Delek US Holdings, Inc.

Good day and welcome to the DELAC U.S. Holdings Second Quarter 2022 conference call. All participants will be enlisted on the mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Blake Fernandez. Please go ahead.

Good morning. I would like to thank everyone for joining us on today's conference call and webcast to discuss Dellick U.S. Holdings' second quarter 22 financial results. Joining me on today's call is Uzi Amin, Executive Chairman, Abigal Sur, President and CEO, Todd O'Malley, EVP and Chief Operating Officer, as well as other members of our management team. The presentation materials used during today's call can be found on the investor relations section of the DELEC-US website. As a reminder, this conference call may contain forward-looking statements as that term is defined under federal securities laws. Please see slide two for the safe harbor statement. In addition to reporting financial results in accordance with generally accepted accounting principles or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release posted on the investor relations section of our website. Our prepared remarks are being made assuming that the earnings release has been reviewed and we are covering less segment and market information than is incorporated into the press release. On today's call, we'll begin with comments from both Uzi and Avigal, then Todd will review financial performance and capitalization, and I will cover guidance and CapEx, and then we'll turn it over for a Q&A session. With that, I'll turn it to Uzi.

Thank you, Blake, and good morning, everybody. I would like to take this opportunity to thank the Board of Directors, our investors, and the employees for all their support over the past 20 years. I know many of you said your goodbye to me on last quarter's conference call, and I really appreciated those kind words. I look forward to remaining accessible and offering any strategic oversight in my role as Executive Chairman. DELEC is in strong position financially, And it's an opportune time to hand the reins over to our new CEO, Avigal Sorek. With that, I'll turn it over to Avigal. Thank you.

Thank you, Uzi, and good morning. I'm excited to rejoin the Dellex family and re-engage with old friends and colleagues. We reported a strong quarter with record utilization rates and earnings. I'm proud of the team focus and performance. DELEC has a long history of returning cash to shareholders, and we are committed to continue. I want to highlight several things we have done to maximize returns. This year, we expect to return around $135 million through a combination of three avenues. One, special dividend of $0.20 a share announced on June 21st. Second, we announced a $0.20 share regular dividend And third, share buyback, including $64 million completed in first quarter and additional $25 to $35 million expected in Q3. On the top of the $135 million, we are evaluating additional buyback during Q4. During the quarter, we generate significant free cash flow and use the opportunity to improve our balance sheet by building our cash balance to over $1.2 billion. On June 1st, we closed on the TreeBear acquisition. I would like to welcome the TreeBear team to the Delac family. This is an important step in our strategy to make DKL independent and less reliant on DK. The transaction increased our third-party revenue. expand our product mix into natural gas and water, and widen our footprint into the Delaware basin. Finally, the macro environment for our refining has improved, and the outlook remained robust. I look forward to meeting many of you in the upcoming months. I want to thank Uzi for many years of leadership and mentorship, and with that, I will turn it over to Todd.

Thanks, Abigail. Net income was $361.8 million, or $5.05 per share. On an adjusted basis for the second quarter of 22, Delic US had net income of $314.5 million, or $4.40 per share, compared to a net loss of $33.9 million, or $0.46 per share, in the prior year period. We had record adjusted EBITDA of $518 million in the second quarter, compared to 46 million in the prior year period. The increase was attributable to the refining segment, where dramatically improved margins, coupled with strong operational performance, allowed us to achieve record refinery utilization rates and earnings. On slide four, we provide a cash flow waterfall. In the second quarter of 22, we had positive cash flow of $559 million from continuing operations which includes a working capital benefit of $7 million. Regarding cash return for shareholders, we declared a special dividend of $0.20 per share on June 21st that was paid on July 20th. Earlier this week, the Board approved the reinstatement of a regular quarterly dividend of $0.20 per share that will be paid on September 6th to shareholders of record on August 22nd. Finally, the Board increased the share repurchase authorization by approximately $170 million, bringing the total authorization to $400 million. During the third quarter, we expect to commence the program with estimated repurchases of $25 to $35 million. Slide five highlights our capitalization. We ended the second quarter with $1.24 billion of cash on a consolidated basis, and on a consolidated basis, we had $1.57 billion of net debt. Excluding net debt at Delic Logistics of $1.51 billion, we had only $65 million of net debt at DK as of June 30, 2022. With that, I'll turn the call back over to Blake.

