Better Buy: Calumet Specialty Products Partners LP vs. Delek US Holdings

Cheap shale oil, the world's best refinery infrastructure, and favorable spreads between domestic and international oil prices all combined to hand American refiners an awesome operations year in 2017. That macro backdrop also helped to propel two refiners in desperate need of a boost: Calumet Specialty Products Partners LP (CLMT -3.83%) and Delek US Holdings (DK -0.87%).

The two refinery stocks are nearly neck-and-neck when it comes to returns in the last year, at 88% and 84%, respectively. While both face opportunities and challenges in the year ahead as they navigate domestic and global markets, there are notable differences for investors to consider. Which downstream oil stock is the better buy right now?

Image source: Getty Images.

The matchup

Calumet Specialty Products is aiming to refocus its business on manufacturing chemicals at the highest end of the refined products value spectrum, although traditional fuel products such as gasoline and jet fuel still provide close to half of the company's adjusted EBITDA. The turnaround strategy's two priorities are to deleverage and to discover consistently profitable growth. Considering the gross margin per barrel of specialty products was $34 in 2017, compared to just $4.61 per barrel for fuel products, it's easy to see why management wants to lean more heavily on the highest margin goods.

While the specialty products manufacturer posted a net loss of $104 million last year, close to $84 million of that came in the final quarter of the year, half of which was due to a non-cash impairment charge. But the company managed to post improving margins on a year-over-year basis in four consecutive quarters. In fact, in 2017 Calumet Specialty Products posted its second-best gross margin in the last five years and its highest level of operating income.

But one line item has made net earnings hard to come by in recent years: interest expense. In 2017 the company spent $183 million paying interest on its debt, which immediately ate up its $158 million operating profit. Management has been keen to restructure and repay the debt, and recently announced progress on that front. Asset sales allowed Calumet Specialty Products to redeem $400 million in debt notes with 11.5% interest rates, which will save an estimated $46 million in interest expense each year going forward. All in all, the company is headed in the right direction.

Image source: Getty Images.

The much larger Delek US Holdings is a more traditional refiner focused primarily on transportation fuels, although it also operates retail and logistics segments. Similar to Calumet Specialty Products, the company is directly exposed to commodity prices. The difference is the corporate structure, which includes ownership stakes in master limited partnerships such as Delek Logistics Partners that feed profits back to the parent through midstream operations.

The advantages showed last year. Delek US Holdings reported operating income of $186 million in 2017, while benefits from the recent corporate tax rate changes helped to push net income for the year to $289 million. But even that wasn't the biggest development for shareholders.

The Texas-based refiner acquired all of the equity of Alon USA Energy and Alon USA Partners that it didn't already own, which doubled its operations. More importantly, the merger cemented Delek USA Holdings as a leading downstream player in the Permian Basin, including refining, logistics, and retail assets. Combine that with recent divestitures of non-core asphalt production and renewable diesel assets in California, and it's easy to see management is all-in on the Permian Basin. Plus, with plans to drop down the acquired logistic assets to its own MLP, even more value will be unlocked for shareholders over time.

Image source: Getty Images.

By the numbers

Shares of both Calumet Specialty Products and Delek US Holdings have bounced back since hitting multi-year lows in early 2016. Then again, it was difficult for any American refining stock to disappoint in 2017 given the favorable market conditions. That's why investors should consider the resilience of each business as a key differentiator in the head-to-head matchup.

Source: Financial Visualizations.

That's not a very favorable comparison for Calumet Specialty Products, and Wall Street analysts don't expect the company to post net income in 2018. A lack of earnings potential is reflected in the company's low price to sales ratio, since revenue isn't valuable if it cannot be turned into profits. The company's high level of debt is also evident in valuation metrics, including a stratospheric debt to equity ratio. That will drop considerably after the recent debt redemption transactions are reflected, but it won't come close to matching that of its larger peer.

There aren't any red flags in the valuation metrics of Delek US Holdings. However, it should be noted that the tax benefit provided a healthy boost to 2017 earnings, which had the effect of lowering its current P/E to just 11. That's expected to rise in 2018 -- this benefit will no longer be factored in, and there will be a slightly less favorable operating environment for domestic refiners than last year. Then again, with a robust network of downstream operations in the heart of America's most important energy play, the business is well positioned for growth in the years ahead.

The better buy is...

While there's no denying that Calumet Specialty Products is making solid progress with its turnaround, it will likely take years to deliver consistent profits at meaningful levels -- if that can be achieved at all. An investment in the specialty refiner brings more direct exposure to commodity prices than other refining MLPs because the company doesn't have any pipeline or logistics assets to provide a consistent cushion against volatility. So although investors could find handsome rewards by correctly betting on a turnaround, several consecutive years of losses hint at the difficult road ahead for the business.

Delek US Holdings is clearly the better buy in this matchup. The corporate structure is more resilient to volatility from commodity prices, and the acquisition of Alon USA's network provides ample opportunity for profitable growth in the all-important Permian Basin. That said, the stock is still more expensive than other, larger refiners such as Phillips 66 and HollyFrontier, so investors interested in downstream oil stocks may want to broaden their search before pulling the trigger here.