Calumet Thrown a LIFO Vest

The next time you balm your lips or light a candle, thank a company that's now struggling to make those products profitably.

Following a dismal first-quarter loss of $3.4 million, Calumet Specialty Products (Nasdaq: CLMT  ) managed a second-quarter gain of $41.8 million. At nearly 12% better than the corresponding 2007 quarter, the results mark a welcome reversal for investors, who've watched shares plummet more than 70% since September 2007. Beneath the surface, however, challenges and red flags still abound.

First and foremost, the company reiterated that meeting its credit obligations is a consideration at this point. While its double-digit dividend yield may be a draw for many investors, Fools should know that Calumet's continued weakness could certainly jeopardize those distributions.

Second, the improved gross profit for the fuels segment that boosted the quarter's results was achieved principally through the liquidation of lower-cost inventory, aka LIFO liquidation. Investors should understand that such profits are pretty much a one-time deal, and that the gains related to the LIFO liquidations aren't sustainable.

The one positive development I observed was a 136% increase in diesel fuel production, while gasoline volumes rose by only 25%. As Valero (NYSE: VLO  ) indicated recently, the market conditions for diesel fuel are currently much more favorable than those for gasoline.

Looking forward, CAPS member nolaloha assessed the company's outlook as follows:

All refiners have been hit by reduced crack spreads. Calumet in particular has been affected by a poorly managed upgrade to their Shreveport refinery...Expect a lot of volatility, with crack spreads fluctuating, and demand dropping for specialty hydrocarbons.

With the entire industry under substantial pressure, though, I don't like the risks associated with Calumet at this point, and I continue to view big-dog Valero as the lone attractive stock in the space.

I maintain that as profitability throughout the refining industry approaches critical levels, something has to give. Both Tesoro (NYSE: TSO  ) and Valero have indicated they will operate below capacity. Marathon Oil (NYSE: MRO  ) is considering spinning off its refining and marketing segment to reduce the drag on overall earnings. It may be a long road to recovery for this sector, but with its debt issues digging potential pot holes, Calumet's journey could be longer than most.

Further Foolishness:

Calumet Specialty Products is a Motley Fool Income Investor recommendation. If income streams float your boat, hop aboard with a free 30-day trial subscription.

Fool contributor Christopher Barker captains yachts and writes about stocks. He can also be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Valero. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (12)

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  • Report this Comment On August 06, 2008, at 5:23 PM, oneijoe wrote:

    I'm disappointed with the article's failure to mention three huge positives with CLMT's business. 1) the company has now increased product pricing for base oils allowing pass-through of crude expenses (and with crude's recent tumble, it creates even more profit), 2) some major competitors have abandoned base oil production due to margin squeeze (but less net competition for CLMT), and 3) feedstock crude is now hedged 75% through mid '09 (expenses now controlled).

    And I'd be curious to know the basis of nolaloha's claim - "...demand dropping for specialty hydrocarbons". I've seen nothing but indications for strong demand in base oils.

    Base oils include more than chap stick and candles, it's also paraffins, greases, and machine oils - products a mechanized world can't do without.

  • Report this Comment On August 06, 2008, at 6:34 PM, NatGasinvestor wrote:

    Article also failed to mention.

    That they will get first full quarter contribution from the shreveport expansion. Specialty product margins are @20%+ compared to 5-8% for fuels. They have pricing power in the specialty products segment many competitiors have left the business.

    They fired 50 people from Parenco after they bought them thus making them even stronger in specialty products. These guys are going to make a killing this year. VLO and TSO are not good comps for Calumet. They have a coverage ratio of 1.8x, meaning they have almost two times the cash they they need to pay the distributions, even with a fat 13% yield.

    Disclosure: I own lots of CLMT and buying more, because I'm a pig.

  • Report this Comment On August 06, 2008, at 8:00 PM, XMFSinchiruna wrote:

    Thanks you two... points well taken! I'm just a cautious guy in this environment, and the admissions in each of the past two quarters' releases stating that meeting financial obligations under credit terms is a challenge... that's enough to keep me away.

  • Report this Comment On August 07, 2008, at 9:23 AM, eoz3106 wrote:

    This was a very unfair article. It fails to mention that the points others made above. More importantly though, the is that the risk of breaking their covenants is eliminated. The way they are calculated is teh trailing 4 quarters. Those horrendous prior quarters are over and now that Shreveport is 100% operational it's basically a moot point.

    Risky yes, but not nearly what it seems.

  • Report this Comment On August 12, 2008, at 12:15 PM, CBrown1818 wrote:

    This article is FLAT OUT WRONG. When the cost of input is rising over a given period (like oil was over the 2Q 2008) LIFO works against earnings because you have to charge your most expensive purchase (the last barrel of oil in) to your cost of goods. This would have actually worked against CLMT. Now when oil begins to fall again you can expect earnings to rise even higher as the rule suggests, the last barrel of oil in (the cheapest barrel) will be the first one charged to cost of sales (lower cost of sales).

    I was very surprised by CLMTs results. I actually bought the call the night before earnings release expecting it to beat, and CLMT destroyed even my expectations. I think a lot of people are underestimating this company's potential. However I steer away from owning any company with more debt than equity long term. I don't blame investors.

  • Report this Comment On August 12, 2008, at 4:25 PM, XMFSinchiruna wrote:

    Wow.. I can see Calumet has a loyal and passionate following. :)


    Check the earnings release. LIFO liquidation was the principle driver of those knock-out earnings. LIFO liquidation in a rising price environment can boost earnings in the short term, but is essentially a one-time boost that has big tax consequences down the road.


    I'm sorry, but the persistence of real challenges to meeting the covenants was stated by management, not by me. It doesn't pay to get more excited about near-term outlooks than a company's own management is.

  • Report this Comment On August 14, 2008, at 1:10 PM, CBrown1818 wrote:

    Alright you got me on the LIFO. I'll read into it a bit closer.

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