PBF - PBF Energy: Attractive As Capital Returns Accelerate

2023-11-02 23:24:25 ET

Summary

• PBF Energy's shares have been a mixed performer, but management's shift towards rewarding shareholders could boost share price appreciation.
• Q3 earnings beat expectations with higher EPS and revenue, despite a decline in throughput and refining margins.
• PBF's strong balance sheet and focus on returning capital to shareholders through dividends and buybacks make it an attractive investment opportunity.

Shares of PBF Energy ( PBF ) have been a mixed performer over the past year, trading slightly higher but lagging the overall market’s gain. Shares did fall about 2% in response to Q3 earnings, despite a 25% increase in the dividend to $0.25. While the company will face some downtime in Q4, forcing an increase in cap-ex spending, management is pivoting from paying down debt to rewarding shareholders, and this can be a meaningful catalyst for share price appreciation in my view.

In the company’s third quarter , PBF earned $6.11 in EPS, $1.24 ahead of consensus as revenue beat by $440 million at $10.7 billion. EPS was down from $8.40 last year as an extraordinary refining environment has turned merely into a “good” one. So far in 2023, PBF has generated $16.76 in earnings, but $9.41 excluding special items, related to the launch of its St. Bernard renewables facility.

Revenue was down by $1.7 billion from last year, but this was because oil prices fell by 13%. Refiners are agnostic as to the level of oil prices to a large degree, what matters is the spread they can earn by turning oil into gasoline, diesel, and other products. So while revenue fell, operating expenses also fell by $1.7 billion, providing a significant pass-through benefit.

As such, income from operations was $1.15 billion from $1.4 billion last year, excluding special items. There were two reasons for the year over year decline. First, throughput of 940,000bpd was down from 985,000 last year. This was primarily because West Coast production was down 10% from last to 295k. PBF is doing significant turnaround work to improve the West Coast facilities. Because of this work, 2023 adjusted cap-ex is going to be higher than initially expected at $800-850 million.

Due to ongoing turnaround work at these facilities, throughput will also be lower during Q4, at about 900,000bpd. Q4 is also seasonally softer typically. Gasoline consumption tends to peak during the summer as families take summer vacations and road-trips and then decline in the winter. That makes this an opportune time to complete turnaround work and having lower utilization before demand begins to ramp back up again in Q2 of next year.

Alongside lower throughput, refining margins did narrow in the quarter with gross refining margins of $22.24 from $24.96. This is still a relatively strong level, but last year margins were extremely wide as there was a final summer of “revenge travel” and Russian sanctions caused product markets, particularly diesel, to get extremely tight. 321 crack spreads, which measure the margin refiners get from turning oil into gasoline and diesel, have narrowed as markets have normalized but still do remain wide by historic standards, which is why PBF has been very profitable.

It is my view that margins are likely to structurally remain relatively wide, certainly wider than the pre-COVID norm because we have limited refining capacity with no growth globally over the past four years, even as consumption continues to grow about 1% per year, and this increased tightness increases refiners’ pricing power, all else equal.

The trend is even worse in the US where refining capacity has been falling since 2019 as some small refineries have closed. Additionally, it is all but impossible to imagine another major refiner being built in the US, given the regulatory environment, cost (Mexico’s refinery ended up costing $20 billion ), and focus on shifting to renewable energy. As a consequence, this strong operating environment for refining should remain the structural norm. There will be cyclical swings, of course, but on average, margins should stay wider.

Critically, we are at an inflection point as PBF can now start shifting its focus from creditors to stockholders. With its strong cash flow, thanks to $2.5 billion in EBITDA this year, and $845 million in investments received for its St. Bernard renewables diesel biorefinery joint venture, which is up and running, producing 17,000 barrels a day and turning a small profit, PBF has brought its balance sheet onto stellar footing. It has $1.9 billion of cash on its balance sheet. Against, this it has just $1.2 billion of debt, down $170 million in the quarter. It also extended 2025 debt to 2030, eliminating any near-term financing needs.

During the quarter, it reduced its environmental credits payable by $340 million. These are payments owed for producing fossil fuels relative to renewable fuels and can be viewed analogous to accounts payable. It has reduced this liability by $900 million this year to $454 million. Over the long-run, it seeks to carry $200-$400 million of these payables, or about a quarter’s worth of payments, typically to what a company might carry in other accounts payable. Even counting this has debt, PBF has a net cash position of over $200 million.

With a strong balance sheet, management is focused on returning more capital to shareholders via buybacks and annual dividend increases. Indeed, on the conference call management said that “as we generate cash, we'll look to reward shareholders.” Management does not plan any further debt reduction, having brought it down to $1.2 billion and environmental payables should be within target by next quarter.

Thanks to this, as noted above, PBF raised its dividend by 25% and now yields over 2%. It also has $410 million remaining on its $1 billion share repurchase plan, which I expect to be used within the next twelve months. With a dividend that should grow and meaningful share reduction coming, PBF shares have meaningful scope to rise in my view.

PBF has $5.8 billion of book equity excluding special items, meaning shares are trading at book value. For a company with a strong balance sheet, that has assets generating cash that could not be replaced for the carrying cost given the regulatory backdrop, that is an extremely attractive valuation in my view. Thus far this year PBF has generated $2.5 billion in EBITDA. Even assuming another 10% reduction in refining margins, this company has over $2.2 billion in EBITDA capacity.

With about $800 million in annual cap-ex needs and a 20-25% tax rate, at that run rate, PBF should generate sustained free cash flow of about $1 billion with over $7.50 in annual EPS. Trading at just 6x free cash flow is extremely attractive, and this positions PBF to reduce its share by 10% per annum, providing meaningful medium-term EPS growth potential. PBF shares may have lagged this year as it focused on strengthening its balance sheet, but as it rewards shareholders, that should change.

I would not let one quarter of increased maintenance activity distract long-term investors from the pivot PBF is about to undertake. Trading at book value with significant free cash flow and accelerating shareholder returns is a combination for strong stock performance. As I view PBF able to sustain $7+ of EPS over time, particularly as its share count begins to fall meaningfully, I see upside into the $70’s or 10x earnings and 1.5x book value. Now is a great time to begin buying PBF.

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