CVI - CVR Energy: Economic Uncertainty And Potential Dividend Cuts On The Horizon

2023-06-06 22:51:21 ET

Summary

• CVR Energy has a strong industry position and diversified business but is vulnerable to commodity pricing and potential dividend cuts.
• CVI's petroleum and fertilizer segments are geographically well-located and have high utilization rates, driving growth.
• Despite these strengths, the current economic backdrop and commodity volatility make CVR Energy a hold, not a buy, for investors.

Thesis

CVR Energy (CVI) has decent industry positioning, especially with its geographical location in Cushing, Oklahoma. It's business is well diversified, but unfortunately is still quite vulnerable to commodity pricing - especially with the current economic backdrop.

The dividend is what everyone is interested in with this stock, but that too is in question. They made it clear that last year's special dividends will not be repeated, and going forward they may need to reassess the base dividend if they spin off their stake in their nitrogen fertilizer business.

As you read through the article, you'll see why I came to the conclusion that this company - although not a bad performer - should currently be labelled a hold and not a buy.

Company Overview

CVR Energy is a diversified holding company primarily engaged in the renewable fuels and petroleum refining and marketing business - as well as the nitrogen fertilizer manufacturing business.

The company is headquartered out of Sugarland, Texas (a Houston suburb) with an increasing focus on the production of renewable biofuels, the energy transition, and lower carbon emissions fuels. CVR Energy is an integrated midstream and downstream company.

The company also formed CVR Partners (traded on the NYSE as UAN) as a growth-oriented limited partnership to own, operate, and grow its nitrogen fertilizer business. CVR Partners operates two nitrogen fertilizer plants located in key farming areas in Kansas and Illinois as nitrogen fertilizer is often applied to corn fields across the corn belt and southern plains. With the growing number of larger farm operations across the Midwest and shrinking smaller operations, the use of nitrogen fertilizer has continued to grow.

The company is currently considering spinning off their interest in UAN, but has no firm plans in place as of the latest earnings conference call :

We are also continuing to evaluate the potential transaction to spin off our GP and LP interests in CVR Partners, and I look forward to providing you additional details at the appropriate time.

Operations

CVR Energy has two main segments of their business - the petroleum segment and the fertilizer segment. They are diversified across both the midstream and downstream segments of the oil & gas industry between their gathering facilities and refining facilities.

The petroleum segment is comprised of two mid-continent complex refineries and an impressive amount and strategically located associated logistics assets, including a significant crude oil gathering business. The company's nitrogen fertilizer segment is comprised of ownership of the general partner and approximate 37% of the common units of CVR Partners, LP ( UAN ).

Petroleum Segment

The company's petroleum segment consists of two complex refineries that hold a 206,500 barrel per day oil capacity close to Cushing, Oklahoma - one of, if not THE MOST prolific and largest gathering hub in North America. With direct access to crude oil fields in the Anadarko and Arkoma Basins, the company is very well geographically located.

This provides a variety of price advantaged crude oil supply options where the company has 100% exposure to WTI-Brent differential. The company's throughput for 2022 was at 97% liquid volume yield and 92% yield of gasoline and distillate - numbers investors should like to see.

CVR Energy also has numerous complimentary logistics assets with access to multiple key pipelines that include over 950 miles of pipeline, over 7 million barrels of crude oil and product storage capacity, and 112 crude oil and LPG tractor-trailers.

Fertilizer Segment

CVI Energy owns the general partner and 37% of the common units of CVR Partners, LP - the company that CVR Energy formed to own and operate its nitrogen business. The company has 2 strategically located nitrogen plants across the southern plains and corn belt in Kansas and Illinois.

With the companies refining operations in Houston, the company has a diverse feedstock exposure through petroleum coke and natural gas. In other words the company has ample supply of feedstocks for its nitrogen business through its petroleum refining business - a natural complement to its core business as can be seen from other major players in the downstream sector.

CVR Energy has shown to consistently maintain high utilization rates at production facilities and this can be seen by the growth of the business.

Revenue

Overall we see the company performing well with the desirable "up-and-to-the-right" revenue curve. They're scheduled however to drop in the coming years:

Their revenue has been erratic, but they have always managed to increase it eventually. At the present, their internal segmentation lists distillates and gasoline as their largest drivers of revenue, around $9B of 2022's total.

Debt

They have regularly been issuing debt, and currently it's primarily in the form of 5.25% - 6.125% fixed interest senior notes. They didn't address a repayment plan in the latest earnings call or the investor presentation, nor was it asked in Q&A. Currently they show a 13.7x interest coverage ratio, however, so there are no concerns that they can service it.

Returning Value to Shareholders

In their latest earnings call they made it clear that the large dividend payments made last year will not be repeated, nor are they planning to raise the base dividend (emphasis added by author):

John Royall

So, maybe just a follow-up on that last discussion on dividends. Maybe you could just give us some updated thoughts on the potential for specials. I think Dave referred to the specials from last year as kind of one-offs on the prior conference call , and correct me if I'm mischaracterizing that. But you did have over $200 million of free cash in 1Q, including the UAN tax payment, and you've locked in some hedges in the future. And so any updated thoughts on the propensity to pay out some of that with the special going forward?

