Alon USA Energy (NYSE:ALJ), which went public in July, reported its third-quarter earnings Tuesday afternoon. Earnings per share for the quarter and the first nine months of 2005 were nearly triple the 2004 numbers, reflecting strong pricing power in the refined products market. Beyond the current numbers, however, I believe there is a compelling growth story for this small refining and marketing company. It has a successful parent company in the Alon Israel Oil Company, experienced management, a differentiated business model, and an incentive plan that would warm a Fool's heart. Furthermore, it is difficult for big oil to expand its footprint in the U.S., giving smaller refining companies an edge.
Alon USA's current chairman, David Wiessman, bought a controlling stake in Alon Israel Oil Company in 1992. Mr. Wiessman aggressively grew the retail side of the business from nothing to a 20% market share in Israel. His plan focused heavily on retail outlets -- adding convenience stores, commercial centers, and fast-food restaurants such as the KFC and Pizza Hut units of Yum! Brands (NYSE:YUM).
Rapid, retail-fueled expansion also appears to be under way at Alon USA. The company was formed in 2000 by purchasing Fina Inc.'s downstream operations in the U.S., which included the Fina brand name and the refinery, pipelines, and terminals in Big Spring, Texas. In 2001, the company completed its acquisition of Southwest Convenience Stores, the largest licensee of 7-Eleven convenience stores in the U.S., adding 167 retail locations to Alon's portfolio.
However, unlike Israel in 1992, the U.S. has plenty of convenience stores already. Therefore, Alon USA is also aggressively growing its petroleum business. The company has acquired additional pipelines to deliver more fuel to its retail outlets and a more flexible crude supply to the refinery. In 2005, an expansion project at the Big Spring refinery increased its capacity by 8,000 barrels per day (bpd) at the cost of $800 per bpd. This is an outstanding use of capital, as new refinery construction can cost nearly $10,000 per bpd. The company plans to further expand the refinery to a total capacity of 75,000 bpd in 2008.
Though it's a small player in the gasoline market, Alon USA is the second-largest supplier of asphalt in Texas -- the largest paving market in the U.S. Alon focuses on rubberized asphalt, making them one of only a few suppliers in the country. Why is this important? Rubberized asphalt is a higher-margin business, used for high-duty services such as interstate highways and airport runways. Alon has expanded this business with the purchase of an asphalt blending terminal in California -- the second-largest paving market in the U.S. -- with plans to purchase additional asphalt terminals and refineries.
Beyond Mr. Wiessman, management at Alon USA has deep experience in the refining and marketing business. Most of the senior managers come from either Alon Israel or Fina. President and CEO Jeff Morris has worked in the refining business since he began his career with Fina in 1974.
Better yet, the compensation plan at Alon is aligned with shareholder interests. According to Capital IQ, Morris is the highest-paid manager, with an annual base salary of $290,000. (His total cash compensation for 2004, including bonus, was $754,000.) Even more importantly, management only gets bonuses when the company produces free cash flow.
At current prices near $18.50, Alon USA shares are worth a look. Alon's P/E ratio is less than 12, and the company has plenty of growth potential. The company has $90 million more cash on its balance sheet than total debt (thanks, in part, to the July IPO). In contrast, competitors such as Giant Industries (NYSE:GI) and Tesoro (NYSE:TSO) are burdened with much more debt than cash. Alon has generated positive free cash flow in four out of the past five years, and is free cash flow positive over the first nine months of the current year. The company's free cash flow turned negative in the past three months, however, due to unfinished gasoline and diesel inventories, which built up following an unplanned shutdown at one of Alon's refineries. In the earnings report, CEO Morris stated that "operations are back to normal." Free cash flow should become positive once again in the fourth quarter.
In another happy sign for shareholders, Alon USA has indicated that it intends to start paying a $0.16-per-share dividend. Few companies would make such a commitment so soon after its IPO.
Of course, Alon USA operates in a cyclical business. The crack spread, the price difference between crude oil and refined products, topped $12 per barrel for the first nine months of 2005, far beyond historical norms of around $4 per barrel. When the cycle inevitably turns down, earnings will take a hit. Yet, because it is nearly impossible to build a new refinery in the U.S., strong pricing may persist for a few more years. By the time the next down cycle arrives, Alon will probably be a much larger company.
Before we all jump in and buy the whole company, it is important to note that Alon Israel continues to own a majority stake (about 75%) in Alon USA. However, with shareholder-friendly policies, experienced management, and a solid growth plan in a profitable niche, I expect Alon to outperform its peers and the rest of the market in the years to come.
Related petro-Foolishness:
7-Eleven was a Motley Fool Stock Advisor pick.
Robert Aronen owns shares of none of the companies mentioned, but he remembers Tesoro shares trading for $1.70 as if it were yesterday. Please feel free to share your comments with him at [email protected].
