HollyFrontier (HFC) Q3 2019 Earnings Call Transcript

HollyFrontier (HFC)
Q3 2019 Earnings Call
Oct 31, 2019, 9:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to HollyFrontier Corporation's third-quarter 2019 conference call and webcast. Hosting the call today from HollyFrontier is George Damiris, president and chief executive officer. He is joined by Rich Voliva, executive vice president and chief financial officer; Tom Creery, president, refining and marketing; and Jim Stump, senior vice president, refining. [Operator instructions] Please note that this conference is being recorded.

It is now my pleasure to turn the floor over to Craig Biery, director, investor relations. Craig, you may begin.

Craig Biery -- Director, Investor Relations

Thank you, Cheryl. Good morning, everyone, and welcome to HollyFrontier Corporation's third-quarter 2019 earnings call. This morning, we issued a press release announcing results for the quarter ending September 30, 2019. If you would like a copy of the press release, you may find one on our website at HollyFrontier.com.

Before we proceed with remarks, please note the safe harbor disclosure statement in today's press release. In summary, it says statements made regarding management expectations, judgments or predictions are forward-looking statements. These statements are intended to be covered under the safe harbor provisions of federal security laws. There are many factors that could cause results to differ from expectations, including those noted in our SEC filings.

The call also may include discussion of non-GAAP measures. Please see the press release for a reconciliation to GAAP financial measures. Also, please note any time-sensitive information provided on today's call may no longer be accurate at the time of any webcast replay or rereading of the transcript. And with that, I'll turn the call over to George Damiris.

George Damiris -- President and Chief Executive Officer

Thank you, Craig, and good morning, everyone. Today, we reported third-quarter net income attributable to HollyFrontier shareholders of $262 million or $1.58 per diluted share. Certain items detailed in our earnings release decreased net income by $16 million on an after-tax basis. Excluding these items, net income for the current quarter was $278 million or $1.68 per diluted share versus adjusted net income of $351 million or $1.98 per diluted share for the same period last year.

Adjusted EBITDA for the period was $523 million, a decrease of $90 million compared to the third quarter of 2018. This decrease was principally driven by lower product margins and weaker laid-in crude advantage across our refining system. The Refining and Marketing segment reported adjusted EBITDA of $425 million compared to $507 million for the third quarter of last year. Consolidated refinery gross margin was $17.23 per produced barrel, an 11% decrease compared to the $19.41 for the same period last year.

We set a new quarterly crude charge record averaging over 476,000 barrels per day in the third quarter. Our Lubricants and Specialty Products business reported EBITDA of $38 million compared to $42 million in the prior year despite improvements in the base oil market. Rack Forward EBITDA was $51 million for the quarter, and EBITDA margin was 11% of sales. Weakness in Rack Forward earnings was driven by unfavorable sales mix and the impact of macroeconomic headwinds on end markets.

With respect to our Sonneborn acquisition, as of September 30, we have achieved run rate synergies of $10 million and continue to expect long-term synergies of $20 million per year. Holly Energy Partners reported adjusted EBITDA of $90 million for the third quarter compared to $87 million in the third quarter last year. This increase was driven by the strong third-party volumes and higher spot revenues on our crude oil pipeline systems in Wyoming and Utah, which contributed to a 10% increase in volumes year over year. During the quarter, we returned approximately $260 million of cash to shareholders through our regular dividends and share repurchases, highlighting our continued commitment of returning excess cash to shareholders.

For the remainder of 2019, we are focused on completing the turnaround work at our Cheyenne, El Dorado and Woods Cross facilities and expect to return to normal operations later this quarter. We are pleased with the current strength and product margins across our refining system and look forward to a strong finish to the year. Looking into 2020, our outlook remains positive and believe IMO implementation will provide uplift to diesel margins and further discounts to heavy crude barrels. With a light turnaround schedule next year, we are well positioned to take advantage of strong product margins and improving crude discounts across our refining system.

Now I'll turn the call over to Jim for an update on our operations.

Jim Stump -- Senior Vice President, Refining

Thank you, George. For the third quarter, our crude throughput of 476,000 barrels per day was our highest ever recorded quarterly crude throughput across our refining system. For the third quarter, our consolidated operating cost of $5.94 per throughput barrel was $0.11 lower versus the same period last year on higher consolidated throughputs. In the Mid-Con, we ran 294,000 barrels per day of crude.

