PBF Energy (PBF) is a bargain at current market prices. PBF’s adept management team, in conjunction with private equity partners, acquired its core refining assets at fire sale prices in 2010 and 2011. Among these assets are the Paulsboro and Delaware City refineries which, following initial turnarounds, are now the crown-jewels of the East Coast (PADD 1) refining system. East Coast refineries have historically lacked the structural advantages of their Mid-Continent and Gulf-Coast counterparts. However, management’s aggressive investment program in a “crude-by-rail” logistical infrastructure promises to close the gap by adding much lacking optionality through access to cost advantaged crudes. Although the ownership structure has legacy problems and the company will undoubtedly continue to face cyclical margin and secular regulatory issues, the stock is much too cheap. A discounted cash flow analysis and an economic book value analysis convergingly indicate that the stock is fairly valued at around $50 per share (about 60% higher than current prices of about $31/share).
On valuation alone, PBF Energy is a strong buy. Moreover, multiple catalysts could propel the stock higher including continued accretive distressed asset acquisitions, rationalization of refining and logistics assets, asset drop-downs to PBFX, and growing returns of shareholder capital. In short, many fundamental drivers of long-term value have already been set into motion.
PBF Energy Inc. (PBF) owns 89.9% of the economic and voting interests in PBF LLC. PBF LLC owns and operates three refineries located in Toledo, Ohio, Delaware City, Delaware and Paulsboro, New Jersey. PBF’s refineries have a combined throughput capacity of approximately 540,000 barrels per day (“bpd”), and a weighted-average Nelson Complexity Index of 11.3. The Toledo refinery processes light, sweet crude, has a throughput capacity of 170,000 bpd, and a Nelson Complexity Index of 9.2. The Delaware City and Paulsboro refineries process primarily medium and heavy, sour crudes and have historically received the bulk of their feedstock via ships and barges on the Delaware River. The East Coast refineries have a combined refining capacity of 370,000 bpd and a weighted-average Nelson Complexity Index of 12.2. PBF sells the majority of its products through unbranded distributor channels in the Northeast and Midwest United States, as well as in other regions of the United States and Canada.
In addition to PBF’s stake in core refining operations, PBF LLC owns and operates a significant portfolio of logistics assets predominated by East Coast rail loading/unloading facilities. On May 14, 2014, PBF LLC formed PBF Logistics Partners (PBFX) as a fee-based, growth-oriented, Delaware master limited partnership, in order to improve access to cost advantaged sources of crude. PBFX’s assets consist of a light crude oil rail unloading terminal (“Delaware City Rail Terminal”) at the Delaware City refinery that also services the Paulsboro refinery, a crude oil truck unloading terminal (“Toledo Truck Terminal”) at the Toledo refinery, and the DCR West Rack. All of PBFX’s revenue is derived from long-term, fee-based commercial agreements with subsidiaries of PBF Energy, which include minimum volume commitments, for receiving, handling and transferring crude oil. As of September 30, 2014, PBF LLC holds a 51.1% limited partner interest in PBFX, with the remaining 48.9% limited partner interest held by the public unit holders.
Figure 1: PBF’s Refining Operations
Source: PBF Investor Presentation: PBF Energy (NYSE: PBF) – Wolfe Research Refining Conference. Jan 2015
Table 1: PBF’s Refining Assets
(dollar amounts in millions, USD)
|Refinery||Acquired From||Date Acquired||Gross Initial Investment||Crude Throughput Capacity (MBPD)||Nelson Complexity Index|
|Delaware City refinery||Valero||6/1/2010||$920.00||190||11.3|
Summary of Valuation
In order to determine the fair value of PBF Energy, I have selected an economic book value (EBV) analysis and a discounted cash flow (DCF) analysis. Both methods can be used to value almost any cash producing asset and the degree to they converge or diverge determines the level of confidence in the estimate. In the case of PBF, the methods strongly converge to indicate that the stock is fairly valued at about $50 per share (or, about 60% higher than the current price).
