Business context and reporting period
Delek US Holdings, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. The company is an integrated downstream energy business with refining, logistics and retail segments. On July 1, 2017, Delek completed its all-stock acquisition of Alon USA Energy, adding two operating refineries and approximately 302 convenience stores. Accordingly, 2017 includes six months of Alon’s operating results; comparisons with 2016 are not directly like-for-like.
At year-end, Delek operated four refineries with combined crude throughput capacity of 302,000 barrels per day. California refinery and renewable-fuels assets acquired with Alon were classified as discontinued operations and held for sale.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $7,267.1 million | $4,197.9 million |
| Operating income (loss) | $186.4 million | $(49.2) million |
| Net income (loss) | $322.6 million | $(133.4) million |
| Net income (loss) attributable to Delek | $288.8 million | $(153.7) million |
| Diluted EPS | $4.00 | $(2.49) |
| Cash provided by operating activities | $332.1 million | $268.2 million |
| Cash and cash equivalents at year-end | $931.8 million | $689.2 million |
| Total debt, including current maturities | $1,465.6 million | $832.9 million |
Net sales increased 73.1%, principally reflecting Alon’s addition, higher refined-product prices and higher refining and logistics volumes. The increase should not be read as organic growth because Alon was consolidated only from July 1. Reported 2017 results also include a $190.1 million gain from remeasuring Delek’s pre-existing Alon investment and a $166.9 million income-tax benefit from the Tax Cuts and Jobs Act.
Refining segment contribution margin was $450.7 million, versus $139.1 million in 2016; logistics contribution margin was $121.9 million, versus $108.7 million. Retail, included only from the merger date, contributed $26.8 million for the second half of 2017. Consolidated segment contribution margin was $510.5 million. Refining results benefited from the Alon assets, a 41.6% improvement in the average Gulf Coast 5-3-2 crack spread and a $47.5 million RIN expense reduction from an El Dorado refinery waiver. The 2016 comparison included $42.4 million of business-interruption insurance proceeds, which did not recur.
Investing activities provided $25.2 million, including net cash acquired in the merger, while purchases of property, plant and equipment were $172.0 million. Financing activities used $104.6 million. Year-end current assets were $2,611.8 million and current liabilities were $2,671.7 million, a reported working-capital deficit of approximately $59.9 million. The company also reported $933.2 million of unused credit availability and $125.8 million of outstanding letters of credit. Total debt included $590.2 million of current maturities.
Material changes versus the prior period
- The Alon merger substantially expanded Delek’s refining, retail and consolidated asset base; total assets rose to $5,935.2 million from $2,979.8 million.
- Operating income and net income attributable to Delek returned to positive results from losses in 2016. The 2016 loss included a $245.3 million impairment of the Alon equity-method investment; 2017 earnings included the merger-related remeasurement gain and tax benefit noted above.
- Debt rose to $1,465.6 million from $832.9 million, reflecting assumed Alon debt and the expanded business. Interest expense increased to $93.8 million from $54.4 million.
- Capital spending was $177.5 million in 2017. Management forecast $211.5 million for 2018, excluding approximately $39 million of midstream projects to strengthen its Permian Basin position.
Outlook, management commentary, risks and unusual items
Management said it expects cash from operations and available borrowing capacity to cover existing operating and capital needs for at least the next 12 months. Its 2018 priorities include completing Alon integration, pursuing expected synergies, improving refinery reliability and efficiency, developing Permian Basin and logistics opportunities, and allocating capital among investment, acquisitions, dividends and repurchases. The company stated that integration work would continue through 2018.
Management expects environmental, health and safety compliance spending of approximately $41.0 million in capital costs in 2018 and $302.6 million over five years; these estimates may change with regulatory action. The Big Spring refinery’s proposed EPA consent decree could require significant pollution-control capital spending over five years, in addition to a $0.5 million penalty. Delek recorded $76.1 million of environmental liabilities at year-end.
Key risks include volatile refining margins and crude differentials; RIN price and availability exposure; refinery outages and dependence on crude supply and product-distribution systems; integration and execution risks following the merger; substantial debt, variable interest rates and covenant restrictions; environmental obligations and regulation; and seasonal operating patterns. Commodity and derivative volatility is material: the filing reports a $130.8 million RIN obligation deficit at year-end and $971.0 million of floating-rate borrowings. A hypothetical 1% interest-rate increase would change annual interest expense by approximately $9.0 million after swaps.
Contingencies include an unresolved EPA/Arkansas environmental enforcement matter related to a 2013 pipeline release. The Big Spring gasoline-standard matter was resolved in January 2018 with a $372,611 penalty. A California low-carbon-fuel-standard settlement called for a $300,000 penalty and retirement of 350 tons of credits. The company stated it did not believe pending proceedings would have a material adverse effect, while noting that outcomes cannot be predicted with certainty.
Subsequent events include the February 2018 acquisition of the remaining Alon Partnership units for approximately 5.6 million Delek shares; approval of a new $150 million share-repurchase authorization; an increase in the quarterly dividend from $0.15 to $0.20 per share; a $75 million agreement to sell four asphalt terminals and a joint-venture interest; and a planned $315 million sale of Big Spring logistics assets to Delek Logistics. The latter two transactions were expected to close in 2018, subject to conditions.
Important facts for investors to verify
- Separate merger-driven scale effects from underlying operating performance; the reported 2017 and 2016 periods are not directly comparable.
- Assess the sustainability of earnings excluding the $190.1 million remeasurement gain and $166.9 million tax benefit, and evaluate the impact of the 2016 impairment and insurance proceeds on comparisons.
- Review debt maturities, refinancing needs, borrowing availability, covenant restrictions and the effects of variable interest rates, especially the substantial 2018 maturities.
- Track execution of Alon integration, expected synergies, refinery reliability, the planned turnaround and the 2018 capital program.
- Monitor RIN exposure, environmental liabilities, regulatory capital requirements, outstanding legal matters and the closing and financing of announced asset transactions.
- Note that management’s 2017 internal-control assessment excluded Alon, which represented 51% of consolidated assets and 27% of net sales; management and the auditor reported effective controls for the assessed scope.