Opex per throughput barrel was $4.77, a decrease of $0.30 versus the same period last year. Our El Dorado Refinery set a new quarterly crude charge rate record during the third quarter averaging 160,000 barrels per day. In the Southwest, we ran 107,000 barrels per day of crude. Our operating expense per throughput barrel was $5.23, an increase of $0.54 versus in the third quarter of last year.

This was mainly due to higher-than-normal operating cost associated with the mechanical problem that we had with our reforming unit, which we repaired this month in October. In the Rockies, we ran 75,000 barrels per day of crude. Our operating expense was $11.34 per throughput barrel, a $0.38 decrease over the same period last year. As George mentioned, due to our significant planned maintenance, we expect to run 38 -- 380,000 barrels to 390,000 barrels per day of crude in the fourth quarter.

We are currently ramping up the scheduled turnaround at our Cheyenne refinery. The ongoing turnarounds at our El Dorado and Woods Cross refineries are expected to be completed on schedule and return to normal operating rates in the second half of the fourth quarter. I will now turn the call over to Tom for an update on our commercial operations.

Tom Creery -- President, Refining and Marketing

Thanks, Jim, and good morning, everyone. For the third quarter of 2019, we ran 476,000 barrels of crude oil, which was composed of 32% Permian and 18% WCS and black wax crude oil. Our average laid-in crude cost was under WTI by $1.95 in the Rockies and $0.08 in the Mid-Con and over WTI by $0.43 in the Southwest. In the third quarter of 2019, gasoline inventories in the Magellan system started the quarter at 7.1 million barrels and ended the quarter at 6.6 million barrels.

Current inventories are slightly lower at 6.2 million barrels to date. Group III diesel inventories dropped by 800,000 over the quarter to finish up at 7.6 million barrels. Current distillate or diesel inventories are at 6.1 million barrels. Third quarter 3-2-1 cracks in the Mid-Con were $17.29, $26.78 in the Southwest and $26.85 in the Rockies.

In our Southwest and Rockies regions, we continued to see higher margins as refinery operations on the West Coast and their problems have affected the markets in Phoenix and Las Vegas. In the Mid-Continent, gasoline cracks are trading lower as fall refinery maintenance ends, along with weaker seasonal demand. Diesel cracks remain high, however, as harvesting has been delayed due to inclement weather. Crude differentials widened across the heavy barrel and narrowed on the sour slates during the third quarter.

In the Canadian heavy market, third-quarter differentials for WCS at Hardisty averaged $12.24 per barrel, slightly higher than second quarter levels. Both the current and the forward market for WCS remains even wider with differentials in the $17 range as the market perceives incremental crude production, coupled with the perceived positive impact of IMO 2020. Apportionment on the Enbridge system remains high at 44% despite the continuation of production curtailments by the Alberta government. We, however, continue to be able to -- are able to purchase and deliver adequate volumes of price-advantaged heavy crude oil to meet our refining needs.

Canadian heavy and sour runs averaged 72,000 barrels per day in our plants in the Mid-Con and Rocky regions. We refined approximately 153,000 barrels a day of Permian crude in our refinery system composed of 107,000 barrels per day at the Navajo facility and 46,000 barrels per day at our El Dorado Refinery, delivered by the Centurion pipeline. Midland sour differentials averaged the third quarter of $0.50 below WTI. And currently, we see the same differential trading at $0.20 above Cushing, as new pipeline capacities come onstream.

We anticipate this differential to narrow through the balance of the year as additional pipes come online. Our rent expense for the quarter was $8 million, which includes $37 million in small refinery exemption labors we received from the 2018 year at our Woods Cross and Cheyenne refineries. And with that, let me turn the call over to Rich.

Rich Voliva -- Executive Vice President and Chief Financial Officer

Thank you, Tom. As George mentioned, the third quarter included a few unusual items. Pretax earnings were negatively impacted by a lower of cost or market charge of $34 million and Sonneborn integration costs of $4 million, which were offset by a $37 million reduction in the cost of RINs as a result of a small refinery exemptions granted to our Woods Cross and Cheyenne refineries for the 2018 calendar year. A table of these items can be found in our press release.