Economic Book Value Analysis
EBV produces a modified balance sheet which allows for certain types of assets and liabilities to reflect market and fair valuations while ignoring the value of other non-operating items. The process of EBV identifies assets and liabilities which should be revalued and/or impaired (using any number of subordinate methods including a DCF analysis, market value adjustments, peer group analysis, regression, etc…). The adjusted values of those assets and liabilities are then reinserted into balance sheet in which the core accounting principle holds: Equity = Assets – Liabilities.
PBF LLC acquired its core refining assets at fire sale prices from Valero Energy (VLO) and Sunoco in 2010 and 2011. Since PBF maintains the value of these assets using the cost plus depreciation method, their respective book values are misaligned with those of other refiners. On the most basic level, the value of any tangible asset is proportional to the quality and quantity of stuff it can make (and perhaps to the degree and competence in which it is utilized). Stuff, for refiners refers to yields, including gasoline, diesel fuel, fuel oil, other distillates, and petrochemicals. A more complex refinery, which is able to process heavier crudes and maximize yields of higher-value petrochemicals, should be worth more than a simple one given equal crude throughput capacities.
In order to bridge the gaps in valuing refining assets, the industry uses the Nelson Complexity Index (NCI) which indexes the cost of various refinery components in relation to the cost of a basic atmospheric distillation unit. The product of a refinery’s complexity and its basic crude throughput capacity is its Equivalent Distillation Capacity (EDC) or complexity-barrels capacity. For information on interpreting NCI and EDC, please refer to an earlier post, A Crash Course in Refining Fundamentals.
A peer regression analysis indicates that PBF’s assets are worth significantly more than their book values. On paper, as of the 26 February’s 2014 10-K, PBF Energy values its net plant, property, and equipment (PP&E) at around $1.94 billion (Note 5 indicates the vast majority PP&E consists of “Process units, pipelines and equipment”). The peer group regression of 14 publicly-traded, U.S.-based refiners indicates that the fair value of any given refiner’s core refining estimates can be accurately estimated through linear interpolation using EDC as the only independent variable. The analysis further indicates that PBF’s core refining assets are likely worth close to $5 billion. Simply, PBF acquired its core assets (including initial turnaround expenses) at about 1/3 fair value.
Figure 2: Peer Regression Analysis of Net PP&E to EDC
Sources: Oil & Journal’s 2015 Global Refining Survey; EIA’s 2014 Refinery Capacity Report; Portfolio123
Notes to Figure 2: The peer group consists of publicly traded companies with tickers: PSX, VLO, MPC, TSO, HFC,WNR, CVRR, PBF, NTI, CLMT, DK, ALDW, ALJ, and BDCO
Table 2, below, reconciles PBF’s EDC to an estimate of refining asset fair value. Note that the regression analysis of fair value does not differentiate between refining assets and related PP&E (pipelines, power facilities, marketing and retail facilities, etcetera). As such, it is only a rough estimate.
Table 2: Reconciliation of PBF’s Refining Assets to Fair Value Estimates
|Refinery||Gross Initial Investment (incl. initial turnarounds)||Crude Throughput Capacity (MBPD)||NCI||EDC (MBPD)||Fair Value of Asset (millions)|
|Delaware City refinery||$920.00||190||11.3||2147||$1,812.07|
The adjustment to refining PP&E and some other less consequential adjustments produces an Economic Balance Sheet. When compared to the company’s most recent balance sheet from the 2014 10-K, the differences in asset and equities values are significant.
