Source: HollyFrontier.
Unlike many other companies in the oil and gas space, refiners like HollyFrontier (HFC +0.00%) have had a pretty good run as of late. For HollyFrontier, not only has the decline in oil prices helped increase profit margins, but the company itself has recently completed a few projects that should help it produce better-than-average returns for a while. This was something that the company highlighted in its recent conference call with investors and analysts, but it wasn't the only thing. Here are five quotes from management that indicate what it is planning for in both the near- and long-term future.
1. We're running a very efficient operation right now
Refineries have a lot of fixed costs like labor and equipment, so profitability with these facilities is determined in large part by the ability to run at high efficiency. According to management, it is doing just that right now:
Second quarter 2015 refinery utilization rate was 101% of nameplate capacity and 106% of expected crude throughput, the highest quarterly rate realized since our merger. -- CEO Michael C. Jennings
Thanks to some well-placed capital investments in its facilities over the past couple of years to bring in new technology and give each of its refineries the ability to run several different crude qualities, it has resulted in very strong operational results. This in turn brings down per-barrel operating costs and increases net income. Based on management's projections, it doesn't anticipate any downtime for the rest of 2015, so barring any unforeseen events, the company should be able to crank out similar results for the rest of the year.
2. Growth is coming, so we're buying shares now
For years, HollyFrontier paid a very generous special dividend on top of its regular dividend that yields 2.9% today. At the beginning of the year, though, it changed strategy and is using that special dividend money to buy back shares. The reason it started that plan was that it believed shares were undervalued. Even after several hundred million in share repurchases this year, it still sees room to make more:
We feel like we have a very visible plan that stands to increase the value of the company by 50% or so. And with that in mind, our shares are undervalued in our view. It's not opportunistic in terms of buying gifts. It's opportunistic in terms of putting our capital to work more efficiently, particularly in view of what we think the company will be worth as we execute this plan. -- Jennings
It's hard to say whether management's assessment of the company's value is completely accurate because market conditions can change. At least we know that management believes in it enough to put large amounts of cash flow into buying back shares. That, more than anything else, should be a sign that the company is confident in its outlook.
3. We could even tap the debt market to buy shares
In fact, the company is so confident in its future value that it is viewing the possibility of issuing debt pretty soon in order to buy back shares at an even faster rate:
The trajectory for this year's EBITDA is obviously very strong. As we think about it going forward, though, I would expect that at some point over the next 6 to 9 months we'd likely be issuers of some debt securities and be able to use that capital toward share buyback. -- CFO Douglas S. Aron
This may sound slightly concerning for an investor, because typically buying stock by taking on debt sounds like a risky move. Before jumping to conclusions, consider this: The company's current long-term debt outstanding -- excluding its MLP non-recourse debt -- is less than $100 million. Management is looking to target a debt-to-EBITDA ratio of 1.0 times, which is still a pretty conservative debt ratio. So this could be a decent opportunity for the company to increase shareholder value without stretching its finances.
4. Some deals were in the works, but they are on hold for now
At the end of last month, news leaked that Tesoro was in negotiations to acquire HollyFrontier. However, those talks broke down. HollyFrontier itself has been mum about future deals, but it did mention last quarter that it would like to facilitate some consolidation in the industry. It appears that for now, that strategy has changed:
I think that the market probably reads it a little bit wrong. We were very involved and hopeful toward a large and transformative acquisition and had pretty high expectations along that front. It obviously didn't work out and we needed to make a strategic shift. That shift involved a hard internal focus of what we can do inside the fence to drive value at this company. And that's where the plan comes from. So Reuters and whatever else really isn't relevant to that assessment. It's simply what do you do following missing a large transformative opportunity to take control of your own destiny, and that's what we're doing now. -- Jennings
By the sound of it, HollyFrontier's management has shied away from the merger and acquisition talks. However, based on some other comments, it hasn't completely ruled out other deals in the future. If the company can do a deal that not only makes financial sense but that fits well into the company's existing asset profile, then HollyFrontier will certainly be interested.
5. We don't expect to do a lot of growth at Holly Energy Partners anytime soon
Holley Energy Partners (HEP +0.00%) has been a core aspect of the larger company's growth strategy for many years. Not only has the parent company benefited from the distribution payments that comes from shares and incentive distribution rights ownership, but Holly Energy Partners' assets have specifically been developed to increase HollyFrontier's ability to source crude oil from multiple sources at its refineries. There is definitely room to grow Holly Energy Partners in the future through dropdowns of assets, but there is one element Jennings mentioned that may slow that growth today:
The ability to absorb drops really relates to the ability to raise capital principally. HEP is an effective operating organization, and I don't think they have any problem folding these in. The ability to raise capital, the MLPs have gotten hit pretty hard in the last month or 2, but I think we need to -- we will distinguish HEP as the high-quality asset that it is. Its cash flows are very, very predictable. Currently it yields 7%, which I think is an undervalued HEP. But through time, its lack of commodity exposure and very consistent yields I think will show through and it will be able to raise capital pretty efficiently, particularly with the addition of some growth-based drops from HFC.
Over the past year or so, shares of Holly Energy Partners have declined about 11%, and at some points, it was trading well below that. Since issuing shares is a form of currency for making dropdowns, it would require that much extra dilution to make those deals happen today. Based on where things are, management thinks it's prudent to wait until shares have a higher value before making any big moves.
What a Fool believes
HollyFontier's excellent results are not just the whims of the oil and gas market. Management has done a very commendable job of building highly efficient operations at all of its refineries, which has helped to drive some of the best returns on capital employed in the business. With targeted investments it has coming online, its large share repurchase program, and a management team on the lookout for just the right time and place to make a deal, it looks as though HollyFrontier is well positioned for the long term.
