Investors who left Calumet Specialty Products Partners (CLMT +0.00%) for dead were entirely justified as recently as a couple of quarters ago. Thanks to management's moves recently, though, the situation on the ground is looking much, much better.
To get the company back into a position where it is a worthy long-term investment, however, it will still take some time. Fortunately, its management team has a coherent plan to get there. Here are several quotes from Calumet's most recent conference call that shows where it has made progress and where it intends to go from here.
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Improving debt metrics
Perhaps the greatest threat to Calumet today is its debt load. The prior management team went on a spending binge and loaded the business up on high-interest loans that ultimately led to cutting its distribution. New CEO Timothy Go was handed a crappy hand when he took the reins at the beginning of last year, but he has made the best of it by cutting operational costs and working to generate enough cash to start paying off some of those loans.
The plan is starting to work. While the business isn't generating enough cash to pay it down, it is sufficient to prevent from taking on more debt. Also, increasing EBITDA is improving some of its leverage ratios. According to CFO David Griffin, the company is making progress.
Our improving financial performance is having an impact on our key ratios. Specifically, our debt to trailing 12-month EBITDA has declined [to] 9x, which is much better than where we have been. We remain committed to continued improvements and are targeting a long-term leverage profile of less than 4x.
Our fixed charge coverage ratio has also improved significantly over the last 2 quarters and now stands at 1.3x. And our liquidity, as measured by our revolver availability, has been reasonably steady over the last year since we completed the secured notes offer. This is especially relevant as we have largely stabilized our liquidity while simultaneously building our seasonal inventory during the first quarter to support our summer asphalt business. As we execute against these capital plans in 2017 and continue to drive further self-help initiatives, including lowering costs, higher margins and growth, we expect to become cash flow positive.
In a vacuum, these numbers look atrocious. A company with a nine times debt-to-EBITDA ratio sounds like a business on the brink of collapse. But compared to the third quarter of 2016, when debt to adjusted EBITDA ratio was 22 times, this looks like incredible progress.
The company is by no means out of the woods yet. That loan Griffin mentioned is an 11% interest rate second lien loan. Those kinds of financing deals reek of desperation. So until the company can start to chip away at those high-interest loans, Calumet's profitability is going to suffer immensely.
Hedging our bets
The largest factor for a refiner's profitability on a day-to-day basis is the volatility of crude oil prices. So as a means to alleviate some of those costs, management inked a rather intriguing deal at the end of the quarter that should help to ease some of that variability.
On March 31, we sold almost all of our inventory from our Great Falls refinery to Macquarie, an investment bank. The Great Falls refinery will now purchase all of its crude from them, thus shifting the majority of the underlying commodity exposure to them. Since our borrowing base can swing fairly dramatically with crude oil price movements, this again helps us to derisk the business by stabilizing our long-term liquidity profile as we work to continue to turn the corner in our core base business. We've only taken action with the Great Falls refinery at this time, but we will likely expand the program to include at least one other facility in the future.
Had oil prices increased significantly since that deal was made, it would have looked like a stroke of genius. However, oil prices have declined a little since then. If the company had foreseen it, it's doubtful it would have struck a similar deal.
If the bigger concern is volatility, however, and if the price at which Calumet locked in that deal is in the range it wanted, then this is a pretty good idea. It will be worth watching to see if management does similar deals in the future.
It's the little things
Go's turnaround plan so far has been focused on simple operational fixes to cut costs and run its existing facilities more efficiently. It would seem that based on its most recent earnings results, those moves are paying off. Go went into detail on such things as changing its feedstock crudes and finding new transportation methods for its facilities.
On the raw material optimization front, we are utilizing our heavy-up strategy to improve our cost of crude. This quarter, we processed 36,800 barrels per day of heavy Canadian-based crude oil, which was nearly 5,000 barrels per day more than last year's first quarter. Also of note, we are pleased to report that the new crude oil pipeline that we mentioned last year for our Shreveport refinery started up January 1.
Use of that pipeline has improved our crude oil flexibility and has lowered our delivered crude costs as well. In terms of margin enhancements, we continue to focus on capturing greater efficiencies in our supply chain and saw a $2.7 million reduction in our total transportation and procurement costs during the period.
Western Canadian Select crude has historically been a much cheaper crude than domestic crudes. It is a heavier, harder-to-process crude that doesn't yield the light products like gasoline and diesel. If a refinery is geared to make asphalt, lubricants, and other petroleum products, then Western Canadian Select is a great input crude.
Also, moving from truck deliveries to a pipeline is an absolute no-brainer. It may take some extra up-front cash to make it happen, but it will be worth it in the long run.
New product to drive growth
Once Calumet gets its operational issues under control, Go's next step in the turnaround process is to start to target some quick-hit investment opportunities. These are high-return or growth projects that have a one- to two-year payoff period.
During the quarter, Calumet announced one of those new initiatives: a new Group III base oil for lubricants. Here's Go on the details of what a Group III base oil is and why it is a lucrative market.
[W]e announced that Calumet is introducing its first Group III synthetic base oil, which we call CALPAR 4GIII. The Group III classification characterizes the most highly refined base oil derived from crude oil, providing viscosity index levels above 120 and very high saturate content. CALPAR 4GIII is designed for extensive use in engine oil formulations to improve gas mileage, reduce emissions and extend oil change intervals. Our proprietary technology was developed in-house by our product development team and shows the innovation capabilities of our organization. In fact, with the launch of CALPAR 4GIII, Calumet becomes the first virgin producer of Group III base oils based in the United States. We expect this to have meaningful contributions to our self-help goals this year, and we also know the full impact may take another year to develop.
Just to give you an idea of the return potential for this kind of product, the per-barrel margin for Group III base oils is in the $50-$70 range. Compare that with traditional Group I base oils that get $10-$20 a barrel or gasoline that fetches $5-$15 a barrel. Calumet isn't the only one getting into Group III oils, either. Late last year, HollyFrontier bought Suncor Energy's Ottawa lubricant facility, which is one of the largest Group III oil producers in North America.
For a company that wants to improve margins without having to make significant capital improvements, shifting some of its product mix to Group III base oils is a great place to start.
Asset sales may no longer be in the cards
Some of the assets in Calumet's portfolio just don't make much sense or aren't generating significant returns. This situation led many analysts to believe that management would look to unload some assets to pay down debt. When asked where management is in the process of selling some assets, Senior Vice President Bruce Flemming seemed to suggest that it may not be selling anytime soon.
[W]e're here to maximize shareholder value. And that may have a short or a long-term component, but usually in the portfolio, that's a longer term. So we've got a market point of view for our businesses discretely. We look at what they're worth in context, and there are some intrasystem synergies that are important in that regard, such as between our 2 northern refineries where we have exchanges in materials. So given all that, we've got a pretty good grasp of our hold values, and while we're certainly open to looking at the portfolio and having it evolve, that is only one way to create shareholder value.
Of course, this doesn't speak much to the glaring weakness in the portfolio that is its oil-field services business. It has been a drag on profitability for nine straight quarters. What's even more discouraging is that the business lost money in the first quarter even though onshore drilling activity in the U.S. is up significantly. Unless this part of the business has greater ties to offshore or international drilling, it's hard to see why management hasn't unloaded it already.