Table 3: PBF Economic versus Accounting Book Value
(millions USD, except shares)
|Assets||Book Value (2014 10-K)||EBV (2014Q4)|
|Cash & Equivalents||$397.9||$397.9|
|Other Current Assets||$846.5||$624.2|
|Process units, pipelines and equipment||$1,977.3||–|
|Property, plant and equipment, net||$1,936.8||$5,137.4|
|Other Non-current Assets||$912.8||$580.1|
|Liabilities & Shareholder’s Equity|
|Other Current Liabilities||$1,542.8||$1,466.1|
|Delaware EDA loan||$8.0||$8.0|
|Other Long-Term Liabilities||$62.6||$62.6|
|Non-controlling Interests in PBF LLC||$138.7||$526.78|
|Non-controlling Interests in PBFX||$336.4||$391.20|
|Class A Common Shares – diluted (millions)||74.46||85.78|
|Common stock equivalents (millions)||21.77||9.69|
|Fully-converted shares outstanding – diluted (millions)||96.23||95.47|
|BV of Common Equity per Common Share||$16.4||$50.1|
|BV per Fully-converted Share (excl. NCIs of PBFX)||$14.1||$50.5|
Source: PBF 2014 10-K; multiple
Notes to Table 3: According to the 10-K, PBF maintains “no off-balance sheet arrangements as of December 31, 2014, other than outstanding letters of credit in the amount of approximately $400.3 million.” Fully-converted shares (a non-GAAP measure) assumes that all outstanding Series A Units are converted to Class A (i.e., common) Shares. Series A Units and Class A Shares are economic equivalents.
The above EBV analysis indicates that with a few adjustments to the fair values of both PBF’s assets and liabilities, the company’s equity is fairly valued at about $50 per share. This indicates a price-to-EBV of around .6 (or about 60% upside from PBF’s current market price of $31 per share). Aside from the major adjustment to PP&E, other adjustments include: omissions of certain deferred assets and liabilities; adjustments to non-controlling interests of PBF LLC to reflect its 10.1% ownership of the underlying operating entities; inclusion of PBFX at its current market value (including related non-controlling interests); and, adjustments to shares to reflect recent corporate actions.
Discounted Cash Flow Analysis
For this DCF analysis, I focus on estimating economic profit, which is defined as Net Operating Profit (NOPAT) less income attributable to non-controlling interests and a capital charge for equity. The underlying concept of this approach is that equity capital is expensive regardless of any given company’s short-term shareholder return policy.
The first step to determine economic profit is to estimate NOPAT by removing accounting distortions in order to arrive at a true approximation of cash profit. In this respect, NOPAT is functionally equivalent to free cash flow with the exception that the certain expenses are allowed to be reclassified as investments (and vice versa). Over the long-run, NOPAT and Net Income theoretically converge. Economic Value Added (EVA™) analysis borrows from the same precepts and, according to many sources, is the single most successful valuation methodology currently used by financial consultants and analysts.
According to an estimate of future discounted economic profits, and assuming a 7% discount rate, PBF Energy is fairly valued at about $50 per share. The equivalent internal rate of return (IRR) is about 11.2%.
Table 4a: Discounted Cash Flow Analysis of Economic Profits
(millions USD, except percentages, shares, and per share ratios)
|2013||2014||2015 (E)||2016 (E)||Horizon|
|Total Throughput Capacity (MB/CD)||540.0||540.0||540.0||540.0||540.0|
|Refinery Utilization Rate||83.9%||83.9%||88.0%||88.9%||88.9%|
|Total Throughput (MB/CD)||452.8||453.1||475.0||480.0||480.0|
|Total Throughput (MMB)||165.3||165.4||173.4||175.2||175.2|
|Weighted Throughput Margin / bbl||$8.16||$12.12||$11.80||$10.68||$10.44|
|Gross Refining Profit||1348.1||2004.2||2045||1870||1829|
|Weighted Operating Cost / bbl||$4.92||$5.34||$4.75||$5.00||$5.00|
|Refining Operating Cost||812.7||883.1||803.1||811.5||811.5|
|add: Logistics Operating Income (Loss)||-18.3||16.0||62.2||70||100|
|less: Interest Expense||93.8||98.8||105||105||110|
|less: Tax Expense||-70.2||-40.9||271||216||206|
|less: Sustaining CapEx||383.01||357.80||185||190||200|
|Net Operating Profit After Tax (NOPAT)||5.7||577.7||633.2||503.1||481.0|
|Non-controlling Interests in PBFX||8.3||32.4||36.5||52.1|
|Equity Capital Charge||116.7||115.0||108.6||108.6||110|
|Fully-converted shares outstanding – diluted (millions)||97.23||96.23||90.53||90.53||90.53|
|Economic Profit per Share||-$1.14||$4.72||$5.44||$3.95||$3.52|
|Present Value of Cash Flow (r = 7%)||$0.00||$0.00||$5.08||$3.45||$41.08|
Table 4b: Discounted Net Present Value and IRR
|Current Stock Price||$31.00|
|Fair Value (r = 7%)||$49.61|
|Discount to FV||60.0%|
Sources: PBF Energy Reports Fourth Quarter and Full Year 2014 Results, Declares Dividend of $0.30 Per Share; PBF Energy’s (PBF) CEO Tom Nimbley on Q4 2014 Results – Earnings Call Transcript; PBF Energy (NYSE: PBF) Wolfe Research Refining Conference – January 2015; PBF 2014 10-K; multiple
Note that estimates of future profits are extremely sensitive to assumptions about crack spreads, margin capture rates, and asset utilization rates. This sensitivity underscores refiners’ susceptibility to market conditions beyond any single entity’s control. Changes in market conditions could throw these estimates significantly off. Rather than trying to be precise, it is much more important to use consistent assumptions when estimating future profits of refiners.
