DINO - HF Sinclair: A Deep Value Play With Recession Resistance For Dividend Investors

2023-05-06 10:00:18 ET

Summary

• Vertical integration throughout midstream and downstream allow this company a certain amount of recession resistance.
• It has a good dividend with a very sustainable payout ratio, along with share buybacks that haven't been reflected in the price.
• Steep drops in share price have put this stock into deep value territory, potentially picking up a big winner at a rock-bottom valuation.

Company Overview

HF Sinclair is a diversified energy company headquartered in Dallas, Texas that manufactures and sells products like gasoline, diesel fuel, jet fuel, chemicals & lubricants, asphalt, and more.

The company primarily markets its refined products in the Southwestern United States and Rocky Mountain regions. The company has also engaged in the growing renewables business, with three production facilities that are expected to produce approximately 380 million gallons of renewables annually.

HF Sinclair operates seven complex refineries in Kansas, Oklahoma, New Mexico, Utah, Washington, and Wyoming through the company's subsidiaries. Additionally, HF Sinclair manufactures base oils and other specialized lubricants in the US, Canada, and the Netherlands and exports products to more than 80 countries.

HF Sinclair supplies fuels to approximately 1,300 independent Sinclair-branded stations and licenses the brand to an additional 300 locations. HF Sinclair also owns a 47% limited partner interest and a non-economic general partner interest in Holly Energy Partners, L.P. (NYSE: HEP ), which provides petroleum product and crude oil transportation, terminaling, storage, and throughput services to the petroleum industry, including HF Sinclair.

Products

The products that the company manufactures can be broken down into three categories. These categories are Light Products, Lubricants & Specialty Products, and Heavy Products.

Light products that the company manufactures include wholesale gasoline, diesel, and ethanol-blended transportation fuels that supply automobiles, light trucks, aircraft, trains, and heavy equipment.

The Lubricants & Specialty Products category includes products like lubricants and base oils marketed under Petro-Canada Lubricants, Sonneborn, Red Giant Oil, and HollyFrontier Specialty Products.

Finally, HF Sinclair also manufactures heavy products that include performance-graded asphalt, fuel oil, carbon black oil, and roofing flux.

Operations

Downstream

Through its subsidiaries HF Sinclair operates seven complex refineries with an annual average crude oil capacity of approximately 678,000 barrels per day. The company's refineries have the capabilities to process heavier, less expensive types of crude and still produce a higher percentage of high-value refined products. In addition, HF Sinclair also has the capability to produce 34,000 barrels per day of lubricant.

The company markets Elite Diesel and DINOCARE, Sinclair's top-tier gasoline, at more than 1600 independent stations across 30 states in the U.S. In addition to the slew of products that the company offers, HF Sinclair is putting a growing focus on renewable energy, like renewable diesel. In today's world where the topic of climate change can subject energy to new regulations, this focus is helping put HF Sinclair ahead of some other downstream companies.

Midstream

HF Sinclair owns and operates crude and product pipelines, loading racks, processing units, terminals, and tanks in and around the company's refining assets. The company's assets are located in attractive high-growth markets. Revenues collected are mainly fee-based with limited commodity risk. The company offers product and crude oil transportation, terminaling, storage, and throughput services.

Revenue

HF Sinclair struggled for several years with revenue, essentially moving sideways, until record profits in 2022 with the rise in oil prices. This windfall of cash allowed them to make some important moves, including conducting share buybacks.

Most importantly, their revenue is estimated to remain relatively flat moving forward as of right now and shouldn't drop back to previous levels. The revenue estimates do not include the full acquisition of HEP, which was announced on May 4. This could put them back on track for growth.

Revenue estimates (currently as of writing):

Source: Sentieo

Let's look at their segment data:

Source: Sentieo

In the conference call yesterday they spoke a bit about their renewables segment, and that it's now finally showing positive EBITDA for the last quarter. They've been having issues sourcing hydrogen for the production process, and they've been able to sort a lot of it out and expect to continue to do so in Q2. An increase in this segment will be important going forward, given the current trend of regulations in governments around the world.

Debt

The newly combined company, HF Sinclair, carries a pretty significant amount of debt. A lot of this has been driven by acquisitions and PP&E. Let's look at their CapEx:

They've certainly spent a ton of capital recently, but given the estimated revenue moving forward it looks like it was a gamble worth taking, since their revenue is going to be at all-time highs for years now. Especially if they get HEP.

They addressed this spending a bit in the latest earnings call:

Valerie Pompa : Yes. So our turnaround spend is -- this year has really been driven by the acquisitions. We acquired several, as you know, new sites, came with refineries ready for turnaround. We've implemented all of those. And we spent really this last year -- we're working towards an optimized turnaround schedule. So that -- I'll call this kind of our catch-up year to really bring all those acquisitions in, address the reliability concerns that we saw and now get us on a run rate for turnaround.

Tim Go: No, Paul, we've told you that this year was a peak turnaround spending year, and we still believe that's the case the next years. Remember, we had the Parco and the Puget Sound and the Casper turnarounds. All three new assets land on this first year of running the full portfolio. So this was a high watermark, if that's the right word to use, on turnaround expenses. We believe future years will be lower than that. And we have guided in the past to kind of a run rate total capital kind of guidance in the $700 million to $800 million range, and we still believe that the right -- that's right level.

