022 turnaround has been successful, and we've been able to increase total yield throughput by more than 10%. Shifting to Wyoming, we achieved a peak monthly rate in July of 18,600 barrels per day. Production costs were $6.63 per barrel and throughput was 18,000 barrels per day during the third quarter. Fourth quarter throughput is expected to be 15,000 to 16,000 barrels per day. This forecast includes October downtime associated with the catalyst change-out that has been successfully completed. I'll now turn the call over to Jim to discuss the retail results.

Thank you, Richard. As Bill mentioned, the Retail segment reported record adjusted EBITDA of $20 million for the quarter compared to $14 million in the third quarter of 2021. Our same-store sales volumes decreased by 1.9%, which compares favorably to reported industry decreases of more than 4%. Merchandise revenue increased by 4.7% over the third quarter of 2021. While continuing COVID-related impacts kept pressure on both fuel and merchandise sales volumes, these headwinds were more than offset by promotional efforts and resilient margins. Store transaction counts continue to recover with recent indicators suggesting visits higher by approximately 2% year-over-year. Our early fourth quarter results suggest robust margins continue to offer strong profitability. Initiatives to upgrade our store portfolio continue as we entered into an agreement to acquire three existing stores in the Greater Spokane market. We anticipate closing this acquisition in early December. We also expect to break ground on two new locations in the fourth quarter. The first, a fuel location in Hawaii and the second, a flagship non-branded convenience store and fueling facility in Spokane. We hope to open both of these locations by the third quarter of next year.

Thank you, Jim. Third quarter adjusted EBITDA and adjusted earnings were $214 million and $172 million, or $2.88 per fully diluted share. We generated record quarterly cash flow from operations of $341 million, driven by normalizing working capital in combination with strong earnings. Logistics segment adjusted EBITDA contribution was $22 million, up sequentially from the second quarter by approximately $1 million. Refining segment adjusted EBITDA was $188 million compared to $228 million in the second quarter. Focusing on Hawaii first, the third quarter, Singapore 3.1.2 declined approximately $10 per barrel to $26.43. Feedstock costs were approximately $7.80 premium to Brent. Combining 3.1.2 and feedstock indexes, the overall margin environment compressed about $14 per barrel versus the second quarter. However, we were able to maintain a relatively flat adjusted gross margin of $19 per barrel in both quarters. Product crack hedging was a modest cost in the third quarter compared to the $51 million second quarter impact. Declining prices also drove improved capture on our lag priced contracts. On a percentage basis, adjusted gross margin improved to approximately 104% of the combined market indicators. October market conditions remained strong with the 3.1.2 averaging over $23 per barrel. We anticipate fourth quarter landed crude differentials will be between $8.50 and $9 per barrel versus ICE Brent, reflecting steep backwardation and increasing freight costs. We have continued our crack hedging framework and currently have approximately 25% to 30% of our Q4 sales hedged at levels consistent with current market conditions. As Richard referenced, we have some planned maintenance activities that we expect to reduce finished gasoline production by approximately 500,000 barrels during the quarter. In Washington, market conditions declined by approximately $13 per barrel but remained seasonally strong at $33. Much like Hawaii, despite this nearly $13 per barrel drop in the index, we were able to maintain roughly flat adjusted gross margins at approximately $20 per barrel. Improving capture rates were largely driven by increased sales, strong VGO market conditions, wider inland crude discounts relative to ANS and improving asphalt netbacks in a declining price environment. Backwardation remains a partial offset to these improvements. Looking forward, October has been volatile with regional refining outages driving an average PNW 5-2-2-1 of approximately $41 per barrel. WCS differentials continue to widen, providing additional feedstock benefits compared to ANS. Wyoming market conditions declined approximately $9 per barrel compared to the second quarter of $46 per barrel. Adjusted gross margin declined approximately $19 per barrel, which includes approximately $14.6 million FIFO expense or $8.70 per barrel. Wyoming market conditions remained strong with the October 3.2.1 averaging $51 per barrel. Laramie generated hedge adjusted EBITDAX of $26 million, unhedged adjusted EBITDAX of $40 million and net income, excluding unrealized derivatives of $17 million for the third quarter. Capital expenditures totaled approximately $18 million, and exit production as of September 30 was 104 million cubic feet a day equivalent. During the quarter, net debt improved by $14 million, down to $50 million. Shifting back to the Par Pacific cash flow statement, Par Pacific's third quarter cash flow from operations, excluding turnaround funding, was $341 million. Working capital, excluding turnarounds, reversed as expected with an inflow of $44 million. The largest driver to the working capital inflow were normalizing AR balances relative to activity levels and reduced collateral posting to support commercial and hedging activities. Capital expenditures totaled $9 million. During the quarter, we reduced our gross debt by approximately $14 million including open market repurchases totaling approximately $10 million face value. Gross debt sits at $519 million, and our cash position grew by approximately $220 million, leaving us well capitalized to complete the recently announced Billings transaction. Our quarter end liquidity totaled $495 million, made up of $409 million in cash and $86 million in availability. With the strong market backdrop, we expect to continue building liquidity in anticipation of funding the Billings acquisition in 2023. As previously messaged, we are revising our debt target to between $500 million to $600 million of gross term debt based on incorporating the Billings Logistics contribution into our forward thinking. This concludes our prepared remarks. Operator, I'll turn it back to you for Q&A.