For the third quarter, cash flow from operations was $441 million, including turnaround spending of $42 million. HollyFrontier's consolidated capital expenditures were $68 million for the quarter, producing free cash flow of $373 million. The third quarter's strong free cash flow allowed us to return a total of $260 million of cash to shareholders comprised of a $0.33 per share regular dividend totaling $55 million and the repurchase of approximately 4.3 million shares of common stock totaling $205 million. As of September 30, we have approximately $320 million remaining on our share repurchase program.

HollyFrontier has returned over $880 million of cash to shareholders through both dividends and share repurchase over the past 12 months, representing a cash yield of 9%. At the end of the third quarter and with an eye toward substantial planned maintenance in the fourth quarter, our total cash balance stood at $982 million, above our target of $500 million. This strong cash position, along with our undrawn $1.35 billion credit facility, puts our total liquidity at over $2.3 billion. As of quarter end, we have $1 billion of stand-alone debt and a debt-to-cap ratio of 14%.

Total ATP distributions received by HFC during the second quarter were $38 million, a 2% increase over the same period in 2018. HollyFrontier owns 59.6 million HEP limited partnering units, representing 57% of HEP's float with a market value of $1.4 billion as of last night's close. For the full year of 2019, we have increased our capital spending guidance driven by higher turnaround scope and cost. We now expect to spend between $550 million and $590 million for both stand-alone capital and turnarounds at HollyFrontier Refining and Marketing, $45 million to $50 million in HollyFrontier loops and specialties and $34 million to $40 million of capital for HEP.

And with that, Cheryl, we are ready to take questions.

Questions & Answers:

Operator

[Operator instructions] Thank you. Our first question is coming from Matthew Blair, Tudor, Pickering. Your line is open.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

Good morning, everyone. I want to ask about Lubricants. So your Rack Forward EBITDA fell quarter-over-quarter, but your volumes improved. Could you just walk through some of the challenges here? And does your 2019 guidance of, I believe, $240 million to $260 million, does that still hold?

Rich Voliva -- Executive Vice President and Chief Financial Officer

Hey, Matthew, it's Rich. So a couple of things here we'd point out. First, as we described in our press release and you've seen from some of our peers in the loop space, the macro issues that are driven by the trade war are definitely impacting sales here, particularly on the high end of the finished product side. So for example, we saw new tariffs on sales into China this quarter, and we continue to feel the indirect impacts on end markets such as autos.

Second issue we'd point out is, as we discussed in our second quarter call, we have some maintenance occurring on the lube extraction unit with the LEU at pulse set in the fourth quarter, so we did build inventory there to smooth sales and handle customers through the fourth quarter. To your point, looking at our Rack Forward guidance, it's going to be a stretch to get there, but it is possible. And then looking into 2020 and longer term, we're fully confident of our -- of where we are in that business, $275 million, $300 million of mid-cycle EBITDA.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

That's helpful. Thank you. Are you able to break out the contribution from Sonneborn in the quarter?

Rich Voliva -- Executive Vice President and Chief Financial Officer

I don't have that handy, Matthew. No.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

OK. And then final question. There's been some reports that there's some PADD 4 refinery assets on the block. It's obviously a market that you're pretty familiar with.

Just wanted to gauge your interest, if any, in some of these assets.

George Damiris -- President and Chief Executive Officer

Matthew, this is George. We obviously won't discuss any specific opportunities. I think we've been pretty consistent with our messaging regarding our desire to continue to grow in our preference to stay in inland markets, as you just mentioned. So you can draw your own conclusions from that.

Having said all that, any deal would have to be for the right assets, at the right price. We are -- we can bring something more to the table than just cash and whereas that asset and that business can bring something new to our company as well.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

Thank you. I'm going to recuse for a few more follow ups.

Operator

Thank you. Our next question comes from Carly Davenport, Goldman Sachs. Your line is open.

Carly Davenport -- Goldman Sachs -- Analyst

Hey. Good morning. Thanks for taking the questions and congrats on a good quarter. The first one is just on WCS.

We've started to see differentials widen back out toward rail economics here in the fourth quarter. Do you think that it's IMO 2020 fundamentals or some other factor has been driving that mood move? And then, can you remind us on your capacity to run Canadian barrels, especially given the rail allowance deal that was announced this morning by the Alberta government?

