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Holly Energy Partners LP (NYSE:HEP)
Q3 2019 Earnings Call
Oct 30, 2019, 4:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Holly Energy Partners Third Quarter 2019 Conference Call and Webcast. [Operator Instructions] The floor will be open for your questions following the presentation. [Operator Instructions]

It is now my pleasure to turn the floor over to Trey Schonter. Trey, you may begin.

Trey Schonter -- Investor Relations

Thanks, Julie, and thank you all for joining our third quarter 2019 earnings call. I'm Trey Schonter, Investor Relations representative for Holly Energy Partners.

Joining us today are, George Damiris, President and CEO and Rich Voliva, Executive Vice President and CFO. This morning, we issued a press release announcing results for the quarter ending September 30, 2019. If you'd like a copy of today's press release, you may find one on our website at hollyenergy.com.

Before George and Rich proceed with their remarks, please note the Safe Harbor disclosure statement in today's press release. In summary, it says statements made regarding management expectations, judgements, or predictions are forward-looking statements. These statements are intended to be covered under the Safe Harbor provisions of Federal Securities Laws. There are many factors that could cause results to differ from expectations, including those noted in our SEC filings. Today's statements are not guarantees of future outcomes.

Also, please note that information presented on today's call speaks only as of today, October 30, 2019. Any time-sensitive information provided may no longer be accurate at the time of any webcast replay or reading of the transcript. Finally, today's call may include discussion of non-GAAP measures. Please see today's press release for reconciliations to GAAP financial measures.

And with that, I'll turn the call over to George.

George J. Damiris -- Chief Executive Officer and President

Thanks, Trey. And thanks to each of you for joining the call this afternoon. HEP generated solid earnings in the third quarter to allow us to maintain our distribution $0.6725 per unit, representing a 1.1% to the distribution from the third quarter of 2018, the distribution we paid on November 12 to unit holders of record on October 28. For the third quarter, volumes remain strong as HEP's total volume increased 10% year-over-year due to the continued strength of our crude oil pipeline systems in Wyoming and Utah as well as strong shipments on our UNEV product pipeline.

We recently announced our Cushing Connect joint venture with Plains All American. The joint venture will construct a 160,000 barrel per day pipeline, connecting the Cushing Oklahoma crude oil hub to HollyFrontier's Tulsa refinery, as well as own and operate 1.5 million barrels of crude oil storage in Cushing, supporting HollyFrontier's Tulsa and El Dorado refineries. This joint venture provides added growth to HEP by in-sourcing HFC's logistic spend. The JV terminal is expected to begin service during the second quarter of 2020, and we anticipate the pipeline coming on line during the first quarter of 2021. Combined, we expect initial annual EBITDA of $7 million to $8 million representing a transaction multiple of eight to nine times. Looking forward, we plan to hold the distribution constant at $0.6725 per LP unit per quarter through 2020 while maintaining the distribution coverage of one times.

HEPs distribution guidance reflects growth for contractual tariff escalators and the recently announced Cushing Connect joint venture, and balances our commitment to both a healthy balance sheet and distributing cash flow to our unit holders.

And with that, I'll turn the call over to Rich.

Richard L. Voliva -- Executive Vice President and Chief Financial Officer

Thank you, George. For the third quarter of 2019, net income attributable to HEP was $82.3 million, compared to $45 million in the third quarter of 2018. The increase was mainly due to a $35.2 million non-cash gain triggered by the renewal of the original throughput agreement between HEP and HollyFrontier Corporation.

Under ASC 842 from the lease accounting standards that went into effect at the beginning of 2019, we determined portions of this agreement qualified as a sale-type lease, which generated the gain. Excluding this gain, net income attributable to HEP for the quarter was $47.2 million or $0.45 for basic and diluted LP unit. This represents a $2.2 million increase compared to the third quarter of 2018.

In the third quarter of 2019 adjusted EBITDA was $90.3 million, compared to $86.9 million in the prior year. The new lease standard requires us to recognize the tariff revenue on the asset classified as sales leases as either interest income or the amortization of the net investment in leases. During the third quarter, we recognized a total of $2.4 million of tariffs outside of the revenue line, $1.7 million in the form of interest income and approximately $700,000 as amortization.