As of Q4 2022 they're sitting at an interest coverage ratio of 23x, so we have to assume they can service the debt and the risk in the capex should pay off for them.

Valuation

Given DINO's recent share price declines we've seen their EV/Revenue drop to all-time lows. I really, really like this. Compare this chart with their gross revenues above, and the fact that they're estimated to continue making revenues in the $27B - $29B range. Then add on that they might be able to acquire the remainder of the incredibly synergistic HEP.

This has to leave me believing that this stock is very undervalued. Sure, investors had some reason to be pessimistic with the huge capex and potential recession on the horizon. But I think their capex and debt isn't an issue, and I'll address the recession at the end in the conclusion.

Returning Value to Shareholders

They've been bringing up that dividend significantly since the merger and the windfall 2022 year. This is what I love to see. They've also approved a share buyback, and they have $420M remaining to go. This reduction in share float has not been reflected in share prices, and adds more to the deep value case for DINO.

They spoke a bit on the return of value to shareholders in the last conference call:

Neil Mehta: My first question is related to return of capital. And just could you provide your latest thoughts in terms of the share repurchase program and a lower margin environment than where we were? ...

Atanas Atanasov: ... I'd like to start with, first of all, that we're a capital return business, both the return of and on capital. And we're committed to our long-term capital return strategy as well as our paid out ratio, as Tim indicated. While we're still committed to this strategy, while our transaction with HEP is ongoing, that could impact pace, and we don't guide on pace, but we remain committed to that strategy, and there's really no change there.

Tim Go: You look at our first quarter ... we returned 14% cash return through our dividends and our share buybacks. 85% of net income is what that translates to. So we are on a good pace. We feel like this year is going to be another strong year for us. We've done direct buybacks ... and we've done purchases in the open market. We believe that over the long-term, we'll just continue to do similar things as opportunities arise.

Overall their dividend is very easily sustainable at a measly sub-10% payout ratio, so they have plenty of room to continue raising it over time. They currently pay a 4.31% yield, and with purchasing the rest of HEP will have even more room to raise that with additional vertical integration, lower margins, and higher revenues.

Recession Resistance

Sinclair's partnership with Holly Frontier and Holly Energy Partners, L.P. to form HF Sinclair was a home-run decision and investors should be very pleased with the decision. Holly Frontier adds midstream capabilities such as petroleum product and crude oil transportation, terminaling, storage, and throughput services to an already diverse network of downstream capabilities and products. The company owns and/or operates pipelines, tankage, and terminals all across the western and midwestern United States.

As of May 4th, 2023, HF Sinclair has offered to purchase the remainder of HEP. The share price offered is extremely favorable to HF Sinclair. Purchasing the remainder of this company would turn their previous partnership from a home-run into a grand-slam.

Midstream capabilities help shield the company from the potential effects of the looming recession in the U.S. The success of downstream companies is often tied directly to commodity pricing. However, by vertically integrating into the midstream market, the company has now reduced or eliminated certain terminaling, transportation, and storage costs and now has access to storage facilities.

In addition to reducing costs with midstream capabilities, the company now brings in additional revenues that will largely not be affected by drops in crude oil prices. Approximately 70% of the total tariffs and fees for the midstream division are tied to long-term contracts and minimum volume commitments - protecting revenues from demand decrease in the event of a recession.

Accessing these storage facilities without exuberant costs is imperative during times of price drops as it allows the company to continue production to take advantage of lower input pricing while storing the refined products for a later sale when pricing levels support it. In other words, the refineries can maintain price margins and continue production levels, despite decreased demand.

See my last article here , for a discussion on oil pricing in a recessionary environment and how it can affect the different energy segments.

Renewables

The company's growing renewable energy division should be something to watch for investors. HF Sinclair is well-positioned for growth in this arena as demand for renewable diesel is expected to increase as governments continue advancing low-carbon fuel standard programs, particularly in California and Canada.

Renewable diesel is made with recycled animal fats from restaurants and supermarkets and inedible corn and soybean oil. This renewable diesel can also generally be used anywhere that regular diesel is used, without modification to engines or infrastructure.

Some manufacturers are still approving it for use in their engines, while others only suggest a small mix. Slowly but surely it's making its way through vehicle manufacturers. HF Sinclair has a geographic footprint in key areas and is in close proximity to feedstock and already existing low-carbon fuel markets.

Conclusion

Overall, investors should be bullish about the future of the company. With a growing focus on renewable energy like renewable diesel, the company is well-positioned to capture a large share of emerging renewable markets like California and Canada. The regulation pushed by certain state governments are sure to create more demand for these markets, and HF Sinclair is ready to capitalize.

In the event of a recession, HF Sinclair's performance should be resilient when compared to peers that have not vertically integrated into the midstream market. With a massive jump from 2021 to 2022 in refining, lubricant, and renewable revenues, look for the company to have sizable growth in the coming years. If they're able to complete their acquisition of HEP then the additional revenues would only serve to increase their already impressive jumps.

I've got to look at DINO as a deep value play here, and issue a buy recommendation. Their share price has declined sharply down to the $38 area as of today, May 5, 2023. They're sitting right on a spot of very long term support going back to 2011. I think if there's a place to buy, it's here.

It's a little risky, so if you want it then consider entering in multiple chunks instead of all at once. You could also sell the $35 put for May 19, 2023 and try to enter on that pullback. Worst case scenario, you keep the premium.

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.

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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