Per my post on Seeking Alpha, here are some more details on this deal by WNR to borrow over $1B in long term debt to buy the Giant refinery in Yorktown VA in 2007: This was such a monumentally bad deal that business students will be studying it for generations....
At the time the deal was made, the 70,000 bpd heavy crude refiner sold at $1.12B, which is almost $19,000 per BOD capacity. I can understand the desire for the company to increase its heavy crude refining capability, but the $19000 per BOD is greater than a lot of the greenfield projects were going at the time of the deal...
As we mentioned earlier, just to service this debt, the company needs $1.45 per barrel refining margins for the foreseeable future just to pay the debt, and a total of $13-14 to approach being an investment. Current is about $11, Assuming they wanted to make a profit on the deal, their internal analysis must have been telling them that the refining margins were going to be much higher than that....We all know how that worked out. To be fair, a reasonable analyst might have known that this level was pretty close to the long-term industry average for refining margin.....so maybe they were a bit of a victim of the recession.
At the current price of $5.30 per share, WNR can literally be purchased for the value of what they have in the tank farm, and that is probably optimistic. Assuming for the moment that you did this, you would in effect be buying the refining capacity of 220,000 barrels per day for the price of the $1.1B in debt. This comes out to about $5100 per BOD capacity, laughable in light of the $19000 per BOD capacity that they paid for Giant.
To continue the laughability, the Giant facility was bought when WNR was at about 45 per share. Since then nearly 90% of the market capitalization of the company has vanished. Assuming that same ratio, the same deal today might have been only $100M or so and could have been financed out of cash. Recently Valero sold their Delaware City refinery for $220M, at 220,000 bpd capacity this amounts to $1000 per BOD capacity. Timing is everything.
To further the thought exercise, the current value of Valero's 2.8 million barrels of refining capacity is $10.1B in market capitalization, which equates to about $3600 per BOD capacity, which is still greatly lower than the $5100 that WNR would be worth if you incurred the $1.1B debt, so you can assume from that that WNR is at least 40% overvalued at the current price.
WNR only has about $25M of cash on hand. They are 100% at the mercy of the people that they are using to roll over their debt. This debt could be restructured from the 11.25% per year that it currently is down to something more reasonable...somebody is going to have to take a writeoff.
WNR could, at some level, maybe $3 per share, be a buy for someone with deep pockets that could afford to take on the debt, or someone with a lot of credit at the current lower interest rates. FTO might be a candidate, no debt, lots of cash, similar business but in a different part of the country, but why would they? They might be able to get the desirable refinery later on if the company is split up. Valero: Forget it. They have too much capacity as it is......
It's interesting, the company is owned 40% by insiders, the remainder by the mutual fund people. Most of this group is institutionally owned at about 80%. I am thinking if this had been the case for WNR someone would have been a bit more conservative in their analysis, and thought better of the deal, or waited for a better price.
Unless the refining margins get to the highest levels in history for a sustained period, giving people some money, this will not go on much longer
Tuesday, June 29, 2010
Monday, June 28, 2010
FinReg: Trying to Legislate Adulthood
To recap:
A lot of people wanted to have things, and didn't have the money. Houses, consumer goods, office buildings, gove
rnment benefits. Instead of doing what an adult would do, which is wait, save some money, and buy the things they needed and wanted when they could afford them, they borrowed the money to get the things they wanted right away. To be fair, I suppose that there was a big system set up to encourage them to do this. Advertising, government policy of various types, some cultural pressure, political pressure, we can go into this if you want.
There were plenty of people around willing to loan them the money to do this. Mortgage brokers, credit card companies, commercial banks, government bond dealers, politicians. The adult thing to do would have been to say "no" to some of them, but once again, the system was set up for "yes", and a lot of these loans got written, and there were a lot of charges put onto credit cards.