Going forward as we renew old contracts or initiate new contracts, we will evaluate them under the new lease standards and expect growth and the amount of tariffs revenue we are recognizing as either interest expense or amortization. To aid in comparison and economic analysis, we will report an adjusted EBITDA number that reverses this treatment of tariff revenue. The table reflecting these adjustments is available in our press release.

During the period, HEP generated distributable cash flow of $68.8 million, a $2.2 million increase over the same period last year. As George mentioned for the remainder of 2019 and through 2020, we expect to hold the distribution constant at $0.6725 per LP unit per quarter. For the third quarter, our distribution coverage ratio was 1.01 times, averaging 1.01 times year-to-date. Our capital expenditures for the quarter were approximately $6 million, including $2 million on maintenance capex and $3 million of reimbursable capex. For the full year 2019, we expect to spend approximately $7 million of maintenance capital, $35 million in expansion capital and $18 million in joint venture investments. The increase in spending is driven by the Cushing Connect JV.

Interest expense grows approximately $800,000 compared to the third quarter of 2018, primarily due to higher average balances outstanding under our senior secured revolving credit facility. As of September 30th, HEP have $1.4 billion of total debt outstanding resulting in a debt-to-adjusted EBITDA ratio of 4.0 times. Including cash and revolver availability, our current liquidity is over $472 million. During the quarter, Moody's upgraded HEP's corporate family credit rating to Ba2 from Ba3, further reinforcing the strength of HEP's stable cash flows and advantageous relationship with our parent HollyFrontier.

Together the support and our strong liquidity position we'll enable HEP to pursue future organic and third-party growth opportunities as demonstrated by our recently announced Cushing Connect JV.

And with that, I'll turn the call over to Julie for any questions.

Questions and Answers:

Operator

The floor is now open for questions. [Operator Instructions] Your first question comes from Jeremy Tonet with JP Morgan.

James Kirby -- JP Morgan -- Analyst

Hey, good afternoon guys. This is James on for Jeremy.

George J. Damiris -- Chief Executive Officer and President

Good afternoon.

James Kirby -- JP Morgan -- Analyst

Just wanted to start off with the Delek contract, if there is any update on the portion was not renewed and coming due next year?

George J. Damiris -- Chief Executive Officer and President

Not really, we continue to evaluate our alternatives for those asset in both crude oil and product service, but no update at this time.

James Kirby -- JP Morgan -- Analyst

Okay. And I guess just following up that question. For the distribution guidance for the next year, is there any -- what is the assumption there for the capacity being utilized on that system?

George J. Damiris -- Chief Executive Officer and President

So, we've assumed no utilization after the expiration of the contract at the end of the first quarter.

James Kirby -- JP Morgan -- Analyst

Okay, thank you. And then just one more if I could. Do you see leverage ticking above the target to fund the Cushing Connect JV?

George J. Damiris -- Chief Executive Officer and President

I think we're probably going to see a rise a little bit as we're spending capital but not yet earning on that capital with the JV here and then come back down as the earnings kick in from the joint venture.

James Kirby -- JP Morgan -- Analyst

Got you. All right. Thanks a lot. That's it.

George J. Damiris -- Chief Executive Officer and President

Sure. Thanks.

Operator

Our next question comes from Spiro Dounis from Credit Suisse.

Spiro Dounis -- Credit Suisse -- Analyst

Hey, Rich. Hey, George. It's me following up on Cushing Connect, just curious with the eight to nine multiple, what sort of opportunities do you guys have within the JV to kind of work that multiple down over time, either with or without incremental capex?

George J. Damiris -- Chief Executive Officer and President

Well, there is additional crude oil volume we could potentially put on that system. We get some crude oil from other locations besides Cushing and those volumes could potentially migrate under Cushing and we have more crude oil volume from Cushing to toss up for that line. There is also probably some opportunities -- at the terminal more barrels in the long run and we think that's a near-term issue, but there is some upside around that.

Spiro Dounis -- Credit Suisse -- Analyst

Got it. Appreciate that. Then also just a follow-up on the DJ contract assets, maybe just a little bit additional color in terms of the marketability of those assets, I think there is probably some other people out there they would like to get their hands on, but maybe just describe what some of the alternatives are? And who the types I guess counterparties would be that would want those assets?

