Delek US Holdings, Inc.
Q3 2009 Earnings Call Transcript

Published: 6 Nov 2009

[Operator:]

Welcome to the third quarter 2009 Delek US Holdings earnings conference call. (Operator Instructions). Mr. Ryan Noel, Director of Investor Relations and Communications, please begin.

[Noel Ryan:]

Welcome to the Delek US Holdings conference call for the third quarter 2009. Our hosts for today's call are Uzi Yemin, President and Chief Executive Officer and Mark Cox, Chief Financial Officer of Delek US. Other members of the management team will be available during the question and answer portion of the call. As a reminder, this conference call may contain forward-looking statements as the term is defined under the federal securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements. You are cautioned that this statement may be affected by important factors set forth in Delek's filings at the Securities and Exchange Commission and in its third quarter news release. As a result, actual operations or results may differ materially from the results discussed in the forward-looking statements. Delek undertakes no obligation to publically update any forward-looking statements whether as a result of new information, future events or otherwise. Today's call is being recorded and will be available for replay beginning today and ending November 19, 2009 by dialing 800-642-1687 with the confirmation ID number 35479560. An online replay may also be accessed for the next 90 days at the company's website at www.DelekUS.com. During today's call Uzi begin with a few introductory remarks. I will then provide a high-level overview of our financial performance in the quarter. We will then follow with a review of our insurance proceeds in the quarter, capital spending, liquidity, and results from operations within each of our three business segments for the three months ended September 30, 2009. Uzi will conclude with a review of the strategic directives which remain top of mind in refining, retail and marketing segments, as we look ahead to the fourth quarter and into 2010. At the conclusion of these prepared remarks we will open the call for questions. And now, I will hand the call over to Uzi Yemin.

[Ezra Uzi Yemin:]

Welcome to our third quarter conference call. Before we begin our discussion of third quarter results, I would like to take a moment to welcome Mark Cox to our senior management team as an Executive VP and Chief Financial Officer of Delek US. Mark comes to us with extensive energy industry experience as a financial officer. Prior to joining us, Mark was Vice President, Treasurer And Director Of Investor Relations with Western Refining. Previously, Mark served in a number of senior finance roles at Giant Industries resulting in his appointment to the position of Executive VP and Chief Financial Officer of Giant in 2002. Mark's 16 years of experience as a senior financial officer at two publicly traded refining companies and extensive corporate finance and capital market expertise makes him well equipped for this role with our company. We look forward to realizing the benefits of his experience in the years to come and welcome him to the team. Now, I'm really excited to turn the call over to Mark.

[Mark Cox:]

Thank you very much for that kind introduction, Uzi. I'm very excited to be part of the Delek US team. The company has a strong reputation and a diversified asset portfolio that has tremendous potential as we go forward. I look forward to helping to build value with Uzi and the team we have here in place. As our third quarter results demonstrate, Delek is not immune to some of the cyclical challenges facing the downstream energy markets. That said, we're committed to looking beyond the near term challenges facing refiners in order to successfully position the company for the next uptick in the refining cycle. To that end, our desire to acquire niche-in refineries and high quality, company-owned convenience stores remains a key area of focus for our management team as we head into 2010. In the future, I look forward to providing you updates on our progress. With that I'll turn the call over to Noel with an overview of our third quarter financial results.

[Noel Ryan:]

For the three months ended September 30, 2009, Delek US reported a net loss from continuing operations of $5.1 million, or a loss of $0.10 per basic share, versus a net income from continuing operations of $24.4 million, or $0.45 per diluted share, in the third quarter 2008. Excluding special items, the company reported and adjusted net loss from continuing operations of $8.2 million, or loss of $0.16 per basic share in the third quarter 2009. Special items excluded from the third quarter 2009 results from continuing operations include

[Mark Cox:]