Thanks, Todd. On slide six, we provide third quarter guidance for modeling purposes. Operating costs are forecasted to be in the range of $185 to $195 million, which reflects the ongoing impact of elevated natural gas prices, a strong utilization rate outlook, and minor maintenance expenses. I would like to highlight that G&A expenses were elevated in the quarter, primarily due to bonus accruals for the annual incentive plan and closing costs associated with the three bear acquisition. The step change in bonus accruals was a function of a material increase in the forecasted profitability of the company for the year, and this expense is expected to normalize as reflected in our third quarter guidance range of $67 to $72 million. Interest expense guidance of $46 to $50 million for the quarter reflects the consolidated impact of DKL debt, which reflects a full quarter impact from the three-bear acquisition that closed in June. During the second quarter, our total refining system crude oil throughput achieved a record of approximately 295,000 barrels a day. In the third quarter of 22, crude oil throughput is expected to average between 285,000 and 295,000 barrels a day, or approximately 96,000. utilization at the midpoint. On slide seven, capital expenditures during the quarter were 60 million. The full year 22 capital program is now expected to be in the range of 290 to 300 million on a consolidated basis. This factors in the earlier than anticipated closing of the three bear acquisition and additional growth in our Permian gathering business where we continue to see strong producer demand. With that, operator, can you please open the call for questions?

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster.

Our first question comes from Carly Davenport with Goldman Sachs.

Please go ahead.

Hey, good morning. Thanks for taking the questions today, and great to hear you back on the call, Avigal. So just wanted to start out on the demand side. We've seen some noisy stats coming in from the weekly DOE data, so just wanted to get a sense of what you're seeing from a real-time demand perspective across your system, particularly for gasoline, but commentary on the other products would be helpful as well.

Yeah, first of all, Kelly, great to have you on the call as well, and we'll meet soon. So I will start, and Blake will continue. We see a solid demand on our system, both on the retail side and on the wholesale. We have no issue placing bills, and we see robust demand. So, Blake, maybe you can chime in.

Carly, good morning. So obviously you see the same store sales reflected in the press release, up 5% or so on 2Q. I think what's important to note is some of the DOE stats. here recently reflect a dramatic decrease. We are not at all seeing that in our system. Quarter to date, we're actually seeing an increase year over year in 3Q. So I think, you know, part of that could be partially driven by the fact that we are Permian-centric and the activity there is robust. But in our system, we are actually seeing increases on a year over year basis, even into 3Q so far.

Great. That's really helpful. And then the follow-up was just around capital returns. You've obviously had some positive updates here around the regular and the special dividend, as well as increasing the buyback authorization. I guess as you think about the back half of the year and into 2023, do you expect the focus incrementally to largely be on the buyback, or is there potential to raise the regular dividend or even consider incremental specials?

So I will answer the question a bit more generally than that. And obviously, it's too early, a bit too early for me to give a specific number for second half of the year, but I would like to give some guidelines or highlights around that. So we need to look and cash holistically between cash return, dividend, buyback, and obviously debt. And we, as you probably saw, have done the $400 million approval of the buyback for a reason, right? We believe that the DELEC share is well undervalued, and we see... much value in the sum of the part, and we are exploring options and ways to deleverage that.

Appreciate that. Thanks, Carla.

Our next question comes from Lana Gupta with Credit Suisse. Please go ahead.

Hey, guys. All regions showed material improvement, but the noticeable improvement at crotch capture, very good capture compared to, I mean, you have been showing improvement on a consistent basis, but this was off the charts. So help us understand exactly what you're doing over there, which is delivering these excellent results.

Yeah, hey, good morning, Manav. It's Todd. So a couple of things are happening at Krotz that we've done a good job over the last couple of years setting it up for the success that it's having right now. One is there were incredibly strong fuel margins on the Colonial Pipeline driven by demand in New York and under supply out of Northwest Europe into that market. As you know, we had a project a number of years ago to build an alkylation unit. alkylation values traded at massive premiums during the quarter relative to alternate disposition, even in premium gasoline. We have also pretty significant exposure to the distillate side of the barrel there via our jet make. And in addition to that, we have our yield gain where, you know, every barrel that comes in, we're actually yielding over 100%. So You put all those together, and that really makes Crot Springs a powerful refinery during kind of the margin environments that we've seen over the last couple of months and that we think we'll continue to see on a go-forward basis, albeit slightly lower than the levels that we saw during Q2.

And the second question would be, we're seeing ENP companies raise their capex. We're seeing people basically trying to grow in the Permian. So, I want to focus more on Permian versus Brent spread than WTI versus Permian. And how do you see that spread between Brent and Permian crude widening as these additional rigs come in as the production grows? And I'll leave it there. Thank you.

