Yield-chasing is in every single place these days, and that features throughout the midstream area. Retail buyers have appeared a bit bit flummoxed on why PBF Logistics (NYSE:PBFX) has skilled such destructive outcomes, notably as company sponsor PBF Energy (NYSE:PBF) has carried out reasonably nicely. Since the IPO of its midstream belongings again in 2014, PBF Energy has been risky, however is now flat on its efficiency over that time-frame, regardless of having important possession of PBF Logistics. That agency, in the meantime, has misplaced 28% of worth in its widespread inventory, regardless of rising its distribution from $zero.16/quarter to $zero.48/share as of the final declaration. What offers?
Monitoring PBF Energy Health, Overall Production Volumes
Before I get into precisely why PBF Logistics has had such a tough go of it, it’s value exploring PBF Energy’s enterprise mannequin, since considerably all of PBF Logistics’ income is sourced from its company sponsor. PBF Energy depends closely on with the ability to buy and course of heavy, bitter crude oil feedstock – most of PBF Logistics’ belongings revolve round supplying that product, or transporting merchandise refined from that base. While it might not appear intuitive, the bitter crude the corporate sources from mid-continent performs (comparable to North Dakota bitter) and from Canada are usually priced primarily based on West Texas Intermediate (“WTI”), which is a light-weight/candy crude. The Toledo facility is the exception because it processes much less heavy grades of crude, however each PBF Energy and PBF Logistics generate solely a small portion of their income from the Toledo refinery, which was acquired from Sunoco in 2010. As a consequence, PBF Energy advantages fairly closely when the unfold between North Sea Brent crude oil (which is what’s most worldwide refiners worth on) and WTI, in addition to the regional low cost (how far beneath WTI can the corporate purchase feedstock from producers). From a contest standpoint, the broader the differential between Brent and WTI, the extra cost-advantaged U.S. refiners are in the case of international competitors, notably refiners like PBF Energy that supply practically all of their oil feedstock domestically.
Recently, the unfold between the 2 has expanded, with Brent rising to a roughly $6.50/barrel premium to crude oil. Historically, this is not all the time the case. Before fracking grew to become what it’s at present, WTI usually traded at a premium versus a reduction. As it’s lighter and sweeter, it’s cheaper to refine into gasoline and different refined petroleum merchandise. WTI’s availability modified market dynamics, and up to date progress within the unfold is because of OPEC’s manufacturing reduce deal, alongside a number of non-OPEC nations like Russia. Today, there are merely much less Brent-derived barrels on the market; provide and demand at work. The potential of U.S. oil exports hamstrings this ratio a bit, as at present ranges, it’s at the moment financial for oil to be exported off our shores and transported to Europe for processing at amenities that may deal with it. The infrastructure continues to be being constructed out to help crude export, however in a short while, there will likely be little probability of growth of the Brent/WTI differential past the present pricing. In my opinion, that is “peak value” time for home refiners of WTI-based feedstock. Even probably the most bullish of sell-side badysts forecast present spreads as – at greatest – a brand new actuality. Most anticipate contraction; PBF Energy expects it settle within the $four.00/share vary in the long term. If you take a look at present Brent/WTI futures by way of the Intercontinental Exchange (“ICE”), you may discover that futures merchants are pricing in a reasonably wholesome decline within the unfold all through 2018.
Refiners aren’t asleep on the wheel. Overall, refinery utilization in response to the EPA was 92.eight% in August, greater than the common of 90.5% over the previous ten years. Last month’s utilization determine of 95.zero% was the best since 2004. Such small incremental adjustments won’t appear to be a lot, however if you notice that U.S. refiners are processing greater than 18mm barrels per day, small will increase like these ends in much more product. PBF Energy CEO Thomas Nimbley had this to say concerning the firm’s 3Q 2017 utilization:
We had 5 working refineries, we achieved report throughput ranges, and we had been capable of capitalize on sturdy market situations. While one quarter just isn’t victory, we really feel that this quarter is reflective of the true potential of our belongings.
Investors ought to remember the fact that the Northeastern belongings for PBF Energy (Delaware City, Paulsboro) have traditionally had the worst gross refining margins, merely because of the merchandise used, their value, and the decrease complexity score. This will change into essential afterward. The Toledo facility has the best margin, however is capacity-constrained (which is why there was no throughput quantity will increase this yr; its already working close to nameplate capability). The case is badogous with the Torrance Valley facility. Outside of a bit incremental capability, PBF Logistics is seeing the best utilization of its belongings that it will get; notably throughout its most recently-reported quarter (Q3 2017). This is a excessive water mark for the agency, and because of this, is a excessive water mark for PBF Logistics.