Thank you. We will now start the question-and-answer session. The first question will come from Matthew Blair with Tudor, Pickering and Holt. Please go ahead.

Hey, good morning, Bill and Will. Congrats on the results.

Thanks.

Just looking at the extremely strong margins in Hawaii, I guess there's a question for Will. Could you go through the moving parts here? What kind of benefit did you realize from the fuel oil lag? I think you talked about the hedging impact, but maybe you could cover that again. And just how should we think about all the moving parts in Hawaii in Q3?

Sure. So, I think, Matthew, three buckets to think about. So, we called out the product crack hedging benefit. That was roughly $5.50 per barrel improvement compared to the second quarter. I think the second factor I referenced was the price lag benefit with the falling prices that we saw during the quarter. It's roughly a $30 per barrel decline in flat prices, and that was approximately a $7.50 per barrel improvement in price lag. So, again, keep in mind, second quarter, you had rising prices. Third quarter, you had falling prices. So, again, those two combined end up with a $7.50 benefit in the third quarter. And then again, this was partially offset by roughly $2.50 per barrel higher backwardation costs during the third quarter. So, all-in-all, those are the big moving pieces on capture during the quarter and I think drove the strong results.

Sounds good. And then, there's been a fair amount of industry chatter on the prospects for rising product exports out of China. Could you talk about how you're thinking about that issue and the risk to Par's Hawaii margins?

Yeah, Matthew, this is Bill. There's certainly been a lot of discussion and speculation, but I believe China's policy hasn't changed significantly. Their focus remains on building up their refining capacity to serve their domestic markets. Additionally, they have announced intentions to eliminate exports by the end of 2025. It's important to note that many of their exports go into jets and ships, which they count as exports despite supplying the domestic market. Overall, we haven't observed any major shifts. The zero COVID policy has impacted demand, and they have more capacity available, but they have maintained discipline. At this stage, it seems like speculation. The industry needs to focus on global demand and how economic conditions might worsen due to rising interest rates from central banks and its impact on the market. So far, we haven’t seen any significant changes. Our demand remains robust, and no alterations in the market have been noted. The main change is the widening spread between distillate and gasoline, which is at historic levels and is likely influenced by the ongoing war and concerns regarding heating oil demand this winter.

Would you expect that spread to widen? There's talk that Russian product exports would be banned. I think Russia exports about 1 million barrels a day of diesel. I would imagine that, that would also be constructive for diesel cracks in 2023?