So, what to do with all of these mortgages and credit card debt and soveriegn debt that were taken out by people that could not reasonably pay them back? Well, an adult thing to do would have been to take the high risk ones, bundle them together with other high risk ones, and charge enough interest to compensate the lenders for their risk. Instead, they were mixed in together with a lot of good loans, and then the ratings companies, and we all know who they are, gave them a nice high rating, and the interest rates were kept nice and low, and no one, well almost no one, could tell the good from the bad. Pretty immature, to hide all of those bad loans in with the good and not tell anybody about it but that's what happened.
These bundled loans of various types (CDO's, commercial paper, sovereign debt) were traded back and forth, and a whole system of insurance, derivatives, and other financial instruments were developed by the so-called financial engineers, and this whole system was basically done with play money, since the underlying financial instruments were only loosely connected with adult-based reality.
Then, when the system collapsed, the government(s) involved said to the people that perpetrated it: "Do-Over, you do not have to suffer the consequences of your childish actions, all is well, we will take care of this and you can go back to your play money game" The governments fabricated a lot of money out of thin air, and the game started back up again. Where did the goverments involved get this money? Well, rather than doing the adult thing, and getting it from the people that benefited from the system by raising taxes or interest rates to re-adjust the system, they borrowed it from someone who would not know the difference, the nation's 3-year olds. Here is the big injustice, as I see it.
Now, a law has been passed, FinReg, so called financial regulations, which basically set out a few rules to re-introduce adulthood into each of the layers of the system: More regulations at the bottom levels, put some controls at the mid-levels. Was there any regulation put on at the top level, to keep the government from saying "do over" and bailing out the next catastrophe? There is no talk of this. There is also minimal talk of going back through the system and making people accountable for the collapse of the system as it previously existed.....
So will all of this work? Oh, maybe in a broad sense to at least put a bureaucratic drag on the system, maybe there is some benefit to that...but until a system is set up to encourage people to be adults, I think we have not seen the end of it.
I will go back to writing about oil. If I am wrong on any of this, please feel free to comment.
Disclosure: none
A lot of people wanted to have things, and didn't have the money. Houses, consumer goods, office buildings, gove
rnment benefits. Instead of doing what an adult would do, which is wait, save some money, and buy the things they needed and wanted when they could afford them, they borrowed the money to get the things they wanted right away. To be fair, I suppose that there was a big system set up to encourage them to do this. Advertising, government policy of various types, some cultural pressure, political pressure, we can go into this if you want.There were plenty of people around willing to loan them the money to do this. Mortgage brokers, credit card companies, commercial banks, government bond dealers, politicians. The adult thing to do would have been to say "no" to some of them, but once again, the system was set up for "yes", and a lot of these loans got written, and there were a lot of charges put onto credit cards.
So, what to do with all of these mortgages and credit card debt and soveriegn debt that were taken out by people that could not reasonably pay them back? Well, an adult thing to do would have been to take the high risk ones, bundle them together with other high risk ones, and charge enough interest to compensate the lenders for their risk. Instead, they were mixed in together with a lot of good loans, and then the ratings companies, and we all know who they are, gave them a nice high rating, and the interest rates were kept nice and low, and no one, well almost no one, could tell the good from the bad. Pretty immature, to hide all of those bad loans in with the good and not tell anybody about it but that's what happened.
These bundled loans of various types (CDO's, commercial paper, sovereign debt) were traded back and forth, and a whole system of insurance, derivatives, and other financial instruments were developed by the so-called financial engineers, and this whole system was basically done with play money, since the underlying financial instruments were only loosely connected with adult-based reality.
Then, when the system collapsed, the government(s) involved said to the people that perpetrated it: "Do-Over, you do not have to suffer the consequences of your childish actions, all is well, we will take care of this and you can go back to your play money game" The governments fabricated a lot of money out of thin air, and the game started back up again. Where did the goverments involved get this money? Well, rather than doing the adult thing, and getting it from the people that benefited from the system by raising taxes or interest rates to re-adjust the system, they borrowed it from someone who would not know the difference, the nation's 3-year olds. Here is the big injustice, as I see it.
