HollyFrontier's Impairment Charges Wipe Out Any Chance of Earnings This Quarter

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One thing you can pretty much count on in the oil refining business is that market conditions can change very quickly. This time last year, HollyFrontier (HFC) was riding high on the hog thanks to slumping oil prices and high demand for gasoline. This year, though, rising crude prices and higher gasoline inventories cut heavily into the company's second quarter earnings. Here's a quick look at the company's earnings and operational results and what it means over the longer term. 

By the numbers

Source: HollyFrontier earnings release

One thing to keep in mind with this quarter is that the company took a $654 million charge related to asset and goodwill impairments. If we strip out those charges, net income per share was a slightly better looking $0.28 per share.

The big issue for HollyFrontier and other refiners this quarter was declining refining margins and costs of RINs -- compliance credits for the US EPA's Renewable Fuel Standards. Gross margins, which is the net sale price minus cost of product and is before a refiner does anything with it, was cut in half to $8.88 per barrel. Rising crude oil prices, higher levels of gasoline in inventory, and $57 million in RIN costs were the driving factors that led to the decline. 

Although income results were less than stellar, the company maintained a pretty solid balance sheet that should help it get through these tough times. At the end of the quarter, HollyFrontier generated $303 million in operational cash. Despite a $500 million build in working capital since the beginning of the year, the company has increased its cash on hand to $533 million and a total debt load exclusive of Holly Energy Partners is $595 million.

The highlights

From an operational standpoint, there isn't much to complain about in these results. HollyFrontier's utilization rate remained high at 96% even while it completed major modernization work at its Cheyenne refinery; its gasoline and diesel yields remained high at 87%; and it's increasing its use of cheaper feedstocks such as heavy sour and black wax crude.

The one place where we saw a small slip in operational performance was in operational costs per barrel produced. Refinery operating expenses per throughput barrel increased slightly from $4.83 this time last year to $5.18. That's still a relatively low cost compared to some of its peers, but with margins as thin as they are as of late, every penny of operational cost counts. 

With the modernization work at Cheyenne and the expansion of the Woods Cross refineries complete, management has said that its major capital spending projects are complete and the company plans to spend on various smaller projects. As cash from operations is going to be a little tighter with lower refining margins, management has decided to defer $40 million of these smaller projects planned for 2016.

From the mouth of management

In this lower commodity environment, some investors are likely going to have some concerns whether or not HollyFrontier will be able to maintain its dividend that currently pays a very attractive 5% today. When CFO Douglas Aron was asked about the long term sustainability of its dividend, he gave a pretty frank answer.

I think our regular dividend is one that if our research is correct, and with Holly being sort of the accounting acquirer of Frontier Oil, we show having paid a consistent and never sort of stopped 28 years of dividends at Holly Corporation, and now HollyFrontier. We feel strongly about continuing to support that dividend. Obviously, in this margin environment, we're distributing slightly more than what we earned in the quarter. And so I don't think that if we saw this margin environment persist for 36 or 48 months that we could be committed to it for that period of time. And it's a decision that our board makes every quarter. But certainly, as you look at our liquidity position being in excess of $1.5 billion and our expectation for Woods Cross to be contributing additional EBITDA, as George mentioned, sort of starting at the end of June, we feel very good about the near to medium term at certainly the current rate.

There are some good and bad things to extract from this. The first is that the company seems committed to maintaining the dividend and that it has the balance sheet strength to preserve it for a while as it rides out these tough times and brings new projects online. Management isn't completely blind to the realities of the market, though, and even gave investors a timeline of when it thinks it would need to make some big decisions related to its payout. 

What a Fool believes

Clearly the market for refiners is not good right now. Like so many other refiners, HollyFrontier is still putting up some strong operational results during these down times. For the market to improve, though, some refiners are going to have to pull back such that the glut of refined products can be cleared. HollyFrontier's management doesn't think they will need to do so because there are other refiners that are not in as strong of a position. 

Now that the work has been completed on the Cheyenne and Woods Cross refineries, investors should be on the lookout next quarter to see if the company can deliver on its promises of higher EBITDA. Earnings will likely be muted again next quarter as margins and RIN costs continue to weigh on the market. It's always important to remember, though, that the refining market can change pretty quickly.