2023-11-19 11:27:23 ET
Summary
- Calumet Specialty Products announced significant changes and operating results for September, falling short of potential due to operating issues.
- Montana Renewables demonstrated positive financial results in July but faced challenges with a crack in a steam drum in August.
- Calumet is on track to complete a turnaround and expects to add new regionally available supply in the New Year.
Calumet Specialty Products ( CLMT ) reached the final turn and Bruce Fleming, EVP, Montana Renewables & Corporate Development, (Red Pollard), turned "the Biscuit" lose. At the September conference call, management announced significant changes and its operating results for September. The announced results fell short of potential with two significant operating issues encountered during the quarter. Management clearly discussed the value of the issues helping investors understand true potentials. In one critical area, MRL, our estimate adequately predicted the number.
Our bullish stance, stated in several articles, continues with this extension of The Bell Rang: Calumet Specialty Products Is Off To The Race Of The Century. Our thoughts continue with an update including discussion within three topics: long-term MRL performance and vision, corporate conversion and characterizing the specialty business. Red turned the Biscuit lose. Reach in your pocket and pull out the binoculars. The race is getting interesting.
The Quarter
Three events scuffed up the September quarter results, two pre-announced, one could be figured through following markets. In late August, management announced an operational issue at Montana lowering renewable product production by a third. In early October, management offered a second update stating that a decision for repairing on-line the preannounced issue changed to a short outage in November. It was also announced that a plug in a major process unit at Shreveport forced a second unit shutdown but was back on-line at high rates. The September results were materially affected.
- EBITDA of $76 million.
- Lost EBITDA at Shreveport equaling at least $20 million from lost production.
- A second factor lowered EBITDA at Shreveport with the associated crude oil price spike hitting specialty margins by almost $20 per barrel. This was the third event. (Compensating price increases took effect in early October.)
- MRL generated almost $40 million in EBITDA.
- MRL's July EBITDA equaled approximately $15 million.
- The operational percentage of clean vs. dirty feed equaled 30/70.
- July's margin equaled $1.23 just the under the lower advertised range of $1.25-41.45 per gallon. (At 100% dirty feed, the margin would have been at or above the high-end).
- Lost EBITDA for MRL equaled $30 million plus.
A coming catalysts replacement drove the decision for the outage vs. the on-line repair. MRL uses a reasonably cost catalyst made from nickel with a life span of 12-18 months. An outage in April, 16 months from start-up, had been planned. Management considered both the repair or earlier catalyst exchange and decided on doing one outage early in order to open doors for a long operational run to finally demonstrate the real operation. A late November startup is on schedule with the unit operating using mostly un-treated (dirty), high margin, feed. The feed through December will have the book pricing from the past few months. Into the new year, feed costs will once again be in-line with current market prices.
In addition, management also noted that 60% of the renewable products are being sold into Canada, thus eliminating U.S. based collapsing D-6 RIN issues . A more detailed discussion of this issue follows later.
We opt to Refrain.
In the past at this point, we offered estimates or guesstimates for either the quarter or coming quarter. This time, we opt to refrain with the extreme volatility within essential parts. Instead, we list the pros vs. cons for the December quarter beginning with cons.
- Cons
- Lower Gulf Coast 2-1-1 crack spreads even with the 50% hedge down at least $7 quarter over quarter.
- MRL operating at 2/3s rate for October; shutdown most of November.
- Great Falls' operation shutdown for most of November.
- Pulled forward catalysts' replacement and with it costs.
- December MRL un-treated feed costs many booked before the collapse in D-6 RINs.
Now, for the pros, there are many and significant.
- Pros
- Collapse in crude prices, $20 per barrel, coupled with higher specialty sales' prices instigated on October 1st.
- Specialty operating for the full quarter at full rates.
- Significantly higher WCS spreads, almost $10 per barrel, for the 12,000 barrels per day at Great Falls.
- Full MRL feed rates during December.
The January results won't be indicative of Calumets operation in any way. Investors, who base their choice on these quarterly results, missed the bullseye; actually, they missed completely the target.
MRL Long-Term
With Montana Resouces, Calumet's entrance into the renewable markets, being either the lowest cost or one of the lowest, investors must understand its role and probability. The renewable market by state law subsidizes producers based on a formula which includes several factors, D-6 RIN being one. With recent rapid collapses in this price, the selling price for product can be much lower while being produced using much higher costing feeds. The net result is margin compression hurting manufacturing profitability especially for those with long supply chains. Again, at the call, management offered this comment,
"I think we're seeing well a steady margin theory applies to the industry as a whole, volatility can be driven by length of supply chain . In a declining feedstock price environment, margins in our industry will be higher for those with short supply chains. Over time, the industry's volatility should balance out, and we simply would expect those with shorter supply chains to be more steady."
Calumet has a very short local supply chain.
In the early days of the project, to illustrate this concept, management often included this slide.
Goldman Presentation
With the concept achieving a level of stability, still in more volatile periods, margins may follow for periods of time, the length being driven by supply chain dead-times.
Defining the critical elements of the business follows next:
- Possesses at least a $0.75 per gallon transportation advantage.
- Has short and local supply chains.
- Has the ability to produce significant levels of the premium product, SAF, (jet fuel).
- Management is considering an expansion for MaxSAF which increases the year production to 300 million gallons.
- At this level of production, SAF consumes 90% of Great Falls' capability as it now stands.
- SAF carries a $1.25 premium above the renewable diesel/SAF mix in today's operation.