Yeah, sure, Manav. Obviously, right now we're still in a situation where we have excess pipeline takeaway capacity. We believe that based on the growth that we're seeing on our system, and to your point, the increasing capex that a number of the producers are messaging during their earnings calls, that we'll continue to see robust growth in the Permian. We don't see a lot of new build projects, if any, coming to the table. So our view is that by the time we get to late 23, early 24, we should see that differential continue to widen out. You know, right now, if you look at the Midland MEH spread in 24, it's about $1.25. But Brent is trading significantly over that. So, you know, that spread is pretty robust and pretty wide. And we're obviously ideally situated to take advantage of that with our ownership stake in Wink to Webster and the DPG gathering system that we've built out over the last couple of years. So we feel good about our position. And we think that as we move forward, we'll have ample opportunity to reap the rewards of the hard work that we've done.

Thank you, guys, and all the best, Susie.

Thanks, Manav.

Our next question comes from Roger Reed with Welsh Fargo.

Please go ahead.

Thank you. Good morning. And, Uzi, I missed my chance, I guess, in the last quarter, so I will say thanks for everything over the years. And, as you said, maybe a temporary goodbye, not a permanent one in terms of seeing you around. Maybe to just get into the call and to follow up on Manav's question about Crot Springs. And my apologies to you, Uzi, for back at the time you acquired Crot. our friends, the view that crotch should be shut down. I guess this pretty much proves opposite on that. The question I have on the unit is, if we look at some of the dislocations in Q2, they were on the distillate side. Q3 on the colonial, they seem to be on the gasoline side. So should we expect potential for crotch to again outperform versus the rest of the delic system?

Thank you for the question. We're obviously very optimistic about COTS. We think it's well positioned with high oil price and differentials. So the answer is yes, we are very optimistic about COTS.

And Roger, I would just add one thing too. We can't speak for what peers are doing, but I think in the industry what has happened is there's a strong demand pool globally. And so a lot of barrels are being exported that would normally have flowed through Colonial. And that is allowing us to receive better netbacks through the system. So I think that's a contributing factor as well, in addition to what Todd had mentioned earlier.

Okay, that's helpful. And then, just kind of asked earlier, but I'm just a little bit curious. As you look at the overall balance sheet structure at DELIC, inclusive of DKL, Is there an optimum debt structure? I mean, granted, you've taken a step up with a three-bear acquisition, but is there a goal to take debt to a certain level of EBITDA, an aggregate level of debt? Just how should we think about that over time?

Hey, thank you, Roger. Thank you for the question. And obviously, that's a bit related to the first answer I gave. We look at the cash use and resources holistically between... return cash to shareholder, dividend, buyback, and obviously net debt. And obviously it's a bit too early for me to be with specific numbers, but obviously we are looking on that extensively. And as long as the refining outlook will remain robust and the economy will be stabilized, and we are optimistic on both, we'll have more upside on that.

Well, let me ask it slightly differently. With the balance sheet that you have now following an acquisition, would you want to reduce debt before the next acquisition or a big step up in CapEx? I'm just trying to kind of understand the overall corporate structure on the balance sheet side, like any sort of broader goals.

Yeah, absolutely, Roger. Part of our goal is to reduce the debt level, and we're going to do some of that in Q3 and going forward later on this year. So the answer is yes.

Okay, thank you.

Our next question comes from Matthew Blair with Tudor Pickard & Holt.

Please go ahead.

Hey, good morning. You've charted kind of a unique path here on the midstream side by still pushing distribution growth at a time when many of your peers are either not growing their distribution or even rolling up their MLPs. And, you know, looking at the yields, it doesn't really feel like DKL trades at a premium. So I was hoping you could talk through that strategy. Do you intend to still continue growing the distribution at DKL? And what are the next moves there?

Yes, sure. So first of all, we see a DKL is a growth engine, and we have seen that for years, and we are able to capitalize on that over the years. We don't have any intention to stop the dividend unit return hold in the future, so we are optimistic on both of them. Blake, I don't know if you want to chime in and give some more color around that.

Yeah, Matthew, you kind of alluded to the fact that a lot of the peers are rolling them up, and I think you're a little bit different. and unique. We are very third-party oriented with about 40% of our EBITDA coming from third parties, and we're looking to continue growing that. And so I think obviously there's a leverage component where leverage has moved up, but I do think we are experiencing free cash flow, and we should be in a position to continue distribution growth. We've committed to 5% growth this year, and obviously we're not in a position to guide for next year, but I 38 quarters consecutively of increase in distribution, and I think that's a long track record we're looking to continue.