The Upcoming Cliff; Rail and Trucking Falling Out Of Favor
Unfortunately, PBF Logistics doesn’t break down the utilization charges of its varied belongings anymore. They stopped doing this in the course of final yr, which I discover a bit disingenuous, as a result of when you dig into the numbers, it turns into obvious why. While PBF Logistics now not discloses throughput, within the quick time that they did, it was clear that throughput by way of the Delaware City Rail and West Rack belongings had been collapsing after the agreements had been set. From 2014 to 2015, oil processed by way of the Delaware City Rail collapsed from 74,400bpd to 33,300bpd, earlier than rising incrementally in 2016 (then disclosures cease): At the top of Q2 2016, the final time they made throughput disclosure, the Rail Terminal was at a 36,400bpd run-rate, with West Rack at 10,400bpd. This is the only greatest cause why buyers ought to keep away from this agency; these two belongings. As a reminder, MVCs on these belongings are 85,000bpd for the Delaware City Rail settlement (expires starting of 2022) and 40,000bpd for West Rack (additionally early 2022). PBF Energy is receiving $2.00/barrel at Delaware City Rail as much as the MVC, in addition to $2.20/barrel at West Rack. These two belongings are answerable for at the very least $94mm in income for PBF Logistics, extra when you think about the corporate additionally receives funds for ancillary companies it supplies. That is sort of one third of the highest line.
These contracts have renewal choices, however they’re at PBF Energy’s possibility. There is completely no cause for them to agree to increase these belongings at present phrases. While PBF Energy is a key shareholder, on the finish of the day, the overall badociate goes to guard its personal pursuits first. Come 2022, buyers are going to face a harsh reduce in each distributable money movement (“DCF”) and EBITDA as soon as these contracts are renegotiated. Asset stage margins should not identified, however consolidated EBITDA for PBF Logistics is within the 65-70% EBITDA margin vary. Assuming the MVC agreements get reduce in half (at greatest) with comparable greenback/barrel phrases, that is (at the very least) a $32mm EBITDA headwind on the horizon, which might get rid of 17% of Q3 2017 run-rate annual EBITDA. That nonetheless builds in some enchancment from seemingly present ranges, as administration alluded to “improving” rail fundamentals these days (with out quantifying).
Further stressing the agency is the present sturdy working atmosphere outdoors of Delaware City at PBF Energy. Dollars paid per barrel on volumes above MVCs are considerably decrease than beneath the dedication throughout the agreements, however that is additionally seemingly near free cash given the low variable prices. Investors ought to anticipate some weak point there as nicely within the medium-term. As an instance, whole throughput by way of all the Pipeline belongings (Delaware City, Torrance Valley) averaged 137,000bpd in Q3; MVCs for these belongings (in totality) are 110,000bpd. Split there’s roughly 50/50, with numerous the good points in throughput in recent times coming from elevated crude product being processed within the Northeast (Hint: away from truck and rail). Back in 2015 and early 2016, movement by way of the Delaware City Pipeline belongings was across the MVC threshold. Given the tight refining margins already current at Delaware City, the chances are processed volumes are going to get reduce there first within the occasion of a decline in spreads, with volumes bumping up towards that MVC threshold on the Pipeline belongings. As talked about, payrates on volumes above the MVC are incremental, so this is not a big deal (roughly $3mm annual EBITDA influence), however it’s one other bump on prime of an already harbaded mannequin. In a nutshell, you are a PBF Logistics shareholder, I’d be watching Delaware City/Paulsboro refinery well being like a hawk over the following a number of years.
Diversification and Balance Sheet Health, Takeaway
Management’s plan right here is to get out from beneath any pesky monetary covenants (see the transfer after Q3 shut, the place the corporate provided $175mm in extra 6.875% notes due 2023, which is along with the $350mm in excellent UPB on the identical phrases. The pricing of those notes could be very telling; 6.875% is a excessive price of curiosity in at present’s atmosphere for many midstream corporations when you think about PBF Logistics doesn’t carry numerous leverage, and that’s seemingly because of the maturity date falling after the aforementioned terminaling contract expirations. Creditors see this concern simply as a lot as I do.
Diversification is probably going additionally the secret. The agency lately accomplished two natural progress initiatives, a 625,000 crude oil storage tank at Chalmette, in addition to a 24 inch pure gasoline pipeline to attach the Paulsboro refinery to pure gasoline sourced from Utica and Marcellus shale. Total annualized EBITDA contribution is predicted to be $12mm, and represents a great return on the corporate’s $82mm in whole venture funding. Dropdowns might be a supply as nicely; comparable to a possible drop of the remaining 50% within the Torrance Valley Pipeline from PBF Energy; one other $175mm to get full possession of that badet would go a good distance in the direction of additional diversification, in addition to contributing one other $20mm in EBITDA. Current leverage of three.2x web debt/EBITDA does permit a bit wiggle room.
In a nutshell, there are very actual and legitimate causes that this midstream agency trades at 10% yield. PBF Energy’s Northeastern refinery belongings will likely be beneath stress if differentials weaken and crack spreads slim(as anticipated), and that’s actually not going to badist PBF Logistics’ terminal belongings publicity downside there. The longer this goes on, anticipate administration to be very cautious in rising the dividend additional; whereas Q3 2017 protection regarded beautiful at 1.4x, they’re going to want to depart a bit little bit of meat on the desk in case these belongings don’t flip round, and negotiations pressure steep cuts within the contracts. Expect numerous deal with administration within the coming years on additional diversification, whether or not natural or through dropdown – ideally away from Delaware City if in any respect potential.
For broad funding protection, however with a deal with small/mid cap names that do not get a lot press, think about following me to get real-time updates each time I launch badysis.
Disclosure: I/we have now no positions in any shares talked about, and no plans to provoke any positions throughout the subsequent 72 hours.
I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from Seeking Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.