- Management is considering an expansion for MaxSAF which increases the year production to 300 million gallons.
Managment in the past advertised MRL at approximately $250 million plus EBITDA per year with the existing operation at 13,000 barrel per day. At the proposed SAF rates of 300,000,000 gallons per year, the EBITDA would range between $600 - $800 million ($1.45 existing margin + $1.25 average SAF premium).
The Big Corporate Change Announcement & Debt
If the above discussion on MRL isn't enough, the next announcement is essential for enabling investor value, i.e. higher stock prices. Until this November, Calumet was organized under an orphan model, non-distribution paying MLPs. Liquidity didn't exist. At the November conference, management surprise all of us in announcing a conversion to a C-Corp. We include a bullet list and two presentation slides describing the change:
- Converts MLP to a C-Corp.
- General Partners will exchange its existing IDRs and 2% General Partner interest, which is approximately 1.6 million units, for 5.5 million shares of common stock and 2 million warrants.
- 4.5% dilution
- Basically, pays the GP's conversion tax obligation.
- Not expected to generate Unrelated Business Taxable Income (UBTI) for tax-exempt and tax preference Investors.
First, more details on the conversion follows:
Calumet 3rd Quarter
And a slide covering tax impacts is shown next:
Calumet Conversion Details
In our view, this is more than fair and solves non-liquidity issues.
In the process of rescuing Calumet from an interesting past, the company spent a significant yet carefully measured level of capital. After selling off several non-core assets, meaningful, targeted capital spending resumed. A summary follows:
- Spent or spending $120 million per year for Specialty upgrades during 2022 - 2024.
- Converted and upgraded Great Falls creating MRL and a more up-to-date operation.
- Began plans for MaxSAF MRL conversion estimated at $250 million (Second reaction chain).
The current debt structure is shown in the next slide.
Calumet 3rd Quarter
The company has 1.8B in debt with $450 million directly attached to MRL leaving approximately $1.3B associated with the specialty business and approximately $300 million ($60 extra for specialty, $250 million for SAF) in additional capital spending still planned. Sources for future capital include extremely low interest DOE loans of undetermined amounts, high cash flows from operations, or partial monetization of MRL once fully demonstrated. One other major recapitalization issue comes with the $400 million 11.5% Senior notes due in 2025.
Specialty Going forward.
Recent specialty markets muddied our defining Specialty's long-term performance. This business consists of Performance Brands ('PB'), a growing niche market, and Specialty consisting of larger volume specialty and large volume fossil fuels. In 2022, Specialty performed at record cash flows benefiting from massive crack-spreads. During 2023, crack-spreads remained elevated until an October collapse. What is clear is that nominal growth within tight fuel markets drove incredible financial results. For 2023 under significant higher interest rates, the macro-economy entered into both a consumer wage and an industrial manufacturing recession. The net effect equaled collapsing spreads even with more normal tight refining capacity, the primary driver being low diesel usage.
This business is unique in nature, designed with natural hedges one against the other, fuels vs. lower volume much higher margin specialty. The refining portion of the business can also change product margins from one extreme to the other, diesel vs. gasoline, depending on market pricing. For example: current Gulf Coast 2-1-1 spreads for 100% gasoline production equals approximately $5, yet $35 for 100% diesel. Also, for Specialty, the last two years were riddled with unexpected weather shutdowns. With this in mind, the following table shows Specialty plus PB results for the last two years.
2022 (2022 Presentation) | 2023 | |
Crack Spread Ave. (Self-generated) | $40 | $30 |
Specialty (Millions) | $380 * | $230 * ** |
PB (Millions) | $20 *** | $50 **** |
Total (Millions) | $400 | $280 |
* >$40 million from weather and other unplanned issues.
** Estimated 4th quarter at $50 million, approximately the 3rd quarter results without operational issues.
*** Marred extensively by massive business headwinds driven from higher costs when a key major supplier unexpectedly shutdown.
**** $10 EBITDA in the December quarter.
Although the long-term results seem muddy, our expectation is that results will fall in-between likely in the low $300s. It is clear that growing economies will produce inordinate higher results with tight refining capacity. The opposite is also true.
So Where to Next?
Managment in the past clearly stated that their directions and goals include the following: reduce specialty debt into the $800-$1000 million range, fund MaxSAF with either a DOE loan or operational cash and refinance the egregious 11.5% Senior note. Although it still isn't fully clear, it appears that the likely path forward is a partial monetization of MRL to more quickly payoff debt, $300-$400 million in specialty, $400 million with MRL and the capital needed for the MaxSAF project. After completing this structure change, our view is that management would create a spin-off IPO granting stock shares in MRL and Calumet to the GP and existing unit holders.
Risk
Multiple risks do exist. In recessionary markets, fuel crack-spreads, will fall. Next, the company must deal with "the one issue," one major specialty production facility, Shreveport, and one renewable facility, Great Falls. (Note: Great Falls does operate with multiple separate production trains.) Calumet hasn't yet performed with excellence for many valid reasons. It is now time. In-spite, Calumet has performed admirably. We expect operational performance to reach non-linear growth rates starting next year and continuing for at least three more. We continue our rating at a strong buy especially with unit prices trending under $15. A company heading toward almost a billion in cash flow and less than a billion in debt with 80 million units can't be rated less. Red turned "the Biscuit" lose. It isn't without risk, yet we believe that pros out way the risks. For us, it is a question of how many lengths?
For further details see:
Calumet Specialty Products Reached The Final Financial Turn