Sounds good. And then you had a nice improvement in the overall refining capture rate in Q2 versus Q1. Is there anything that we should be aware of for Q3, or do you think you can hold on to these capture rate gains this quarter?

Yeah. Sorry, Matthew. It's Todd. Yeah, I think... You know, as we've talked about over the last couple of quarters, we've done a lot of proactive maintenance. We took the strategic strike in Tyler with a view that margins were going to be improved, albeit not to the level that they've reached in Q2. But we set ourselves up very well because of our view to be able to run to capture the margin environment that has materialized. We don't have any major work planned in the quarter. And we feel very good about, you know, the levels that we've been running, obviously, you know, up towards the upper end of our range historically. And as a result of that, we think that that will continue on a go-forward basis.

Terrific. Thanks.

Our next question comes from probably Kat and I with Bank of America.

Please go ahead.

Hey, good morning. It's Kalei Akimeni from Bank of America. Thanks for taking my question here. My first question is just a follow-up on WTI Brents. So I'm wondering what you guys think about the current spread, whether it's structural or a response to the SPR releases that are continuing through the turnaround season. And I suppose on a related note, can you give any color on whether the SPR provided a benefit across?

Yeah, sure, Kalei. It's Todd again. I'll start in reverse order. When we looked at this most recent SPR release that is from August 15th through September 30th, we were involved in the bidding, but as we suspected, the values that cleared that market were well and above what we would be willing to spend relative to alternative barrels. So we weren't a winner in that, and that information is public, obviously. at this point. So we think, though, the benefit is those barrels moving offshore give us access to barrels that are currently onshore, and we're able to backfill without having to worry about, you know, some of the logistics issues that you see with the SPR. In regards to TI Brent, you know, the spread's obviously blown out quite a bit. We don't believe that's a result of the SPR release. We actually believe that's a result of some things happening in Northwest Europe. We're continuing to see incredibly high natural gas prices in the range of $55 to $60 in MMBTU. That, as a result, is causing European refiners to continue to shed very sour barrels in search of sweet barrels. That's put a very significant bid into the dated frontline market which has been as high as $7 to $10 premium relative to the Brent marker. So we feel like it's much more of a pull out of Europe that's causing Brent to perform versus TI, as opposed to TI being pushed lower because of SPR releases, which again are largely moving offshore. So I hope that answers your questions.

I appreciate that, Todd. Thank you. My second question is a follow-up on the buyback. First off, congratulations on getting back to this point. It's been a volatile couple of years. but I want to try and understand your capacity to lean in. I saw the guidance for Q3 of $25 to $30 million, but it feels like you could do more given the shape of the balance sheet, at least at the DK level, and it doesn't appear like you guys have a lot of constraints here.

Thank you. I think it's a great question, and that's what the highlight I was trying to give on my first answer. We are trying to smooth the buyback program not to make it on one time. That's part of the reasoning that you have seen the approval that we got from the board to go all the way to $400 million. So obviously if the market continues as it looks like and the economy is still as we think it will, we will obviously continue with that buyback along the year.

Got it. I appreciate that. If I could sneak one more in here, it's just a housekeeping question. Refining CapEx looks second half loaded. Can you just remind us of any planned work you have? And I'll leave you there. Thank you.

Kalei, the bottom line is there's definitely a ramp-up to get to the full year spending. So it's roughly $100 million per quarter that you're seeing. We have some minor maintenance that we're doing in the second half of the year, but basically what we've indicated all along is that there's no major turnaround activity for this year. So obviously you can see the throughput guidance for 3Q, and... You know, we'll give 4Q guidance once we have results next quarter.

Great. Thanks, Blake.

Yep.

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

Morning. Thanks for taking my questions. The first one is an open-ended one for Abigail. And I just wanted to get your thoughts as you step into the big seat from taking over for Uzi. what your priorities are for the company and where you see the strategic path for it over the next few years. And I have a follow-up.

Thanks. First of all, thank you for such a nice question. And my first priority as I stepped into the job around six weeks ago was first to learn to know the people better, to visit the assets, And I was extremely impressed by both dedication and the love that people have for the company and how much everyone wants Delek to be successful and great company we are. So I was very encouraged, see many people visiting most of the assets, and it was great. Obviously, until we can present a holistic strategic plan, it's going to take a bit more time, but I will give one conclusion we have so far, right? So we believe that the sum of the part is not working, and we are exploring ways how to unlock the value there.

Okay, understood. And then the second one is just on the 2Q numbers. It looked like OpEx for the quarter was a bit high, I think $45 million higher than where guidance was. Can you just discuss the factors that... drove that and if you expect any of those to repeat in 3Q. Thanks.

