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Holly Energy Partners LP (NYSE:HEP)
Q3 2020 Earnings Call
Nov 4, 2020, 4:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Holly Energy Partners Third Quarter 2020 Conference Call and Webcast. [Operator Instructions] Please note that this conference call is being recorded.

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

Trey Schonter -- Investor Relations

Thanks, Simon, and thank you all for joining our third quarter 2020 earnings call. I am Trey Schonter with Investor Relations for Holly Energy Partners. Joining us today are Rich Voliva, President; and John Harrison, Senior Vice President and CFO.

This morning, we issued a press release announcing results for the quarter ending September 30, 2020. If you would like a copy of today's press release, you may find one on our website at hollyenergy.com.

Before, Rich and John 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, judgments 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, November 4, 2020. 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 a 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 Rich.

Richard L. Voliva -- President

Thanks, Trey. Good afternoon, everyone, and thank you for joining our call today. On behalf of Holly Energy Partners, we hope that you and your families are healthy and safe. I'd like to take a moment to thank our employees for their hard work and their flexibility as we continue to navigate these challenging conditions. During the quarter, I'm happy to report that we maintained safe and reliable operations.

Despite the ongoing volatility and challenging macro environment, HEP delivered solid third quarter results, highlighting the consistency of our fee-based business model, underpinned by long-term minimum volume commitments. During the quarter, total volumes improved 14% across our system, driven by improvement in refined product demand, which in turn drove our customers' refinery utilization. This was most visible on the Frontier and SLC Pipelines, where volumes ramped substantially, and Salt Lake Valley product demand rebounded.

As a result of our minimum volume contracts and customer base, total revenue has remained relatively stable. And we have been able to generate cash flow, which allows us to, both distribute cash to our shareholders and in the third quarter repay $47 million of debt. In October, we announced a $0.35 per unit quarterly cash distribution to be paid on November 12. This represents the same amount paid in the previous quarter.

Turning to project updates. The pipeline portion of our Cushing Connect Joint Venture is currently on schedule and expected to be in service in the first quarter of 2021. We are also excited to announce the expansion of the Frontier Pipeline, which will allow for an additional 10,000 barrels per day of crude oil transport into the Salt Lake City market. Thanks to a successful open season, the project is backed by long-term minimum volume commitments with third-party refiners and is expected to be completed in the third quarter of 2021. Total cost is estimated to be $7 million.

We also announced the tank project to HollyFrontier's Navajo refinery. We plan to build and operate four new refined product tanks with the total shell capacity of 200,000 barrels. These additional tanks will help HollyFrontier optimize refined product deliveries out of its Navajo refinery. Estimated cost of this project is $7.5 million and is expected to be in service in the third quarter of 2021. HEP and HollyFrontier have reached an agreement in principle on the long-term minimum volume commitment.

Additionally, following HollyFrontier's previously announced conversion of the Cheyenne Refinery to renewable diesel production, HEP and HFC have reached an agreement in principle to terminate the existing minimum volume commitments related to HEP's Cheyenne assets, and enter into new agreement effective January 2021. These new agreements will provide for: a 10-year annual lease for HFC use of certain HEP tanks and racks with an annual lease payment of approximately $5 million; a five-year contango service fee arrangement that will utilize HEP tank assets inside the Cheyenne Refinery where HollyFrontier will pay a base tariff to HEP for available crude storage; and HollyFrontier and HEP will split profits generated on crude oil trading opportunities; and a $10 million one-time cash payment from HollyFrontier to HEP for the termination of the existing contract.

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

John Harrison -- Senior Vice President, Chief Financial Officer and Treasurer

Thanks, Rich. For the third quarter of 2020, net income attributable to Holly Energy Partners was $17.8 million, compared to $82.3 million in the third quarter of 2019. Third quarter results reflect special items that collectively decreased net income attributable to HEP by a total of $29.6 million. These items included a $36 million goodwill impairment charge related to our Cheyenne business unit and a $6 million gain related to a business interruption insurance settlement resulting from a loss at HollyFrontier's Woods Cross Refinery. In addition, net income attributable to HEP for the third quarter of 2019 included a gain on sales-type leases of $35.2 million. Excluding these items, third quarter 2020 net income attributable to HEP was $47.4 million, or $0.45 per diluted LP unit, compared to third quarter 2019 net income attributable to HEP of $47.2 million, or $0.45 per diluted LP unit.