During the third quarter 2009, Delek US continued to receive proceeds on a series of property damage and business interruption claims related to the 2008 fire at the Tyler refinery. Delek US received gross insurance proceeds of $12 million in the third quarter of 2009. We classify insurance proceeds between business interruption, which is included in our adjusted income, and property damage, which is excluded from this calculation. Of the $12 million in proceeds received in the three months into September 30, $6 million was allocated to business interruption claims. We recorded property damage related expenses of $200,000 during the third quarter, resulting in net property damage proceeds of $5.8 million in the period. Through September 30, 2009, Delek US received $108.6 million in combined insurance proceeds relating to claims stemming from the 2008 incident. In addition, since the start of the fourth quarter of 2009, we've received additional cash payments totaling $4.1 million. We continue to believe that we will receive additional insurance proceeds in the future. As of September 30, 2009, Delek US had $107.7 million in cash and $341.5 million of debt, resulting in a net debt position of $233.8 million. Our net debts capitalizations stood at 29.7% at quarter end, the lowest it's been since the third quarter of 2008. Turning to capital spending, we had $12.1 million in capital expenditures during the third quarter of 2009. For the nine months into September 30, 2009 our capital expenditures totaled $153.6 million. $142.9 million of which was related to discretionary projects, regulatory projects and unit repairs at Tyler. For the full year 2009, we forecast total capital spending of $175.3 million. Now moving on to a discussion of our performance by business segment in the third quarter. For the three months into September 30, 2009, capacity utilization at Tyler was 82.6%, compared to 86% in the third quarter of last year. The 5

[Ezra Uzi Yemin:]

Thank you, Mark. Allow me to provide you a brief strategic outlook as we head into the fourth quarter and look ahead to 2010. At the corporate level, we continue to exercise good balance sheet discipline while retaining a high level financial flexibility. During the third quarter, we received $65 million to our majority shareholders to help bolster our balance sheet, given current market conditions. In the refining segment, we expect lower capital spending requirement or requirements as we look ahead to 2010 when compared to prior years. Since purchasing Tyler in 2005, we have invested nearly $400 million in capital improvements, which over time should improve the overall profitability of the refinery. Longer term, we remain focused on acquiring niche inland refining assets similar to Tyler. Within the retail segment, we continue to focus on the sale of non-core assets in order to focus on higher growth retail opportunities. As we look ahead to 2010, we remain focused on our store reimaging initiative, the development of a revised fresh food concept and our ongoing product label program. This concludes our prepared remarks. Operator, would you please open the line for questions?

[Operator:]

(Operator Instructions). Your first question comes from Paul Sankey – Deutsche Bank Securities

[Paul Sankey:]

Uzi, you said a bit about your strategy there but can you just talk a little bit more about what you're planning for Delek in the past? You've talked about some fairly specific growth ideas you've had in terms of earnings growth and everything else. Can you just update us on how you see the current environment and how you want to play it? Thanks.

[Ezra Uzi Yemin:]

Thanks for the question. Let me divide the answer to two parts if you will. First one, as we all know, current conditions are pretty rough. And the cracks are pretty depressed and we all feel the pain here. However, if we are at the bottom, we're somewhere around the bottom. And we feel that this is the right time for us to start thinking about making a move to acquire more refining assets. We don't want to stay a single asset or 1.3 – well, right now we have 30%, 35% supply and we don't want to stay like that. And we think that similar to this situation when we bought Tyler in 2005 when the market wasn't so good, it's pretty similar now. And we're planning to be more aggressive than we were in the past to acquire assets. As you well know, there are several assets on the market and we intend to look at them seriously. On the retail side, since we now are behind last year's great margins or fuel margins, prices are coming down as well, so we look at that as well. You probably know that on our balance sheet there are more than $100 million cash. The purpose of that loan from Delek Group and we really appreciate their help with not only to create liquidity but to create a situation that we can move fast into an acquisition mode if we decided that this is the right time.

[Paul Sankey:]

Uzi, remind me what you're prepared to do in terms of leverage last time and how much leverage you'd be prepared to take on this time?

[Ezra Uzi Yemin:]

We didn't change our long-term strategy, not more than 2.5 times EBITDA at any given time. So it won't be more than 2.5 times EBITDA.