Tom Creery -- President, Refining and Marketing

Carly, good morning. It's Tom Creery, speaking. I'll try to answer the first one. We'll answer the first question first.

Yes, we have seen them widen out to $17, $18. We do believe some of that, a lot of it is basis on IMO 2020. It's very difficult to ascertain how much of that move is attributable to IMO 2020, but we've been saying it's going to widen as we get closer to the offset of that program. And when we look at the forward curves, we see it staying at those levels, if not increasing, through the year 2020.

We truly believe that some of it is basis on the incremental rail rates. As you know, the Canadian or the Alberta government has said that if you move it by rail, you can move over and above the quota system. So that barrel is the last barrel being moved, so it does tend to set the market price. And as we all know, rail is a lot more expensive than pipeline economics.

George Damiris -- President and Chief Executive Officer

The volumes.

Tom Creery -- President, Refining and Marketing

Oh, the -- our volumes that we're able to run, that depends on overhead prices and what our LP models are saying. Typically, we're somewhere between through the whole refining network 60,000 to 100,000 barrels a day, if not more, depending on market conditions.

Carly Davenport -- Goldman Sachs -- Analyst

That's great. Thank you. And then the second one is on the Lubricants business. The -- your guys' market data showed 3Q base oils' margins were materially improved from prior quarter.

From what you've seen so far, do you expect that to sustain here into the fourth quarter? And what do you kind of see as the biggest factors outside of maybe the macro that you already talked about to watch out for that could swing margins?

Rich Voliva -- Executive Vice President and Chief Financial Officer

Hey, Carly, it's Rich. Yes, we're pleased to say what we've seen so far in the loop market -- what we -- in the base oil market, excuse me, is what we've expected, which was really a trough in late first quarter, early second quarter. With some typical seasonality, we're basically expecting us to grind better from here. The supply/demand balance in base oil improves in the next few years, and we'd expect cracks to move with it.

To your point. There is usually a little bit of seasonality around year-end, so that's probably something to watch out for, but we're pretty optimistic going forward here.

Carly Davenport -- Goldman Sachs -- Analyst

Great. Thanks so much.

Operator

Thank you. Our next question comes from Phil Gresh from JP Morgan. Your line is open.

Nick Lampman -- J.P. Morgan -- Analyst

Hi, guys. Nick Lampman on for Phil Gresh. First question would just be on working capital. So 1H, guys, a real strong performance there.

Looks like 3Q was kind of neutral. Was just wondering how you're thinking of working capital going into 4Q. And you've been carrying the high cash balances, wondering if there's any other correlation there.

Rich Voliva -- Executive Vice President and Chief Financial Officer

Yes. So basically, working capital is roughly neutral, you're correct, in the third quarter. What we saw was a build in inventory ahead of all the maintenance we had planned here in the fourth quarter. So we would expect to release that inventory in the fourth quarter, and get that benefit accordingly.

Going -- I'm sorry, I'm spaced on your other question.

Nick Lampman -- J.P. Morgan -- Analyst

All right. Yes. And just to follow up there -- oh, sorry.

Rich Voliva -- Executive Vice President and Chief Financial Officer

Sorry, just on cash balance. Thank you, George. Yes. And then we kept a higher cash balance into the end of the third quarter, again, with an eye to maintenance in the fourth quarter.

We're going to have both the builds for the work performed, and we're going to have some, obviously, lost revenue from having assets down, so we plan accordingly.

Nick Lampman -- J.P. Morgan -- Analyst

OK. And then just to follow up there on -- so how are you guys thinking about capital allocation now going forward? If you're carrying the higher cash balances, you see ability for increase on share repurchases, any further thought on the dividend increase? Or are we really just keeping it there for a possible M&A?

Rich Voliva -- Executive Vice President and Chief Financial Officer

I think we'd start with our cash waterfall that we always reference, which is, first and foremost, we want to protect the balance sheet and the assets. Secondly will the dividend. Third will be growth capital or acquisition, and we view those as equally, the best returns will win. And fourth, if we got excess cash, cash over $500 million will go to share repurchase.