Third quarter 2020 adjusted EBITDA was $86.4 million, compared to $90.3 million in the same period last year. The reconciliation table reflecting these adjustments can be found in our press release.

During the quarter, HEP generated distributable cash flow of $76.9 million, an $8 million increase, compared to the same period last year. Our distribution coverage ratio was 2.1 times for the quarter, bringing us to just over 2.0 times year-to-date.

Capital expenditures and joint venture investments during the quarter were approximately $11 million, including $6 million for the Cushing Connect Joint Venture, and approximately $2 million in maintenance capex. We are reducing our full-year 2020 capex forecast from a range of $58 million to $69 million down to $43 million to $58 million, inclusive of our share of joint venture investments. This 20% reduction is largely a result of deferred maintenance and turnaround-related expenditures.

As of September 30, 2020, HEP had approximately $1.4 billion of total debt outstanding, consisting of $500 million of senior notes due 2028, and approximately $950 million drawn on our $1.4 billion revolving credit facility. Our liquidity at the end of the third quarter was $470 million, and our debt to trailing 12-month adjusted EBITDA was 4.1 times, which continues to be well below our leverage covenant of 5.25 times. During the quarter, we repaid $47 million on our revolving credit facility, and we plan to continue using retained cash flow with the goal of reducing leverage down to 3.0 times to 3.5 times.

In summary, despite the challenging macro conditions, our fee-based business model, which is underpinned by long-term minimum volume commitments, allows us to generate positive free cash flow after capital investment and distributions.

So with that, I'd like to turn the call back to the operator to answer questions.

Questions and Answers:

Operator

[Operator Instructions] Thank you. Your first question comes from the line of Spiro Dounis with Credit Suisse. Your line is open.

Spiro Dounis -- Credit Suisse -- Analyst

Hi, Rich. Hi, John.

Richard L. Voliva -- President

Hey, Spiro.

Spiro Dounis -- Credit Suisse -- Analyst

I want to start off -- hey. Just want to start off with Cheyenne recontracting. I was hoping for a little more color there. I was hoping you guys could walk us through what you're resolving for in that renegotiation? On my math, I'm struggling a bit to get the NPV neutral, but maybe that's not the right way to think about it. And then if you could, are you able to disclose the base tariff related to the contango storage bay?

Richard L. Voliva -- President

Sure, Spiro. So, I don't think NPV is the way to think about this. What we're trying to solve for, there were a few things, obviously. HollyFrontier, their assets, their tanks and the rack that HollyFrontier very much wanted to use as part of our new renewable diesel service. There were also frankly some tanks that needed to be demolished in order to make room for the logistics necessary for renewable service, and really, I'm talking about rail there. So, those were the first two things that we're trying to solve for as part of this renegotiation.

And so, then that left us, frankly, with some additional tankage that we wanted to find an opportunity to use. And those -- the plant, as you know, is really well connected to several pipelines in and then connects on to several pipelines down to Cushing, so is well positioned for crude trading hub. So there what we did was look really for an opportunity at what tanks will repurpose well to that service. So, really end up with those three pieces, if you will.

The fee around -- the way probably to think best about the -- our crude trading arrangement is, really it's meant to be sort of a share the cost situation. So, the fees that HollyFrontier will pay to HEP is effectively its share of the operating cost, if you will. And then what we'll do, obviously, we'll be looking for opportunities to trade crude profitably and split those proceeds.

Spiro Dounis -- Credit Suisse -- Analyst

Understood. And then give a sense of how much maybe latent capacity there is with these assets where third parties come in? And based on this well is, is Holly taking up effectively all the capacity? Or could we see you go out and chin up some third-party business too?

Richard L. Voliva -- President

Yeah. We've got some additional tankage and probably a few related assets around the plant that we can still use for further opportunities. So we'll continue to pursue that.

Spiro Dounis -- Credit Suisse -- Analyst

Got it. My second question, just -- maybe this one for John, give a general timeframe on when you'd expect to reach your leverage goal? And ultimately, once you get there, I guess, what's the plan right now you see for the use of that excess free cash flow?