[Paul Sankey:]

I guess you're still thinking about gas stations as well. I mean, you want to keep expanding the retail side as well as look at refineries, right?

[Ezra Uzi Yemin:]

That is correct. We think that eventually the integration between the two are crucial or is crucial in order to get a situation that the demand fold doesn't influence us, but, yes, absolutely. We look at gas stations as well.

[Paul Sankey:]

And I guess it's blatantly obvious that you're going to want to stay within the vague geographic footprint that you're already in?

[Ezra Uzi Yemin:]

Well, we always said that we prefer to be inland refineries. So, if we are looking at only inland refineries, that specter would probably pre-limit it. And when we say we stay within the Southeast, we may expand that.

[Paul Sankey:]

And then finally for me, can you just update us on [Ally] and where you stand with that particular asset?

[Ezra Uzi Yemin:]

As usual, I don't want to comment online.

[Operator:]

Your next question comes from Blake Fernandez – Howard Weil

[Blake Fernandez:]

Good morning everyone. My first question was on the midstream of the wholesale business. It looked like we saw an unusually weak quarter. And I'm just trying to get an update, if you could give us the status there and what we should think about going forward?

[Ezra Uzi Yemin:]

The midstream, as we all know, suffered from the supply situation on the weak demand. We actually see the demand coming back, not only on the wholesale side, but on the C-store side. And we expect fourth quarter to recover compared to the third quarter.

[Blake Fernandez:]

So kind of reverting back to the first half of the year type of run rate seems a little more reasonable, Uzi?

[Ezra Uzi Yemin:]

Yes, sir. And Blake, in that regard we can always sell more, but we don't want to hurt the margins and kill the market.

[Blake Fernandez:]

Then my other question is on the C-store side of things. It looked like there were some good margin improvement there. I know you mentioned some cigarette sales versus dairy and beer. Is that the key driver or is it the non-core divestitures or maybe a combination of all of the above?

[Ezra Uzi Yemin:]

Probably, all the above. Let me just say that – and Lyn if you want to comment on that go ahead, but the reimaged stores are extremely successful for us. And we saw the fourth quarter with really good numbers as well, but if you want to add to that, Lyn?

[Lynwood Gregory:]

The reimaged stores were – 28% of our stores are now fully reimaged as far as some of the categories that influenced the third quarter. Beer sales were relatively flat but we had a lot of shift down to some budget beers which took away from our premium side. So that kind of nicked our margin down a tad and at the same time our dairy products, there's a lot of promoting in the supermarkets now, especially on the milk to use that as a loss leader. So we took a little dip in our dairy category. And you are aware back in March when the [FPT] tax went we took about a 0.4% margin dip there. So that explains the margin dip from last year to this year. However, we are well on our way now to enhance our margin. We have hired a new Director of Private Label, an individual named [Russ Struesberry] that has extensive background with HEB and A&P and we're very excited about the uptick there.

[Blake Fernandez:]

Great, thanks Lyn. And the last one for me, I'm not sure if Fred's available, but I was just curious on the refining side if there's any opportunity for cost cutting given the environment that we are in?

[Frederec Green:]

Blake, the main focus that we have right now since we now past our major refinery turnaround is to work primarily on the ongoing operating expense. The utility cost, the electricity and natural gas are pretty well fixed by how we operate the plant, but where we really have some opportunities throughout our maintenance and contractors. And that's where we're focused.

[Blake Fernandez:]

And I guess there's no order of magnitude or opportunity you can provide?

[Frederec Green:]

No

[Operator:]

Your next question comes from Paul Cheng – Barclays Capital.

[Paul Cheng:]

Good morning. A number of quick questions, Uzi or maybe [inaudible] can you tell me what is the remaining outstanding claim on the BI that you have that you haven't got an answer from the insurance company yet?

[Ezra Uzi Yemin:]

Paul, let me tell you that we feel that it is a substantial amount. For obvious reasons we don't want to mention numbers here. But it's a substantial amount.

[Paul Cheng:]

Or maybe, Uzi, let me ask you in this way. Have you already put in all your claims for the BI?