I think you're right, but we should also consider that the economy might be slowing down. The key factor will likely be demand from China, which will impact not only the Pacific Basin but the entire global market. If there are any changes to the zero COVID policy and Chinese demand begins to rise, that could pose a significant challenge in supplying the world. In the near term, the main issue will likely revolve around degree days.

Sounds good. Thanks for the color.

Sure.

The next question will come from Carly Davenport with Goldman Sachs. Please go ahead.

Hey, good morning. Thanks for taking the questions. I wanted to just start on the strong retail results. Can you talk about the drivers of the strength there? How much of it would you say was related to macro factors like Hawaii reopening versus things that were more idiosyncratic, like the plans that you've talked about in terms of increasing market share across your retail markets? And then just, I guess on the plans to increase store count, any views on kind of where forward EBITDA potential could be going forward?

Let me address those points one at a time. To provide some market context, it's helpful to look at the events of Q2, which underperformed compared to historical trends, whereas Q3 showed a notable improvement. The primary driver for this change was the increase in crude oil prices, which led to higher pump prices. This had two main effects in Q2: it reduced demand and led to lower margins. However, in Q3, we saw a reversal of those trends, which was the main factor at play. Although there hasn't been a significant increase in demand from Hawaii's reopening—considering the state actually reopened to the mainland last year—we are experiencing a good year-over-year increase in mainland visitors. We are also seeing more international visitors to Hawaii this year, although the number of Japanese visitors, who tend to stay longer and spend more, is still only about 20% of pre-pandemic levels. While that may be a factor, I believe the main influences between Q2 and Q3 were related to pricing. Regarding your question about new stores, whether through acquisitions or new builds, we are investing in a manner that ensures the operating cash flow from those stores will be in the range of 5 to 7 times the operating cash flow.

Got it. Great. That's helpful. Thank you. And then just on the refining side, well, I think you mentioned the $8.50 to $9 premium to Brent for crude costs in Hawaii for the fourth quarter, recognizing that you buy forward quite a bit. And can you just talk a little bit about how you expect that premium to evolve over the next couple of quarters based on developments that you've seen in the market more recently?

Sure. I believe we have observed some softening in the market compared to peak levels, which reflects the differences seen in the fourth quarter. The main reasons for our current waterborne differentials are related to time spreads and market structure, as well as freight considerations. It's important to note that the freight markets have been significantly impacted by the rebalancing and changes in crude trade flows, particularly concerning Russian crude movements. These are the two primary factors influencing our situation. Generally, the peak demand and the barrels currently being consumed in the fourth quarter were actually procured in the third quarter, which was when we experienced the highest flat prices and the tightest physical market conditions. Since then, we have seen some softening, which aligns with the decline in flat prices. Moving forward, we anticipate lower differentials, though I still believe we will remain within an elevated waterborne crude differential market due to the factors I mentioned.

Understood. Thanks for the color.

The next question will come from John Royall with JPMorgan. Please go ahead.

Hey. Good morning, guys. Thanks for taking my question. If you could just go through in some more detail on the downtime you mentioned during the quarter in Hawaii. It looks like there was a throughput and an OpEx component of the impact there? So, just a little more color would be helpful on that.

I'll let Will handle the OpEx. But John, the downtime was really just related to some unplanned maintenance for some work that we performed on our crude and vacuum units, and that drove some reduced rates through the quarter. You want to cover…

On the OpEx side, John, the biggest drivers there were really increased energy costs. We had some tank cleaning expenses during the third quarter. I expect some of that is going to continue in the fourth quarter, but it should roll off. And then again, some additional unplanned expenses related to the work that we were performing on the crude and the vacuum units. So, I think our absolute OpEx ended up close to $38 million for the quarter, which is on the higher side for us. And so, again, I think those are the primary drivers.

