Calumet's Record Quarter Illustrates Why It's America's Best Refiner

My favorite refiner is an MLP called Calumet Specialty Product Partners (NASDAQ: CLMT  ) .  One of the keys to my argument is the partnership's diversification, which is much like my second favorite refiner, Phillips 66 (NYSE: PSX  ) . As I wrote in a previous article, the key to great refiners is an ability to diversify into specialty products and chemicals, which offer higher and less volatile margins. This is where both Phillips 66 and Calumet triumph. 

In previous articles on the company (you can read them here here and here), I've outlined why I feel Calumet deserves a place in income investors' portfolios. At the time of those articles, Wall Street pessimism was at its peak regarding Calumet due to two bad quarters, which saw a confluence of several factors that negatively affected margins and the distribution coverage ratio. This perfect storm created fear that the MLP's high yield of 10%-11% was threatened, yet I argued that Wall Street's fears were based on short-term thinking and ignored several key growth catalysts that would not only secure the current distribution but lead to strong growth in the future.

Calumet's most recent quarter, which saw record-breaking results, has alleviated most of Wall Street's concerns and seen the company's unit price rally 25%. This article will highlight why Calumet is firing on all cylinders, and most importantly will show investors why today, even after a strong recovery in price, this MLP still represents the best opportunity for investing in American refiners. 

I believe a brief summary of what Calumet does and it's recent troubles is in order, so investors can understand the risks/rewards inherit with this investment. 

Calumet is a specialty refiner who makes money through two business units: fuels (21% of gross profit) such as diesel, jet fuel, gasoline, bio-diesel, and ethanol, and specialty products (79% of gross profit) such as lubricants, asphalt, waxes, and industrial feedstocks. In total, the company makes 6,000 products and has long-term relationships with about 6,000 customers, including such blue-chip names as ExxonMobil, Sherwin-Williams, Procter & Gamble, SC Johnson, and Baker Hughes

The recent difficulties the partnership faced were primarily caused by three factors: A decrease in the WTI/Brent spread, increased renewable energy tax credit (RINs) costs, and maintenance shutdowns at three refineries in 2013. 

The WTI/Brent spread is the difference in price between West Texas Intermediate oil and Brent crude oil (from Europe's North Sea.)

Brent oil is the basis for pricing refined products, while WTI represents Calumet's cheaper input oil prices (its refineries are strategically located to take advantage of North America's recent shale fracking boom.) A glut of shale oil resulted in cheap WTI prices, causing the crack spread (profit margin/barrel of input oil) to be at record highs in 2012 and early 2013. Recently, several pipelines have come online to alleviate the WTI glut, and the spread dropped to a low of $0.86/barrel. It has rebounded recently to $7.5/barrel, however, with the Energy Information Administration projecting 2014-2015 prices of $9/barrel to $11/barrel. 

Another reason for Calumet's recent financial difficulty (distribution coverage ratio dropped to .09 two quarters ago) was sky-rocketing RIN costs (from $0.02/credit to $1.18/credit during its peak). New EPA ethanol mixing standards have caused these to drop in price to $0.5/credit last quarter.

The final reason for the recent financial woes was 2013 regularly scheduled maintenance (which shut down daily production) of three of its refineries. There is no such maintenance scheduled for 2014. 

Growth strategy update: Why Calumet is America's best refiner
In its latest earnings report Calumet announced:

  • Adjusted EBITDA of $82.7 million (a record) which included a one-time $89.6 million debt extinguishment charge
  • Distributable cash flow of $49.4 million (compared to $10.6 million two quarters ago)
  • Distribution coverage ratio of 0.94 (compared to .51 last quarter and .09 two quarters ago) 
Further highlights from the conference call included:
  • The completion of a $900 million bond offering at a record low 6.5% interest rate
  • Sales of Royal Purple (a recent acquisition) at Wal-Mart exceeding internal expectations
  • Capacity expansion strategy on schedule (to potentially double EBITDA by 2016 according to Credit Suisse)
The MLP's growth strategy is a combination of accretive acquisitions (to grow its portfolio of products) and organic growth (to increase its production capacity). To fund this strategy requires access to lots of liquidity. Calumet began the year with $593 million in liquidity. Today that stands at $714 million. Add to this the new "At the Market" equity issuance program (which allows the MLP to sell $300 million in new units gradually, if unit prices are deemed high enough) and management has over $1 billion to fund its proven growth strategy. 
 
Regarding the distribution coverage ratio, Credit Suisse estimates that this will improve for 2014 to 1.34 and 1.6 for 2015 (on the backs of further acquisitions and investment projects).
A coverage ratio of greater than 1.1 allows for safe distribution growth so long-term investors can have confidence that not only is the current distribution safe but likely to grow substantially in the future. 

Foolish takeaway
Calumet Specialty Product Partners represents a unique creature in the investing world. It offers patient, long-term investors the chance for high-yield, distribution growth, and capital gains, the trifecta of investing. 

When combined with its long-term international growth potential, all of this means not only safe, high yields today, but also strong and consistent income growth in the years to come. Truly, Calumet's best years lay before it, and income investors would be wise to consider it as part of their portfolios.

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  • Report this Comment On May 28, 2014, at 11:38 AM, TMFDeej wrote:

    Great article Adam. Thanks for sharing. I completely agree with your conclusions.

    Jason

    Long CLMT

  • Report this Comment On May 28, 2014, at 5:02 PM, AdamGalas wrote:

    Thank you very much. Its always nice to get praise from Caesar himself:)

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