[Ezra Uzi Yemin:]

Yes, sir.

[Paul Cheng:]

Or would you still have more that you're going to submit it?

[Ezra Uzi Yemin:]

Submitting to the -

[Paul Cheng:]

Everything you submit, right?

[Ezra Uzi Yemin:]

The claim is closed with the – well we submitted everything we needed to submit to the insurance companies. Do we have more BI payments to come? Yes, sir.

[Paul Cheng:]

When do you think – well, you said that night or that it or maybe that it doesn't, how long it would take for the insurance company to finalize what is the total payment. When we would know that – exactly how much you would ultimately receive?

[Ezra Uzi Yemin:]

Well, we have an ongoing discussion with the insurance company. Actually in the – we feel that in the next few weeks we will try to get into resolution with that claim.

[Paul Cheng:]

So that hopefully that before the end of the year that we will be finalized then?

[Ezra Uzi Yemin:]

That's our target.

[Paul Cheng:]

On the property damage, how much did you totally spend?

[Ezra Uzi Yemin:]

Again, I don't want to get into numbers.

[Paul Cheng:]

Let me argue it in another way. Uzi, if the property damage insurance that you will see is now equal to whatever you spend, net after deductible or that's still not fully catch up yet?

[Ezra Uzi Yemin:]

It didn't catch up completely yet. There is some more payments to come.

[Paul Cheng:]

And is there a number that you can share in terms of 2010 CapEx?

[Ezra Uzi Yemin:]

$50 million for the refinery and, let's see, how much for the – do you remember? So call it 70 combined.

[Paul Cheng:]

Seventy? Okay

[Ezra Uzi Yemin:]

Yes sir.

[Paul Cheng:]

And in the third quarter your utilization rate, usually is that – I mean in the mid 80s. Is that a function of some economic cuts back because I thought you – because at the time the demand has been pretty strong I thought you would be able to run at a higher rate?

[Ezra Uzi Yemin:]

Well, Paul, if you look at the barrels that were sold, we sold 55,000 barrels. We had some – since the start of it we built some intermediates which we sold during the third quarter. The demand is around 55. Fred, do you want to add to that?

[Frederec Green:]

No, I mean Paul, basically what we do is we look at where does our incremental produced barrel go? And we stayed within the most economical market.

[Paul Cheng:]

Right, so in other words -

[Frederec Green:]

So that level was an economic-driven market.

[Paul Cheng:]

So that means that is an economic-driven decision to run at that level?

[Frederec Green:]

Correct.

[Paul Cheng:]

And in other words, that unless we see the demand in the local markets improve substantially we should not assume even though the hardware may be available, you should be able to run higher than what you run in the third quarter?

[Frederec Green:]

Well it won't be as much a factor of demand as it is a factor of the margin or the crack.

[Paul Cheng:]

But the margin of the crack is a function of the demand, is it?

[Frederec Green:]

On a macro basis that's true. It's not necessarily true at Tyler or some of the more outlying markets for us.

[Paul Cheng:]

And that in the reimaging, maybe Lyn can you give us an update now, how much do you need to spend per store now?

[Lynwood Gregory:]

It depends on whether the store is branded or unbranded, anywhere from 100 to 175 per store.

[Ezra Uzi Yemin:]

This is for the reimage, Paul. Ongoing CapEx maintenance, we're talking about $15,000 a store.

[Paul Cheng:]

Fifty –

[Ezra Uzi Yemin:]

Fifteen, one five.

[Paul Cheng:]

One five, okay. And the final question, Uzi, you mentioned that you've gone to look at or maybe step up your activity level on M&A side or the pace, hopefully. I think we just had a conference call with one of your competitor, and they were saying that – and I think that they are also looking at similar asset that you guys own, the inland niche market And their comment is said that there was still a pretty big gap between the bid-ask, between the seller and the buyer. Have you guys seen the similar things in terms of the asset price or that you think the bid-ask prices actually have come down in assets? Now starting pretty close to one refiner trading on the public market?