Okay. Great. Thank you. And then on working capital, you guys had the $120 million headwind in 2Q. You had guided to a partial reversal there. You got about $44 million back and you went through some of the moving pieces in your remarks. But do you see more of that reversing in 4Q? Or any other moving pieces we should think about in 4Q? I know price going up would have an impact and any other drivers there for 4Q working capital?

Yeah. I wouldn't point to any specific items that we think are idiosyncratic in that we sort of can clearly point to would reverse. I think it's going to be highly dependent on crude price changes in the quarter. So I don't have any specific items to reference this quarter for you.

Thank you.

The next question will come from Ryan Todd with Piper Sandler. Please go ahead.

Thanks. Your balance sheet made significant improvements in the third quarter. You're now at the lower end of your target, with gross debt around $500 million to $600 million. Can you discuss your strategy for the balance sheet moving forward? It seems that you're still generating a lot of cash this quarter. How do you plan to utilize any excess cash in the future, especially concerning the upcoming Billings transaction?

Sure. Thanks Ryan. I think, in general, our approach is going to be to continue to build cash and liquidity in anticipation of that transaction closing as we get a finer point on the transaction close date and our cash position into that. I think we'll begin to think about our alternative cash deployment alternatives. I think you've heard Bill referenced, there are a number of other growth alternatives that we're studying. But I think the medium-term objectives here are going to be to build our cash position to be well funded and well capitalized to close the Billings deal and integrate that successfully.

Great. At a high level, as you consider your growth strategy, you've accomplished a series of successful transactions that have strengthened your PADD IV and PADD V capabilities. While it may feel early since you just announced a new deal and haven't closed it yet, could you discuss your plans for the long-term? Are you looking to continue acquiring and seeking opportunities to build significant presence in those markets? How do you see your growth strategies evolving moving forward?

Well, as you noted, our key focus right now is just successfully closing the Billings transaction. That's going to take some time and commitment on the part of our team. And as Jim mentioned, we actually are closing a small retail deal at the same time. That's obviously easier to tuck-in. But both of those are elements of our growth strategy. And as we've said in the past, we intend to be a growing company. We intend to put capital to work. And I think we've demonstrated high returns on investments through acquisitions. We'll continue to look at that, but we also have a lot of organic projects. So, I think you'll see us investing in renewables around our existing footprint, and we have a much more robust footprint once we close Billings. We'll continue to look at building out the logistics system, which also will be growing substantially with Billings. And we'll continue to add to our retail footprint. Putting all that together, I would not preclude, but we're not particularly focused on extending the number of communities served through additional refinery acquisitions at this point.

Thanks very much.

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

Hey. Thanks for taking my questions. I first wanted to ask on the renewable diesel projects you're pursuing. First, the smaller co-processing at Tacoma. Can you remind us on the quantity and any earnings guidance you could give on that? And then, on the Hawaii project, any more details on the potential capacity of that SAF project? And any thoughts on feedstocks sourcing would be helpful. Thanks.

Sure. So, with respect to the Tacoma project, that's about 500 barrels per day, and that is an RD project. With respect to Hawaii, keep in mind, that's actually largely a sustainable aviation fuel project. I mean, we will be producing some other products as part of that, but we're really focused on SAF in Hawaii. It's probably going to be about 4,000 barrels per day in capacity based on the size of the unit that we're converting. And it's premature at this point to really get into feedstocks sourcing for Hawaii. Thank you.

Okay. And then secondly, maybe just a quick one on turnarounds. 2022 was a limited year of turnaround activity for you. Do you have any major turnarounds coming up next year?

No. We don't.

Okay. Super. Thanks.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. William Pate for any closing remarks. Please go ahead, sir.

Thank you, operator. With a high distillate yield, our system is perfectly situated for the current market environment, and we really look forward to closing the Billings transaction next spring. I want to congratulate our team on another strong operational and financial quarter. Have a good day.

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