Now, a law has been passed, FinReg, so called financial regulations, which basically set out a few rules to re-introduce adulthood into each of the layers of the system: More regulations at the bottom levels, put some controls at the mid-levels. Was there any regulation put on at the top level, to keep the government from saying "do over" and bailing out the next catastrophe? There is no talk of this. There is also minimal talk of going back through the system and making people accountable for the collapse of the system as it previously existed.....
So will all of this work? Oh, maybe in a broad sense to at least put a bureaucratic drag on the system, maybe there is some benefit to that...but until a system is set up to encourage people to be adults, I think we have not seen the end of it.
I will go back to writing about oil. If I am wrong on any of this, please feel free to comment.
Disclosure: none
Wednesday, June 16, 2010
FTO: Maintenance People Need Love Too
Awhile back we developed a little model to predict the profitability of Valero, which worked quite well, based on the relationship between the company's net operating income (NOI) and a weighted average WTI/finished products crack spread. Maybe we can learn something by applying the same technique to Frontier:
Here is FTO's NOI and the same refining margin model that we developed earlier:
and when we adjust the model for industry refinery utilization and seasonality, we arrive at the following:
In fact, when you do the regression analysis, FTO's net operating income is even more strongly correlated to the refining margins than VLO's was. R-squared was 0.82, compared to Valero at around .66.
Based on the model, we would then expect them to benefit even more than VLO from the current improvement in refining margins, which as of a week or so ago were getting into the $11 per barrel range, and if you plug in the same assumptions we did earlier into FTO's NOI equation, you get earnings of about the same level as they saw in the the fourth quarter of 2006, or the first quarter of 2008, when they were earning somewhere in the mid-40's per share.
But, the consensus of the analysts right now are for earnings in the upper 20-s. What's happening?
If you look at the periods of time they deviated from the model, the second quarter of 2008 and also, really, the last two quarters, and review their management statements these are both periods during which they were experiencing some maintenance issues at their refinery in Cheyenne.
FTO is a lot smaller company. They do not have retail locations, a pipeline network, or any other noticeable diversification, and make their money, or not, on the basis of how good of a job they do of keeping their refineries running. Their Cheyenne refinery makes up 1/3 of the company's total capacity, and they are doing a lot of work to make this operation more efficient and deal in a better way with heavier crude oil.
So, in a real sense, the ability of FTO to get back to what they have been historically doing comes down to the ability of somebody to turn a wrench. Makes you want to give the maintenance people a little more respect doesn't it? Actually, it makes you want to invite the maintenance people to the next earnings conference call to find out how the work is going. It would not be completely unheard of for these guys to be overachievers and get their work done a little faster, and one of the analysts is actually optimistic that this can be done, and they will end up in the 40's somewhere for earnings this quarter.
The last question is: What would be the better investment, FTO or VLO? Well, at a price of 18 and expected earnings this year of about $1 per share, VLO is the less risky of the two. With a current price of 14 and earnings prediction in the mid $0.20-s, FTO is a bit more expensive right now. The possibility of a pleasant surprise for FTO is already in the price.
Keep in mind, of course, that the market does not always care how much money a company is making, and NOI does not always transfer down to EPS because of write offs, and various other things that are going on in a company, including where the refinery is, and what your prediction is going to be for refinery margins and crude oil pricing.
But, in this case, what we really need is the phone number of FTO's Cheyenne maintenance shop. If it rings and someone picks up, it means they have spare time to answer the phone, and things are nice and peaceful, which, if you are a maintenance guy, means you are good at doing your job. If it rolls to voice mail, it means they're busy. That can't be good, in this case.
Here is FTO's NOI and the same refining margin model that we developed earlier:
and when we adjust the model for industry refinery utilization and seasonality, we arrive at the following:
In fact, when you do the regression analysis, FTO's net operating income is even more strongly correlated to the refining margins than VLO's was. R-squared was 0.82, compared to Valero at around .66.
Based on the model, we would then expect them to benefit even more than VLO from the current improvement in refining margins, which as of a week or so ago were getting into the $11 per barrel range, and if you plug in the same assumptions we did earlier into FTO's NOI equation, you get earnings of about the same level as they saw in the the fourth quarter of 2006, or the first quarter of 2008, when they were earning somewhere in the mid-40's per share.
