Business context and reporting period
Delek Logistics Partners, LP filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. It operates pipelines, gathering, storage, transportation, wholesale marketing and terminalling assets, primarily supporting Delek’s refineries and serving third parties. Much of its contracted business depends on Delek.
Comparability caveat: 2015 comparative results were retrospectively adjusted for assets acquired from Delek in March 2015, but the predecessor assets did not record certain intercompany service revenues. The partnership also notes differences in predecessor cost allocations and financing.
Financial performance and condition
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $111.9 million | $172.1 million | $215.9 million | $315.6 million |
| Contribution margin | $30.0 million | $28.8 million | $56.9 million | $53.2 million |
| Operating income | $22.5 million | $21.1 million | $41.5 million | $37.6 million |
| Net income | $18.9 million | $18.3 million | $34.3 million | $32.3 million |
| EBITDA | $27.1 million | $25.7 million | $50.9 million | $46.6 million |
| Distributable cash flow | $23.7 million | $20.9 million | $44.1 million | $37.6 million |
Net sales fell 35.0% in Q2 and 31.6% year to date, chiefly because lower gasoline and diesel prices and reduced west Texas marketing volumes lowered wholesale sales. Cost of goods sold fell more sharply, while higher terminal throughput, stronger Q2 west Texas margins and lower operating costs lifted contribution margin. Q2 interest expense rose 25.5% to $3.3 million; six-month expense rose 35.8% to $6.5 million, reflecting debt utilization, rates and joint-venture funding.
Common-unit earnings were $0.66 basic in Q2 versus $0.71 a year earlier, and $1.23 for six months versus $1.28. The 11,999,258 subordinated units converted to common units in February 2016, substantially increasing weighted-average common units; per-unit comparisons should be considered in that context.
Six-month operating cash flow was $57.6 million versus $46.6 million. Investing used $35.9 million, including $33.1 million contributed to equity-method joint ventures; financing used $21.7 million. Cash and cash equivalents were nominal at June 30. Total assets were $381.8 million, and total deficit was $9.3 million.
Revolving-credit borrowings were $362.6 million, at a reported weighted-average rate of approximately 2.8%. The $700 million facility had $329.9 million of unused commitments, plus $7.5 million of letters of credit; maturity is December 2019. The partnership reported covenant compliance. Management said available liquidity sources should cover anticipated requirements, including minimum quarterly distributions, for at least 12 months.
Material changes and developments
- Wholesale marketing and terminalling sales declined 42.3% in Q2 and 39.8% year to date, while segment contribution margin rose 22.3% and 25.2%, respectively. Pipelines and transportation contribution margin was nearly flat year to date, at $40.6 million versus $40.2 million.
- Q2 west Texas marketing throughput averaged 12,594 barrels per day versus 17,490; margin per barrel increased to $2.13 from $1.31. Management attributed improved Q2 margins partly to a third-party pipeline outage, which also constrained volumes.
- Subordinated units converted to common units in February, ending the subordination period. The quarterly distribution increased from $0.55 per unit for Q2 2015 to $0.63 for Q2 2016, or $2.52 annualized. The Q2 2016 distribution, totaling $18.1 million including IDRs, was declared after quarter-end and scheduled for August 12.
- The RIO Pipeline was substantially complete in July and expected to begin operations in August 2016. The Caddo Pipeline was expected to be completed by January 2017. Total projected investment in the two joint ventures was approximately $99 million; $74.2 million had been contributed through June 30.
Outlook, risks and contingencies
The partnership forecast approximately $14.3 million of 2016 capital spending, including $9.3 million maintenance, $1.5 million regulatory and $3.5 million discretionary. This is a budget, not earnings guidance. Management stated that capital spending may change with project scope, costs and timing. It also described reduced crude-oil prices as affecting production, pipeline throughput, credit availability and the cost of capital across the midstream sector.
- Delek dependence and its ability to meet obligations under commercial agreements are key risks. Delek’s majority ownership and control may also affect partnership decisions; certain Delek debt covenants could indirectly constrain access to the partnership’s revolver.
- Environmental and operating exposures include spills, pipeline integrity, regulatory changes and remediation costs. January 2016 releases included less than 30 barrels near El Dorado and approximately 350 barrels from the Paline Pipeline; Paline remediation was expected to continue through Q3 2016. The partnership accrued $0.2 million for Paline.
- The DOJ and EPA were evaluating potential Clean Water Act enforcement related to the 2013 Magnolia release. The partnership was negotiating with the EPA and Arkansas and had accrued $1.0 million; penalties or other relief remained possible.
- Commodity volatility affects west Texas marketing margins. Derivative losses were $1.3 million for Q2 and $1.5 million for the first half of 2016. Floating-rate debt creates interest exposure: a hypothetical 1% rate change would alter annual interest expense by approximately $3.6 million.
- The Noble Petro supply contract for west Texas products expires December 31, 2017, with no renewal option. The partnership also cited seasonality, customer/refinery maintenance, joint-venture execution, competition and environmental compliance as risks.
Most important facts for investors to verify
- Whether lower west Texas volumes and commodity-driven sales declines persist, and whether stronger marketing margins and terminal throughput offset them.
- Progress, start-up and funding needs for RIO and Caddo, including remaining investment relative to the approximately $99 million projected total.
- Debt levels, revolver availability, covenant headroom, floating-rate exposure and the impact of Delek’s own financing covenants.
- Resolution and ultimate cost of the Magnolia enforcement matter, Paline remediation and other release-related obligations, including the extent of Delek reimbursement.
- Whether cash generation supports the increased distribution and the 2016 capital budget; the filing reports $44.1 million of first-half distributable cash flow against $35.2 million of distributions earned.
- How the unit conversion and predecessor accounting affect year-over-year per-unit and operating comparisons.