Should You Invest in CVR Refining?

For Carl Icahn that new MLP smell is sweeter than crude. The activist investor is up nearly 70% since bullying short-term-minded investors out of CVR Energy (CVI -2.35%) last year for just $30 per share. No buyers emerged when the company was on the table for $35 per share, and now Icahn has decided to stick his big fat gains in the faces of, well, everyone. CVR Energy, looking to take advantage of oil benchmark spreads and lower taxes, has rolled out its refining business into a master limited partnership in a recent IPO (S-1 filing). With the awesome success of refiners in 2012, should you invest in CVR Refining (CVRR)? Let's breakdown the moving parts and see if the company gets a passing grade.

We've been here before
First, let's acknowledge a successful story with several parallels. In April 2011, CVR Energy repackaged its nitrogen fertilizer business into CVR Partners (UAN 0.42%) in an attempt to take advantage of strong and growing demand for the industry's products. The result? Shares are up 60% since the IPO and pay happy investors (like me) well over 10% on the debut share price.  

On top of the hefty distribution, CVR Partners has also taken full advantage of its lower corporate tax rate as a limited partnership by spending $130 million on plant expansions in the last two years. The upgrades, which will be functional in early 2013 after an unexpected delay, will increase the company's urea-ammonium-nitrate production capacity by 50%. Despite swiping 5 cents off the distribution, investors have a lot to look forward to in 2013. Not only are farmers in need of more nitrogen after a historic drought last summer, but the company also benefits from low WTI prices by utilizing petroleum coke as its feedstock.

Source: CVR Partners, 2012

Where does all of the pet coke come from? The Coffeyville, Kan., oil refinery right across the street (literally), which is now owned by CVR Refining. Let's dig through the important aspects of the business to see if it merits an investment.

CVR Refining: infrastructure
The company's refining capacity grew to 185,000 barrels per day (bpd) in late 2011 with the acquisition of the Wynnewood facility. In the six months after the acquisition, utilization (on-stream efficiency) rates were improved from 88% to nearly 98%. This occurred at the same time as an $89 million turnaround at Coffeyville. Moreover, up to $50 million of IPO proceeds are already booked for a hydrocracker project that will further enhance the quality of the Wynnewood refinery's products. Does management's focus on quality and efficiency sound familiar to CVR Energy Partners?

Both refineries are within 130 miles of the country's largest oil storage terminals in Cushing, Okla. The proximity to shale oil basins and facilities at Cushing and 350 miles of pipeline allows the company to purchase nearly two-thirds of its crude oil at a $3.82 per barrel discount to the already discounted WTI. Here's a breakdown of crude oil type through the first six months of 2012:

The historically cheap crude oil is stored at the 6 million barrel Broome Station tank farm – representing 7% of Cushing's total storage capacity – before making its way down a 145,000 bpd pipeline to the Coffeyville refinery. This vertically integrated business model doesn't stop with pipelines. CVR Refining owns 125 crude oil transports and also receives various inputs from the adjacent nitrogen fertilizer plant.

Investors should feel very confident in the company's infrastructure.

CVR Refining: customer base
It is important to keep an eye on how dependent a company is on top customers. A major customer's problems could have sudden and disastrous consequences for any company's sales. How does CVR Refining stack up? The company distributes products to its customers via rail, trucks, and pipelines. Customers include retailers, railroads, farmers, CVR Partners, and even the Department of Defense, which sources jet fuel from Wynnewood. In the end, CVR Refining's two largest customers attracted 15% and 12% of total sales in 2011, while the top 10 customers accounted for 64%.

Investors should have no big concerns about the company's well-distributed customer base, either.

CVR Refining: revenue
The rebirth of American refining helped CVR Refining crank out $222.2 million in net income on $726.2 million in revenue through the first six months of 2012. That represents a profit margin of 30.6%, but there is still some cause for concern. It is more likely for the spread between WTI and Brent benchmarks to close in the coming year. Although the company sees a large spread continuing for the long term the EIA projects that oil refiners will lose 53% of their price advantage by 2014.

Investors will want to keep an eye on margins over the next several years and should remain cautious about paying a high premium for growth that, according to the EIA, may be short-lived. I question the sustainability of the crude oil spread, so this is the biggest long-term concern of mine.

Is the trend your friend?
The MLP business structure is becoming an increasingly important part of the industry. Northern Tier Energy (NYSE: NTI), an MLP focused solely on refining and retail of refined products, is trouncing the market with gains of 72% since its IPO in late July. The company's retail segment contains 166 convenience stores and is an important part of operations, but refining capacity sits at just 74,000 bpd. By comparison, CVR Refining will debut with 150% more capacity in a historically low-price crude oil market. 

Phillips 66 (PSX -1.08%) is planning on bundling several pipelines, rail lines, and natural gas liquid assets into an MLP in the back half of 2013. Similar to CVR Energy, which owns over 80% of CVR Refining, Phillips 66 will sell a minority interest in the assets in an attempt to raise up to $400 million. The extra cash will, you guessed it, go to improving infrastructure and fuel growth opportunities.

Foolish bottom line
It should be noted that master limited partnerships are not for everyone. The high dividends – CVR Refining plans to yield an incredibly high 19% ($4.72 per unit) in 2013 – come with different tax responsibilities. Nonetheless, it is becoming a strategic vehicle for asset growth in the chemical and oil and gas industries.

Despite viable concerns and a little more paperwork come tax time, I believe CVR Refining will have some room to run before crude oil benchmarks regress toward each other and will consider buying shares in the next few weeks. Will you be joining me? Let me know in the comments section below.