HollyFrontier's Earnings Don't Matter as Much as its Recently Announced Acquistion

It can be easy to get caught up in the minutiae when a company reports earnings results. In the case of HollyFrontier's (HFC) most recent report, it's best to not give too much credence to these results since its most recent acquisition announcement should be getting all the attention. Let's take a quick glance at HollyFrontier's most recent results and look at why they are not as nearly as important as its newly acquired asset.

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By the numbers

*in millions, except per share data. Source: HollyFrontier earnings results

Results for the quarter were right about where investors should expect in this tighter refining margin environment. Gasoline and diesel prices are up, which is why you see a small uptick in revenue. Conversely, though, crude oil prices have risen faster, and so refining margins have narrowed compared to this time last year. To be fair, though, the first three quarters of 2015 was one of the highest refining margin environments in decades, so don't use year-over-year declines as a sign things are getting worse.

The reason that second and third quarter income results are so wildly different is because HollyFrontier took some pretty hefty write-downs related to inventory valuations and whatnot. So in reality, it's hard to say if things are any better or worse when comparing this quarter's results to the prior quarter or year over year numbers.

The highlights

From an operations standpoint, not much happened this past quarter. Refinery utilization ran high with the exception of completing some turnaround work at its Cheyenne refinery, and costs per barrel were pretty much in line with the same time last year.

The two things of note this quarter were two transactions that seemingly came out of the blue. The first was the drop-down of a few refining assets at its Woods Cross refinery to its subsidiary partnership, Holly Energy Partners (HEP), for $275 million. The second deal was the real attention grabber as the company announced it was buying Suncor Energy's (SU 0.18%) Petro-Canada lubricants plant in Ontario for about $845 million -- the final price will depend in USD/CAD exchange rates. That also includes about $257 million in working capital, so the purchase price is closer to $587 million.

This Suncor deal is really important for the company's future. The 15,600 barrel per day facility might sound small compared to the 470,000 plus barrels per day of refining that HollyFrontier owns, but it is a much higher margin product that also generates steadier earnings and cash flows through the cycle. In fact, management estimates that the adjusted EBITDA contribution from this facility will be about 20% of the entire company's business once it comes into the fold.

What is even more astounding is the purchase price. Excluding working capital, this facility was purchased at an EBITDA multiple of four times. In the refining and midstream business, a six time to eight time EBITDA multiple is considered a decent deal, so to get this asset at four times seems like an absolute steal. It's also interesting that this sale was executed when the week before this deal was announced, Suncor Energy CEO Steven Williams was saying that the company wasn't looking at doing anymore mergers and acquisitions or sales because it liked the assets it had.

Going back to the surprise deal to drop down reining assets to Holly Energy Partners, management acknowledged in its presentation to shareholders about the Petro-Canada deal that the cash from that Woods Cross deal was used in part to fund this acquisition.

What management had to say

On the conference call announcing the acquisition of Petro-Canada Lubricants, CEO George Damiris was asked about why the company decided to go in this direction for an acquisition rather than in its wheelhouse of refining:

I don't think it precludes us from doing a more traditional refinery acquisition, at least from a balance sheet perspective. My concerns are more on the human resource side of the equation. We're obviously going to integrate business into HollyFrontier and do a good job there. But again, that would not preclude us from a traditional refining acquisition. But what we like with this acquisition, first and foremost, is that it's a great business. It's a differentiated business. It has, as we said, more stable cash flows with high margins. And -- so I think, it diversifies us away from the more traditional fuel frac spread and gives us exposure to these lubricant frac spread that as we've said are -- tend to be in the triple digits per barrel -- on a per barrel basis and less volatile. And we think it gives us a really strong third leg to our investment thesis and growth platform. So in addition to refining, investors get our midstream business and also get exposure to lubricants now. And as we also said, there's tremendous potential synergies between our existing businesses, not only our Tulsa Lubricants business that we mentioned $20 million per year, but we think there's also a tremendous opportunity to optimize the feedstock, supply to this business, take products from Tulsa and Woods Cross to feed this facility that will allow us to make more of the higher-margin products.

What a Fool Believes

HollyFrontier's management does have a bit of a reputation as very good and opportunistic capital allocators, and this recent move to buy Petro-Canada is another example of that. While earnings weren't as great as last year's, they were solid enough that investors should be much more excited about this deal than, worry about the small nuances of this quarter's earnings report.