Dave Lamp

Well, I think the specials, as I mentioned before, was really around a unique set of market conditions. I've been in this business a long time, and I've never seen cracks where they were for a pretty sustained period of time in 2022. And that's why we did specials. We didn't think about raising the regular up to that because we didn't think it was sustainable. And I think the same situation is here. As you know, we're going to take it quarter by quarter and the Board looks at it very closely. We're managing cash to levels we think we need to avoid using our revolver unless we absolutely have to. And that's just the point of view we have. So, specials will come and go there -- if the market is remarkable, and we have the cash on the balance sheet to dividend out, we will.

They also touched on share buybacks and said that they don't believe that buybacks are "really necessarily in the best interest of our shareholders."

It's important to note that they've issued shares in the past to raise capital so there's nothing preventing them from doing so in the future, especially if their dividend drops. There was discussion in the conference call over that as well, since if they spin off their ownership shares in UAN then their cashflow will drop and they'll likely need to reduce dividends:

If we do the spin-off, I think we'll have to look at the dividend again because that's just the effect of doing the spin-off.

That situation could potentially make it more advantageous to issue shares rather than notes to raise capital, so investors need to be wary of that possible share float dilution.

Valuation

It's at the low end of its valuation since COVID, and this is likely deserved. With the current economic backdrop and the company's strong exposure to commodity pricing it makes sense for investors to be concerned over the company's short-term prospects. There's also the question of whether or not their dividend will be cut if they decide to toss their UAN ownership stake. The current valuation, although low, seems appropriate.

Last Earnings Call

A few additional items in the conference call were of note:

CVR Energy had a strong first quarter that was driven by high gas and diesel margins in the refining segment and a record high production volume in the fertilizer segment. Investors should note that refined product inventories have fallen to below five-year average levels in the U.S. However, there have been strong product liftings with higher demand for diesel due to agricultural demand rising across the Midwest during planting season.

Another key point for investors to take away is the high margins for premium gasoline - with approximately 50% of gasoline production being premium. Investors can evaluate demand for premium gasoline in the U.S. to predict revenue rises or drops in the company's petroleum business.

Conclusion

The company is very well diversified and is vertically integrated into the midstream and downstream sectors of the oil & gas industry with a heavy presence in the agriculture business as well. The company seamlessly uses byproducts from its petroleum refining business for feedstock in its nitrogen manufacturing business - giving the company the lowest possible cost of feed source material, something every investor loves to see.

Investors should also take note of the extensive marketing & trading segment of their downstream business. The company has a commodity trading desk that capitalizes on spreads in their refined products markets as well as crude WTI to Brent spread ratios.

This is important for investors to know because this shows that the company is always proactive against market trends and potential commodity price swings - and not reactive like is so often the case. While hedging futures contracts vs deliverables is incredibly common in the downstream market, CVR Energy rightfully places a premium on maximizing margins through these strategies.

CVR Energy is also characterized by their geographical presence near Cushing, Oklahoma. Cushing is the most traded market hub in North America, with access to Canadian oil and all the oil produced in the United States. Pipelines from Canada, the west coast, the east coast, and across the Utah/Colorado basins all converge through Cushing, Oklahoma so this is a highly desirable place to be for primarily downstream companies.

Access to these pipelines ensures that the product gets delivered to the highest demand market for said product - ensuring that companies get the highest prices and margins possible on both their crude oil and refined products. On top of the convergence of these pipelines, some of these pipelines also run south to north, allowing the company to ship its refined products back up north. This means that all of these products travel the cheapest and most direct route to market - and this is all made possible by the company's geographical presence near Cushing, Oklahoma.

The nitrogen fertilizer segment of their business is also of particular interest. Nitrogen fertilizer is used everywhere across the southern plains and corn belt, and heavily in corn fields. And as we discussed earlier, as farm operations continue to consolidate and become larger and more corporate, there will continue to be growth in demand for nitrogen with the operations using larger and more complex spraying equipment which ultimately allows more land to be sprayed and more nitrogen to be used. I look for the nitrogen business to drive continued growth and help protect the company from any potential sharp declines in commodity prices.

Lastly, investors should know that in the event of a recession and drop in demand for consumer products, the company will certainly be affected by commodity price drops as it is directly exposed to market pricing in its petroleum refining business.

That being said, the company should be able to maximize margins across its business with the trading desk if this happens, but demand drop in the face of a recession will certainly hurt the company and throughput volumes in its refining business. The nitrogen business will also help mitigate losses from commodity price drops.

All in all - investors should know that risk does exist with direct exposure to commodity price drops as well as a potential dividend cut in the face of spinning off their stake in UAN.

With the current potential looming recession and commodity volatility I believe it wise to issue a hold on this stock. There are better choices in the market for an investor's limited capital.

About this article: When I research stocks I start with a "bird's eye view" of the target company. Many of the things I went through in this article are what I'll look at first.

When this bird's eye view is complete, I'll decide if I want to avoid the company for the time being or if it's a potential candidate for investment. This article that you are reading is the result of my bird's eye view examination.

It is designed to be an overall high-level view of the company that you can read to determine if this company is something that you might consider as a candidate for investment. It is not possible to report everything about a company in the space of a single article, nor is it possible for me as an author to learn every detail about a company in the amount of time allotted to write an article.

You should not take my final conclusion on the company as your sole recommendation for investment, and you should conduct further in-depth research on your own to come to your final conclusions.

As a result of this, my "buy" recommendations come with an asterisk. And that asterisk is that this is only a high-level examination, and in-depth research that can take many hours, or days, of your time is still required. This is why my articles are short and to the point, with no fluff or filler. Just the facts that you need to know to move forward.

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