Hey, Jason. So, for one, let me just mention, obviously, natural gas prices were elevated. So, that was a contributing factor. The second piece is we hit record high utilization rates. So, as you know, the more you run, the more you consume. So, that's an element as well. The final piece is there was an element of bonus accrual that actually landed in OPEX as well. So we're giving guidance for next quarter, which is in the slides. That does contemplate ongoing elevated natural gas prices. So it does roll over a bit, though, as you can see in the guidance, 185 to 195.

Great. Thanks. Yep.

Again, if you'd like to ask a question, please press Start in 1.

Our next question comes from Paul Chang with Special Bank. Please go ahead.

All right, thank you. Good morning, guys. Hey, Paul. Good morning, Paul. Good morning. Even though that we already say congratulations, so maybe let me add a final congratulation on the semi-retirement. I don't think it's a full retirement, right? So I'm sure that we'll come across and see you. You're just way too young to fully retire.

I just told the guys that you are the one that took us public, Paul. So we know each other well now. 17 years, 16 years.

Oh, far more than that. You were IPO in 2006. 18 years now. Yeah, it has been quite a time. It has been a great one.

We miss you.

And also let me congratulate Arigot to be as a CEO for the first conference call in the company. I think if I may, I have to apologize first. I want to go back into the capital return framework. But it's more on a high level. Some of your peers that have a sort of a formula or at least somewhat of a medium or longer term target whether you say 40-60 or 50-50 in terms of the cash flow will be returned back to the business. Is that approach, Arrigo, you think that may be applicable for the company or that the economic life cycle for CK is much different than some of your larger peers. And so you don't think that this kind of formula stick approach is the way approach. That's the first question.

Okay, so I will try to touch that point, but I'm glad that you asked it again. So we look at the policy, you know, on cash holistically between a share repurchase and buyback, obviously, dividend. We have the regular dividend and the special we just announced. Obviously, the debt, which is an important part of that component. So we are looking on that holistically. I'm not ready just yet to give guidance for the second half, but I'm saying that, again, that as long as the market is going to be robust, and we believe it will, we will see more upside on that side.

No, I understand what you said. I think, Arrigo, my question is that some of your peers will say, okay, they want to return in the long haul or medium term, say 40% or 50% of the cash flow, and then the rest will be reinvested in the business. So I guess that's my question, that do you guys think a... A formula-based approach in the cash return on the cash flow is the right approach for the company, and if not, why not?

So, Paul, this is Blake. Let me just quickly say, for one, I think we're a little bit unique in terms of, A, a lot of the companies that do have these specific frameworks are much larger, more mature companies. We're a growing company. The second piece is that we have a huge midstream component compared to others. And there is a leverage component to that that is a little bit differentiated compared to refining. So we have not wanted, at least until this date, to box ourselves into a specific number or framework. Obviously, Avogal is getting settled in six weeks into the job, so we can evaluate these types of things going forward. But at this point, I think it's a little bit unique for us compared to the peer group.

Okay. Two really short questions. One, you guys are now that under the FIFO accounting, with the oil price lower versus the second quarter, will that, from the accounting standpoint, be reflected in the lower margin, or at least as an adverse impact on your reported margin, or that the hedging and the inventory movement that you guys cite on the press with these other inventory movements, are those going to fully offset that? And then finally, can you maybe share with us what is the link to Webster contribution in the quarter and when you expect that asset going to reach the full contribution to you and how big is that contribution going to be? Thank you.

So Paul, on the second piece, Wink to Webster, that flows through the equity method line item. We aren't disclosing specifics around that, just given the partnership nature of that, but it is progressively ramping up through, call it the next 18 months or so. So we just want to make sure the messaging there is aligned with our partners. In terms of your question on other inventory and hedging, there is a table on the back page. You're going to notice back there we had a benefit from other inventory of $40 million. That was much more than offset by hedging, realized hedging losses of $113 million. So technically speaking, if you wanted to strip all the noise out, our EBITDA would have been $73 million higher than what you see. But obviously, we're trying to work from an adjusted EBITDA basis going forward just to make sure all investors are clean and everything is much more straightforward.

All right. Thank you.

This concludes our question and answer session.

I would like to turn the conference back over to Avagal Surak for any closing remarks.

Thank you so much for the call. Thank you to the investors for trusting us. The management team around the table that worked so hard for that best quarter Delek ever had. The board of directors trusting us and allowing us to manage the company the best way we can. And obviously and mostly our employees that make this company great every day. Thank you so much.

The conference is now concluded. Thank you for attending today's presentation.