John Harrison -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah. So, overarching goal is, obviously, live within cash flow. So, first and foremost, we want to maintain our assets, then make sure recover that distribution. And then excess cash flow, then we'll go to pay down debt until we get down to that 3.0 times to 3.5 times level.

In terms of pace, so when we can get there? Q4, we have a little bit more capital spend in Cushing Connect, but after that, I think you could see a pretty ratable decrease from there. So the short- to medium-term is probably the best way to describe it.

Spiro Dounis -- Credit Suisse -- Analyst

Okay. And, I guess, once you reached that level, you obviously, have a few options in front of you between share buybacks or increasing the dividend again, or of course, buying something. Are you guys thinking about any one of those buckets more than others?

Richard L. Voliva -- President

No. Spiro, I think you're correct. So we agree with the buckets you laid out and we'll do the thing that makes the most economic sense at that time.

Spiro Dounis -- Credit Suisse -- Analyst

Perfect. That's it from me. Thanks, guys.

John Harrison -- Senior Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

[Operator Instructions] Your next question comes from the line of Joe Martoglio with J.P. Morgan. Your line is open.

Joseph Martoglio -- J.P. Morgan -- Analyst

Hi, guys. One more question here just related to the Cheyenne assets. Is there any capex required to repurpose those for the renewable diesel production?

Richard L. Voliva -- President

Hey, Joe, it's Rich. So, for renewable diesel, there's really not any capital to speak of, and that will be covered by HollyFrontier. We've got a couple million dollars of capital around repurposing the assets for crude storage and trading, and we'll split that -- those dollars with HollyFrontier.

Joseph Martoglio -- J.P. Morgan -- Analyst

Okay. That makes sense. Then also wanted to ask on the Cheyenne pipeline, the crude pipeline that connects there, that's your JV. What's kind of the outlook for that pipeline? And are there opportunities to repurpose that? Or do you still expect some volumes there?

Richard L. Voliva -- President

Yeah. Joe, we do expect us to continue to see volumes there. That line connects Guernsey and the way Casper down into a couple different hubs and on to Cushing. So there is some regular business that flows through there. Importantly, I think that line will get very full in the event but you had a DAPL shutdown, not that -- I have an opinion whether that's going to happen or not. But -- so we do see opportunities around that line. We'll look at all the options around it, too. For us, at this point, it's not integrated with HollyFrontier system really to speak of, but it's a good asset and we'll look to find ways working with Plains to optimize that.

Joseph Martoglio -- J.P. Morgan -- Analyst

Okay. That makes sense. That's helpful. And then, one more, just kind of a bigger picture question. I guess, what are the industry dynamics driving the couple expansion projects you noted, Frontier Aspen and Navajo one? It just kind of seems like bigger picture kind of crude demand is down and refining product demand is down, but you're kind of able to add those two projects. So kind of what was driving that?

Richard L. Voliva -- President

Sure. To your point, let's speak about the short-term and the longer-term. In the short-term, Salt Lake City and the sort of the surrounding refined product markets have held up probably the best of any single area in the US through the COVID-19 effects. So we continue to see pretty high volumes through that area. That is being coupled, frankly, with something -- the longer-term issue of seeing crude production declines in the Uinta Basin and some of the Rocky Mountains, Wyoming and the Utah sweet barrels. That we see is more of a longer-term issue and that's tied more to what we're seeing in the upstream space.

So when you look at the longer-term, that's where the refiners and the value you're seeing what's really a very good product market combined with declining local crude production, and they have to go find ways to feed their plants going forward, which is why we're able to see a few plants sign up for long-term capacity on Frontier. I think you probably see Marathon have a successful open season with the airline as well. So, there really is -- at the end of the day you're talking about long-term need to move crude from the East into Salt Lake to feed those refineries.

Joseph Martoglio -- J.P. Morgan -- Analyst

Got it. That's helpful. Thanks. That's all from me.

Richard L. Voliva -- President

Absolutely.

Operator

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

Trey Schonter -- Investor Relations

All right. Well, 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: 18 minutes

Call participants:

Trey Schonter -- Investor Relations

Richard L. Voliva -- President

John Harrison -- Senior Vice President, Chief Financial Officer and Treasurer

Spiro Dounis -- Credit Suisse -- Analyst

Joseph Martoglio -- J.P. Morgan -- Analyst

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