And to your point, we obviously would expect a little bit lower pace of buyback in the fourth quarter, again, just because we've got this maintenance period going, and then we'll see how we go into next year. To your question on the dividend, we're continuing to review that and balancing that with opportunities to grow our business and then what we're hearing from investors and their preferred form of cash return. I'll just note that we view the dividend as a commitment to the shareholder. We do not want to overextend, and again, we want to balance against our total priorities.

So still working on that.

Nick Lampman -- J.P. Morgan -- Analyst

Great. Thanks a lot and congrats on the quarter.

Operator

Thank you. Our next question comes from Matthew Blair, Tutor, Pickering, Holt. Please go ahead. Your line is open.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

Thanks. Just one follow-up. So I think yesterday, Seaway announced a 200,000 barrel per day expansion. They're hoping to do that at a tariff of just $1.25 a barrel, I believe.

George, do you have any thoughts? Does this have any implications for narrower Brent TI differentials going forward?

George Damiris -- President and Chief Executive Officer

No. I think directionally, the $1.25, if it comes to fruition, is lower than we would expect for Cushing if Houston moved. But again, even factoring this in, it's really the incremental barrel that always sets the pricing markets. So when we look forward to the Brent/WTI spread, we still feel confident in that $5 per barrel range.

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

Thank you very much.

Operator

[Operator instructions] Our next question comes from Kalei Akamine from the Bank of America. Your line is open.

Kalei Akamine -- Bank of America Merrill Lynch -- Analyst

Hey, guys. I'm on for Doug. Thanks for taking my question. My first is just on the MLP.

So one of your peers this morning announced a strategic review of their MLP. The market today just not support it. Wondering if you can share any updated thoughts since you guys have the structure of that business and what the strategic benefits to HFC is.

Rich Voliva -- Executive Vice President and Chief Financial Officer

Hey, Kalei, it's Rich. So yes, like HEP's unit price performing has been disappointing and confusing, to be honest. And we're talking about a tax-deferred security with really no commercial risk, a 12% yield in a world where the 10-year treasury is at 1.7. So we're incredibly frustrated, but I know we're also not alone.

So all that said, look, we're going to do what's best for the shareholders. HEP was really formed for two reasons. First, to highlight the value of these assets within HFC, and HEP is still trading at about a 4-turn premium to HollyFrontier. The second was to access the capital markets, and clearly, that -- the equity capital markets in particular and clearly are broken at the moment.

So we'll continue to evaluate our options here and monitor what -- how the market's going. The rate, as we sit here right now, we don't believe a buy-in makes sense. And really, the good news is that we're under no pressure here. HEP is very healthy operationally, commercially, has the right amount of leverage.

It's got a coverage ratio north of one. So we feel comfortable here, and we'll continue to monitor the situation.

Kalei Akamine -- Bank of America Merrill Lynch -- Analyst

Rich, my follow-up is just on the quarter. So the [Inaudible] for the Rockies came in very strong. Anything you can offer there?

Rich Voliva -- Executive Vice President and Chief Financial Officer

Yes. I think we had a couple things going on there, Kalei. Obviously, in the quarter, you'll notice, we have the small refinery exemptions. So you got to clear those out.

It was still up with margins in the Rockies, particularly in Salt Lake City, we're very, very strong, and we had a good clean run there this quarter. So I think you should keep that in mind as well.

Kalei Akamine -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Operator

Thank you. And there are no further questions in the queue at this time. I will turn the floor back over to Craig for any closing remarks.

Craig Biery -- Director, Investor Relations

Thanks, everyone. We appreciate you taking the time to join us on today's call. If you have any questions, as always, reach out to investor relations. Otherwise, we look forward to sharing our fourth-quarter results with you in February.

Operator

[Operator signoff]

Duration: 28 minutes

Call participants:

Craig Biery -- Director, Investor Relations

George Damiris -- President and Chief Executive Officer

Jim Stump -- Senior Vice President, Refining

Tom Creery -- President, Refining and Marketing

Rich Voliva -- Executive Vice President and Chief Financial Officer

Matthew Blair -- Tudor, Pickering, Holt & Co. -- Analyst

Carly Davenport -- Goldman Sachs -- Analyst

Nick Lampman -- J.P. Morgan -- Analyst

Kalei Akamine -- Bank of America Merrill Lynch -- Analyst

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