The theme surrounding refining companies' earnings this quarter has been keeping afloat amid a big slide in margins. Western Refining (WNR +0.00%) kept this theme going when it reported a 78% drop in earnings compared with the same period last year. This has put a wrench into the plan that Western laid out last quarter. Let's take a look at Western Refining's results for the quarter and examine why this recent earnings decline is putting a hold on management's plan.
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By the numbers
| Results* | Q3 2016 | Q2 2016 | Q3 2015 |
|---|---|---|---|
| Revenue | $2,065 | $2,107 | $2,569 |
| Operating income | $86.9 | $163.4 | $332.6 |
| Net income | $38.5 | $65.4 | $153.3 |
| Earnings per share | $0.35 | $0.70 | $1.61 |
*in millions, except per-share data. Data source: Western Refining earnings release.
Last quarter, Western Refining's management announced that it was going to stop buying back shares and focus on debt reduction for a while, after completing the acquisition of Northern Tier. Unfortunately, there isn't a whole lot of cash coming in the door to do this. Free cash flow for the quarter was a rather meager $65 million, and after shelling out $49 million in dividends, there wasn't much left for the company to pay down debt.
This isn't necessarily management's fault. Free cash flow just happened to fall at a time when refining margins across the industry have fallen sharply. Just about every refiner that has reported so far this quarter has produced very thin profit margins. For Western, operating income per barrel declined 54%, from $15.61 per barrel to $7.09, due to the decline in gross refining margins.
Luckily for Western, it doesn't appear to be in the same financial bind it was in a few years ago when its debt levels were scaring off investors left and right. Even at today's lower refining margins, all of its refineries are generating positive returns. Also, its debt levels aren't nearly as bad as they were the last time Western made a large acquisition.
The only move of note this past quarter was the transfer of storage and terminal assets from the former Northern Tier portfolio into Western Refining Logistics (NYSE: WNRL), Western's subsidiary partnership, for a purchase price of $210 million.
What management had to say
As CEO Jeff Stevens said in the earnings release, the company had some ups and downs this quarter from volatile oil prices and narrowing margins. Looking ahead, he highlighted some of the work the company is putting into its newest refinery to help boost returns from this already profitable refinery:
The fourth quarter has started off well. We completed a number of capital investments during the St. Paul Park turnaround which allows us to increase our crude oil throughout by 4,000 barrels per day and should improve our distillate yield by two percent. Our crude oil throughput capacity at St. Paul Park is currently 102,000 barrels per day. With the two new desalters, we have also added greater optionality in our crude oil slate for the refinery. These investments position us well for future profitability.
Based on the performance of the St. Paul Park refinery, this investment should prove to be money well spent. It has consistently achieved the highest gross margin per throughput barrel of every independent refinery in the country thanks to its proximity to cheaper crude oils from the Bakken shale in North Dakota and Canadian heavy crude.
What a Fool believes
Western Refining's debt-reduction plan didn't exactly start out on the right foot, but that is mostly a product of factors out of managements hands. Investors don't need to worry too much about this not happening over a single quarter, but a sustained lull in refining margins would make it difficult to enact this plan. For the time being, all it can do is focus on running its facilities at high rates and low cost. If it can continue to do that, then the company will be well-positioned when refining margins do trend back up.
