Calumet: 3 Strikes, You're Out!

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Fools who know me would say that I'm a pretty patient guy. Given these extraordinary times, however, I believe that three consecutive strikes are sufficient to call a company "out!" 

For refiner Calumet Specialty Products (Nasdaq: CLMT  ) , each of the past three quarters have raised major red flags. First, we had a net gain achieved largely by a one-time LIFO liquidation. In the third quarter, the company reported a loss from massive derivative losses and reiterated warnings concerning its ability to maintain compliance with debt covenants. For the fourth quarter, Calumet again managed to profit, and even perpetuated a dividend that's yielding over 14%, but severe underlying challenges provide the third and final strike.

As with fellow refiners Valero (NYSE: VLO  ) and Holly (NYSE: HOC  ) , the abrupt collapse in oil prices during the second half of 2008 permitted profitable operations despite a challenging demand environment. Calumet earned $18.5 million as last year's Penreco acquisition and Shreveport refinery expansion bolstered gross profit from almost $28 million a year ago to more than $81 million for the quarter ended. Gross profit from the specialty products unit continues to gather strength, but that's about where the good news ends.

Cheaper oil was certainly a double-edged sword for Calumet in the fourth quarter, with leaner crack spreads on unhedged fuel sales dragging the fuel segment's gross profit down more than 75% from the prior year. Derivative contracts of the type that plagued third-quarter results reared their head once again for a $28.4 million loss.

With a third blow from cheaper oil, Calumet also indicated that sustained low prices could limit the company's borrowing capacity by reducing the value of existing crude oil inventories. While not as hefty as Western Refining (NYSE: WNR  ) 's $1.48 billion debt, Calumet's $460 million in long-term debt remains an unwelcome burden. Since compliance with debt covenants remains a stated concern for management, it appears Calumet faces a conundrum where it needs oil prices to move higher even though cheaper oil is typically best for refiners.

Citing these significant constraints upon Calumet's ability to benefit from lower oil prices, the stock pickers at Motley Fool Income Investor struck Calumet from their roster of recommended dividend plays in December. As long as major players like Conoco Phillips (NYSE: COP  ) and Tesoro (NYSE: TSO  ) continue to operate well below capacity, the operating environment for refiners remains too tough to call. The easy call, however, is to avoid Calumet Specialty Products.

Further Foolishness:

343 CAPS members expect four-star pick Calumet Specialty Products to outperform the S&P 500. Will you follow the Fools, or blaze your own trail? Join the free CAPS community today and share your own thoughts about Calumet.

Fool contributor Christopher Barker reminds Fools to perform DDDD: due diligence on demand destruction. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Valero Energy.

The Motley Fool has a highly refined disclosure policy.

Read/Post Comments (8) | Recommend This Article (23)

Comments from our Foolish Readers

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  • Report this Comment On February 19, 2009, at 4:58 PM, NatGasinvestor wrote:

    Maybe 3rd time is the charm!

    LIFO gain was the best - as they dumped a bunch of crude inventory at $135 - while reducing working capital.

    Last two quarters they have had avg 2.5x the cash required to pay out the 15% yield.

    Going forward-

    1.Their volumes are 40% higher in 2009 over last quarter.

    2. More sour crude processing means better margins.

    3. Competition going out of business.

    4. Acquisition made last year starting to pay off, by reducing competitions and increasing pricing power.

    5. Most of the derivative loss was brought froward from 2009, that they can have great numbers going forward.

    6. They will probably get a huge distribution increase as the general partner will try to push up the distributions so that they can get greater cut of the distributions (move higher in the IDRs (incentive distribution rights)

  • Report this Comment On February 19, 2009, at 5:20 PM, platformtennis wrote:

    Why do you keep trashing this stock? Every day the market looks terrible and yet even today, Calumet goes up 10% in one day, the very same day you go "3 strikes and you're out".

    I bought the stock at 8.42, it went up to about 14, I sold the profit and now it is nearly that same level. I guess you are saying now is the time to sell it, but in my opinion your reasons are very conflicting and confusing. All the while this is happening, they are also paying out significant dividends?

  • Report this Comment On February 19, 2009, at 6:11 PM, XMFSinchiruna wrote:

    The trifecta of warning flags:

    risk of breaking loan covenants as stated by management in at least three successive earnings reports indicates a level of risk that in my opinion should serve to keep Fools away. There are times to play some risk, but with all the deep value out there in quality companies that are NOT in danger of defaulting on debt, the arguments in support of this company continue to ignore this crucial detail.

    The dividend, while upheld in this quarter, can not be considered safe in light of the item above. Again, there are better options out there for investors seeking solid dividend yields that have less risk of diminishing or disappearing. I encourage dividend seekers to try a free trial to the income investor newsletter service and see some of the companies they recommend for income, as well as the reasons behind CLMT's removal from their list of recommended stocks (link in article above).

    Third. Despite having shelled out much-needed liquidity in Q4 to terminate a chunk of those crude derivative positions for 2009 expiry, the remaining contracts continue to represent an unacceptable burden to bear for shareholders unless crude prices rocket back to the $60+ range. As I suggested in the article, that creates something of a conundrum.