[Ezra Uzi Yemin:]

Well to your first comment about [MOU] and our competitors. All morning I was preparing myself for your question. So I didn't listen, so I didn't know what to say about my colleagues. Do we see a big difference between buyers and sellers? As long there is the difference there's no deals. If we're not sold on the deals, that means that the buyers and the sellers found some common ground. I do think, though that the gap is decreasing.

[Paul Cheng:]

When you say that because sometimes you can close the gap by a buyer willing to pay a higher price than what the publicly traded company may be trading at, so I guess my question is that when you're looking at the M&A market, is your best estimate that the assets that may be available for sale they are selling at a similar level as what the publicly traded company or the refiner are trading at, or that is higher than that level or lower? I guess that's my question.

[Ezra Uzi Yemin:]

I must say that from what we see, that gap used to be much bigger. It's narrowing now. Do I know if it's on the penny? I didn't do the calculation. But it's not as big as it used to be in the past.

[Operator:]

Your next question comes from Brian Shore – Avondale Partners.

[Brian Shore:]

I guess first on the refining side, just quickly looking at operating expenses given where natural gas was in the quarter, I would have thought the operating expense number would have come down a little bit more. Is there any other factor, I guess, looking at it year-over-year? I mean gas was down 50% to 60%. Any other factors that may have played in to offset some of that impact year-over-year?

[Frederec Green:]

Yes, one obvious offsetting factor is our insurance costs have increased significantly after our incident. That was a significant contributor. Some of the other things that played a role, as I mentioned in answering Blake's question, we're really trying to focus on maintenance and contractor expenses. Since we are now post-turnaround and we've worked through any issues with our revamps, we're now moving forward with minimizing our ongoing operating expense.

[Brian Shore:]

So is it, Fred, is safe to presume that that insurance cost will remain elevated going forward?

[Frederec Green:]

We're targeting to reduce our insurance costs back to more normalized levels over the next probably two to three years. Obviously it will depend on our performance.

[Brian Shore:]

I guess, Lyn, just quickly on the private label that you mentioned earlier, is there a scheduled timeframe for when you guys would like to have something completed there and the wheels in motion?

[Lynwood Gregory:]

As we've discussed earlier, it's only 2.9% of our entire merchandise mix and [Russ] has been on board now for approximately three weeks and hopefully the first thing we're going to roll out is our Body Tonics which is an isotonic that will compete against PowerAde and Gatorade, and then we're going to ramp it up pretty rapidly. We're way behind the curve with 28% of the stores out there having a mix of 10% or better. But [Russ] is extremely talented, many years in the business, and we're just very excited about the rollouts going into the first and second quarter.

[Brian Shore:]

And I guess just my last one, it's been nice to see on the retail side the comps moving up year-over-year. The only question I have is last year you had the hurricanes that were impacting I guess both gallons and store traffic in September. Have you guys, I guess, thought about a comp sort of adjusting for that or looking at just July and August year-over-year?

[Lynwood Gregory:]

If you go back in the third quarter and you discount those two weeks, and let's just take the fourth quarter going forward, if you look at our comps on merchandise sales, we were down 8.2% fourth quarter, first quarter down 4.5%, second quarter down 1.3%, fourth quarter we're plus 1.9%. So that's a great positive trend on our fuel gallons discounting the third quarter last year. Fourth quarter we were minus 6%. First quarter we were minus 2%. Second quarter we were minus 1%. Third quarter we were plus 2.2%. If you look at the DOT vehicles miles traveled from April, May, June, July, and August, it continues to increase. If you look at the unemployment rates in our Tennessee and Georgia markets where the majority of our stores are, the rates are declining. So we've got a lot of favorable economic movements helping us here and the trends continue to go forward. Our transaction counts are on the increase and our market basket size is increasing.