But, the consensus of the analysts right now are for earnings in the upper 20-s. What's happening?
If you look at the periods of time they deviated from the model, the second quarter of 2008 and also, really, the last two quarters, and review their management statements these are both periods during which they were experiencing some maintenance issues at their refinery in Cheyenne.
FTO is a lot smaller company. They do not have retail locations, a pipeline network, or any other noticeable diversification, and make their money, or not, on the basis of how good of a job they do of keeping their refineries running. Their Cheyenne refinery makes up 1/3 of the company's total capacity, and they are doing a lot of work to make this operation more efficient and deal in a better way with heavier crude oil.
So, in a real sense, the ability of FTO to get back to what they have been historically doing comes down to the ability of somebody to turn a wrench. Makes you want to give the maintenance people a little more respect doesn't it? Actually, it makes you want to invite the maintenance people to the next earnings conference call to find out how the work is going. It would not be completely unheard of for these guys to be overachievers and get their work done a little faster, and one of the analysts is actually optimistic that this can be done, and they will end up in the 40's somewhere for earnings this quarter.
The last question is: What would be the better investment, FTO or VLO? Well, at a price of 18 and expected earnings this year of about $1 per share, VLO is the less risky of the two. With a current price of 14 and earnings prediction in the mid $0.20-s, FTO is a bit more expensive right now. The possibility of a pleasant surprise for FTO is already in the price.
Keep in mind, of course, that the market does not always care how much money a company is making, and NOI does not always transfer down to EPS because of write offs, and various other things that are going on in a company, including where the refinery is, and what your prediction is going to be for refinery margins and crude oil pricing.
But, in this case, what we really need is the phone number of FTO's Cheyenne maintenance shop. If it rings and someone picks up, it means they have spare time to answer the phone, and things are nice and peaceful, which, if you are a maintenance guy, means you are good at doing your job. If it rolls to voice mail, it means they're busy. That can't be good, in this case.
Monday, June 7, 2010
Marginal Complexity in the Refining Industry
Am I the only guy still around that remembers that plate spinning act that used to be on TV?
Here it is:
http://www.youtube.com/watch?v=Zhoos1oY404
We used to watch this stuff in the 60's for entertainment....
Anyway, the essence of the act is that this guy has the capacity to spin X number of these plates and bowls on the sticks.... You have to keep the ones you have going, then gradually add complexity until you get the whole thing up and running. For you and I, spinning one plate would be difficult, but this guy is an expert, and he can do a lot of them.....By "marginal complexity", we mean that the problem gets increasingly difficult with the addition of the one plate...
So, would it be much of an act if he only spun four bowls instead of five? The system would be running at a state slightly below its maximum capacity. Well, the guy has to be talented, it is true, to do the four bowls, but you would not be quite as impressed, and perhaps for him, the act would be a bit more boring.
The situation in the refinery business right now is a lot like this. There are only four bowls spinning. It takes quite a bit of effort to keep the system spinning at its current level, but there is no need to add the extra complexity, which you can only do temporarily anyway, and so the guy is just going to stand there for awhile and keep the fourth bowl spinning without adding the fifth.....he could add another, but the system does not require it right now...
So I think we're going to go another week as follows: The capacity utilization will be 89 percent or so, the demand will be not quite what it was in 2007 but higher than 2009, and the imports will be about what is needed to keep inventories about where they are. Right now, there is plenty of fuel around, the contango is still in effect, but the market is well supplied and there is no compelling reason to store oil if the buyers think there will be a demand decline later because of a double dip or something.... I think a lot of the emotion in the marketplace to keep oil around went away a month ago when the price collapsed.....
So we will see what happens. Keep in mind that if he does not go back and do maintenance on his bowls, he will lose one.... so he will do that for awhile at least, even if he does not add the fifth bowl....and by fall, maybe he will go back down to 3 bowls and a couple of plates, and have some spare time, to fool with the spoons and glasses....
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