    I assure you, I am not simply trashing this stock for no reason. Sure, their specialty products unit could continue to operate as profitably as it presently is, but again... go back and read the cautionary statements in the release. They're trying to tell you what the risks are, and I believe Fools would do well to listen.

    NatGasinvestor - I just received your e-mail. I refer you back to the comments sections for the LIFO article from Q2. There are significant tax consequences to a LIFO liquidation, so the net benefit may not be as rosy as you portray. Also, from the crude derivatives we can see the collapse in oil prices caught CLMT by surprise just as much as everyone else. Therefore, the move to liquidate last-in inventories can not reasonably be hailed as a shrewd maneuver.

    Bottom line: for those with the risk appetite in this environment to read management's cautionary statements and still feel okay with the investment, all the power to you... I sincerely hope it works out great and you all make a killing. That just happens to reside outside of my risk tolerance zone.

    I made much the same argument concerning dry bulk shipper DRYS a couple of weeks ago, and check out the comments I received then, too. Look at the stock today... right back below $4.

    For all those who are long, and especially the multitudes that might be in the red with this one, I truly hope all will be well with this stock. My wish is for all Fools to be profitable, and the strengths of this company are not lost on me. I have to call them as I see them, though, and given the macroeconomic landscape I do not believe this is a time for Fools to be placing bets with such easily identifiable risks.

    Fool on!

  • Report this Comment On February 19, 2009, at 8:35 PM, hweedle wrote:

    TMFSinchiruna - several comments:

    If you look at the income statement you will note 2 numbers on hedging - realized losses ($45 MM) and unrealized gains ($17 MM), for a net loss of $28 MM for Q4. The unrealized gain represents the mark to market of CLMT's hedging position at 12/31/08. In other words the hedges are in the money, it will take dramatic swings to turn into losses. Therefore hedging going forward looks to be under control for now.

    On the debt covenants, there are 2 components of CLMT debt - term and a working capital line. At 12/31/08 they were in compliance. At the time of the distribution, 2/14 they were incompliance with availability on the lines comparable to 12/31 or $51 MM. As they collect AR from higher priced sales based on older crude prices - crude that has been paid for - they will reduce the borrowings on the working capital line and expand the availability.

    Crude heading back to $60 is not good - higher crude price does not necessarily equate to higher specialty product prices - higher crude will result in lower margins - not good. The fuels portion of the business is fine as they have most of 2009 production hedged at $11 crack spread. A stable crude market is the best situation for CLMT - a period of rapid increase (see their performance when that occurred late 07 to mid 2008) is the worst situation.

    On the negative tax consequences regarding LIFO, A MLP is a pass thru entity, yes LIFO gains were $59 mm, but that will be more than offset by the bonus depreciation due to the refinery expansion.

    Looking forward to volumes, CLMT should have EBITDA of between $150 and $200 MM in 2009. Do the math - there is enough information in the 10k, Interest is $40 MM and Distributions are $60 MM for a total of $100 MM in commitments. With the balance sheet resetting to lower crude, additional money will be squeezed out used to pay down debt. The future is much brighter than you expect.

    You may see this as 3 strikes, yer out, I see it as 1 out with 2 runners on and a 3 and 1 count - a hitters situation. If it wasn't for the market conditions, CLMT would be much higher.

  • Report this Comment On February 20, 2009, at 7:28 AM, XMFSinchiruna wrote:


    The hedges are distinct from the derivatives, which are not treated as hedges for accounting purposes - look again. :)

    There are several promising small refiners out there... I'm amazed at how large and passionate a following CLMT retains despite the significant risk level. Operationally, as I've said, the company has some noteworthy strengths, but some others do as well.

    Furthermore, I see a real possibility for renewed volatility in crude oil markets going forward, making refining one again a tricky space to invest in. The producers are cheap here, too, and there are some - like several of the Canroys - that offer similar dividend yields to CLMT. Just my $0.02. Good luck to all.

  • Report this Comment On February 20, 2009, at 8:48 AM, hweedle wrote:

    TMF -

    I respectfully disagree on your assessment of the hedging/derivative accounting. Those numbers represent all hedges marked to market. The link below explains FAS 133 which dictates this accounting. Further, currently CLMT has $55 MM of Other Comprehensive Income in it's equity section - which possibley could represent the aggregate positive value of its hedging position - need to read the footnotes of the audit when it is issued. Here's the link:

    FAS 133 is one of the more complex accounting pronouncements, with goal to represent somewhere on the income statement or balance sheet what the current exposure of the mark to market on all derivatives (which in this case would inlcudes CLMT's hedges). The old method essentially kept most of this out of the statements.

  • Report this Comment On March 02, 2009, at 11:30 AM, oneijoe wrote:

    Once again, we get an article that ignores the CURRENT conditions.

    The crack spread has been greatly improved over the 1st qtr. and CLMT feedstock hedging from 4th quarter (at nearly $100/br) won't be as harmful (spot crude much, MUCH cheaper this qtr).

    The bottom line is...1st qtr '9 will be much better than 4th qtr '8.

  • Report this Comment On July 11, 2009, at 12:05 AM, NatGasinvestor wrote:

    CLMT loaded up on crude inventory in Jan and Feb at $40 a barrel. Looks pretty smart. In Q1 they generated 3x the distributable cash flow. They should handily beat that this time.

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