[Operator:]

Your next question comes from Eric Walania – William Blair and Company

[Eric Walania:]

Two questions, first one kind of getting back to a topic that was mentioned earlier regarding the gap that you see between what you're willing to pay and what others are willing to sell for a refining asset. I'm assuming some of that's a function of longer run expectations for what crack spreads in the industry will be going out two, three, four, five years. So I'd like you to maybe comment a little bit on what expectations you have or what do you see crack spreads being here as we look out over the next couple of years, because this last quarter we were $7] for the average. And some people have talked about a new normal for the economy being at a much lower rate and a $75 crack spread is obviously functionally related to that economic activity being possibly lower going forward. So I'd like to just pick your brain a little bit and get a sense of what you see industry profitability in terms from a crack spread perspective going out over the next few years?

[Ezra Uzi Yemin:]

We don't see a situation where all the refineries in the world will lose money every day and nothing will happen. So if you are in a niche market and you are protected and you have a strong balance sheet, by the end of the day we'll come out of the situation. Do we know if it's going to happen tomorrow or in two months or in two years? Probably not, but we feel that we're pretty much close to the bottom since if you look at all the refining sector, everybody more or less reported losses. So I think and we feel that we're pretty much close to the bottom. We think it's a situation where all the refineries are losing money on a daily basis won't continue. This is, to answer your question in regards to the level we are in. Now do we know if crack spread will be $12 or $20 or $30? We don't. What we do, we do sensitivity analysis. We take three years, five years, seven years. We play with hurricane season, with hurricanes, without hurricanes, and we do our sensitivities and we make sure that the [category] works. So this is, in a nutshell, the exercise we do here.

[Eric Walania:]

And you would say that maybe like taking all those probabilities and summing them up is a mid to high single digit type of crack spread most realistic assumption that we can make going forward? Is that a fair number? Is that what you more or less use when you put out your bid for an asset?

[Ezra Uzi Yemin:]

When we look at assets, we want to make sure that the cash flow works and the return to the shareholders is there. So if we take what happened in the last, call it five years, I don't know, I don't have the numbers in front of me. We can provide you, but this is a situation that is much higher than the situation we had today. And I'm sure that Noel and Mark will be happy to provide you with information in regard to each one of the models.

[Eric Walania:]

And then my second question is maybe you can just make a quick comment on the gasoline marketplace in terms of how rational the market is in terms of pricing at the pump?

[Ezra Uzi Yemin:]

Are you talking about the fuel margins on the C-stores?

[Eric Walania:]

Correct.

[Ezra Uzi Yemin:]

We are, as you see, we enjoyed a pretty healthy margin during the third quarter. It was 17.8. We feel that with our ethanol program, we can enjoy a higher margin than what OpEx shows and fourth quarter start with decent margins. I'll leave it to that, unless, Lyn, you want to add something to it. So this is, in a nutshell, the situation with gasoline spreads.

[Operator:]

(Operator Instructions). Your last question comes from Jeff Dietert – Simmons & Company International.

[Jeff Dietert:]

I have a bit of a follow-up there. Could you update us on your ethanol business and have you reached 10% both on your gasoline production at the refinery and in the gasoline you're selling at the retail outlets?

[Ezra Uzi Yemin:]

You need to divide this into two. The refinery, yes sir, 10% or mostly 10%. We have a little bit of conventional but mostly 10%. And we did that because of economic reasons over the year two years ago. On the C-store side, we have branded and unbranded. The branded, we can't blend ourselves based on our [Form-D] from the majors. On the unbranded we blend every drop we can.

[Jeff Dietert:]

And those margins have been healthy 3Q and going into 4Q.

[Ezra Uzi Yemin:]

If you look at the market, the market is $0.20. The market for ethanol is $0.20 under gasoline plus the tax credit we're talking about $0.65 so we want to blend anything we can, but yes, sir.

[Operator:]

At this time there are no further questions. Are there any closing remarks?

[Ezra Uzi Yemin:]

That concludes our conference call today. We will look forward to speaking with you during the fourth quarter and full-year 2009 conference call. Should you have any more questions in the interim, please contact our director of investor relations, Mr. Noel Ryan. Thank you again, and have a nice day.

[Operator:]

Thank you ladies and gentlemen for your participation in the third quarter 2009 Delek US Holdings conference call. You may now disconnect.