George J. Damiris -- Chief Executive Officer and President

Yeah. At the end of the day, these are well located assets. They are in the Permian Basin. They are primarily currently in product service, but they obviously have the potential to be convert the crude oil service to get crude barrels from the Permian to the Gulf Coast location. So, to your point, I think there are other parties that may be interested in these lines as well as some internal project ideas that we're looking at.

Spiro Dounis -- Credit Suisse -- Analyst

Yeah, now that's fair. Last one, if I could sneak it in just on the distribution. Totally get your guys point on being able to hold it flat next year. I think that's well within reach. I guess just curious as you guys sort of weigh your options, just given where the yield is. Did you at one point consider, maybe retaining more cash for growth, or as you looked out of the slate of opportunities out there, maybe just didn't seem like it was worth risking your investor base, which I get a sense a little more yield focus to sort of go after any of that stuff? Just thoughts around how you sort of got to that conclusion?

George J. Damiris -- Chief Executive Officer and President

Yeah, I think to your point, Spiro we looked at our options here. Really, historically what we've seen and where we thought consistently we thought of as you really cut the distribution for one or two reasons, one would be if you had a leverage problem, which we don't have here or two to your point if we had $1 billion capital project type program and you needed to finance that. We've got some good growth opportunities, but it's not, we're not seeing them on the order of magnitude that would argue for a real distribution cut here. To your point, that when you combine that with our shareholders and they do appreciate the yield here in the -- the steady distribution. We didn't see a lot of value for anyone in cutting the distribution.

Spiro Dounis -- Credit Suisse -- Analyst

Yeah, makes a lot of sense. Appreciate the color. Thanks guys.

George J. Damiris -- Chief Executive Officer and President

Thanks, Spiro.

Operator

[Operator Instructions] Our next question comes from Shneur Gershuni with UBS.

Shneur Gershuni -- UBS -- Analyst

Hi, good afternoon guys.

George J. Damiris -- Chief Executive Officer and President

Hi, Shneur.

Shneur Gershuni -- UBS -- Analyst

Just a few quick questions here. There is, if I remember correctly, I think it was $2.5 million a quarter when you for -- at the HFC to the HEP level. And I think if I remember correctly, it expires in the second quarter of 2020. Your expectation about coverage, does that assume that gets reup or that expires?

George J. Damiris -- Chief Executive Officer and President

No, we've assumed that expires consistent with the existing contract. You're right on the date.

Shneur Gershuni -- UBS -- Analyst

Okay. And so, and is there any discussion about maybe extending it or you feel comfortable with where you're at right now?

George J. Damiris -- Chief Executive Officer and President

No, we're comfortable where we're at.

Shneur Gershuni -- UBS -- Analyst

All right. In the question, the first question I can't remember who would ask it, you'd ask if you've included the Delek expiration inside the coverage ratio number. Is that just the most recent Delek expiration? Or is that any future expiration if that were considered in that as well, too?

George J. Damiris -- Chief Executive Officer and President

We've considered everything that's coming up through 2020 already.

Shneur Gershuni -- UBS -- Analyst

Through 2020, OK, perfect. One last question about capex related to the Plains joint venture. What is HEP's actual dollar spent with that, because I remember that there is a terminal contribution from Plains, that I think on a $40 million valuation. Just kind of want to understand what is your cash component that is going to come from HEP?

George J. Damiris -- Chief Executive Officer and President

Yeah. Total cash component would be about $65 million. It combines the investment in the JV, and then the capital around the pipeline.

Shneur Gershuni -- UBS -- Analyst

Got it. All right. Perfect. That answers all of my questions. Really appreciate your color today.

George J. Damiris -- Chief Executive Officer and President

Happy too.

Operator

If there are no further questions, I will turn the floor back over to Trey for any closing remarks.

Trey Schonter -- Investor Relations

Thanks again for joining the call today. Feel free to reach out to Investor Relations, if you have any questions.

Operator

[Operator Closing Remarks]

Duration: 17 minutes

Call participants:

Trey Schonter -- Investor Relations

George J. Damiris -- Chief Executive Officer and President

Richard L. Voliva -- Executive Vice President and Chief Financial Officer

James Kirby -- JP Morgan -- Analyst

Spiro Dounis -- Credit Suisse -- Analyst

Shneur Gershuni -- UBS -- Analyst

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