The “Ownership” Problem
PBF’s discount to Net Present Value was at one point, in the very recent past, justified due to its private equity roots which left behind a byzantine organizational structure and various interests. PBF Energy’s IPO in December 2012 was a liquidity event for private equity interests Blackstone (BX) and First Reserve. Private equity is notorious for embedding labyrinthine ownership rights and incentives into equity and debt which make the true economic and controlling interests difficult to determine, particularly for common shareholders. According to the original SEC Form S-1 (i.e., Prospectus), PBR Energy’s interest in PBF LLC and PBF Holding was constrained to a 17.2% economic interest in earnings.
Management has fought to align the company’s interests with those of common shareholders. Since the IPO, the team has largely disentangled the ownership problem by placing more control into common shareholder hands by retiring, buying back, and/or converting “other-than-common” equity interests into common Class A Shares. Efforts to simplify ownership have put about 89.9% of PBF LLC under common shareholder control as of December 2014. Although the complicated ownership structure still remains as an artifact of PBF’s genesis in private equity, common shareholders now exert majority control over PBF and related subsidiaries.
Complexity may even provide a tax advantage going forward. PBF LLC has elected that conversion of Series A Shares to common shares will increase PBF Energy’s tax basis, effectively shielding a portion of future profits from the full corporate tax rate. Tax savvy is good for investors.
In summary, undervaluation is currently unjustified due to the legacy issues of non-controlling interests. For deeper study, compare the graphs of the original corporate structure in the S-1/A Amendment 7 to the corporate structure recently published in the 2014 10-K.
Other Risk Premia
The stock’s discount may also reflect its lack of an operating history, headwinds from margin perturbations, and lack of retail operations.
Since PBF acquired its first operating assets at tail end of 2010, investors must rely on only four complete years of operating history to judge the company’s execution. Lack of a deep operating history makes it more difficult to answer questions about commitment to shareholder value, margin capture, and potential structural problems. Even so, PBF’s management team, in addition to bringing deep industry experience, have already demonstrated acquisitive brilliance and a commitment to common shareholders.
Refining margins are based on crack spreads which are, in turn, extremely volatile and vulnerable to commodity market perturbations. For this reason, commodity-driven refiners often trade at a discount to their respective net asset values. To the extent which a refiner is able to optimize throughput optionality and product slates to meet varying market conditions, that refiner should be able to produce more consistent product margins versus relatively unsophisticated peers. PBF owns and operates the two most sophisticated refineries in the East Coast. In addition, PBF’s Toledo refinery currently has enjoyed structural advantages due to its access to cost advantaged Mid-Continent crudes. Management refers to the NY Harbor Brent 211 Crack as its East Coast refining benchmark and the hybrid Cushing WTI 431 Crack as the Mid-Continent benchmark.
Source: EIA Spot Price Data
Lack of retail operations could weigh on profits. Refiners who are vertically integrated along the retail supply chain can sell gasoline at retail prices vice wholesale prices. Retail prices are also more resilient to commodity price shocks (i.e., demand is relatively inelastic to price changes). In a falling crude price environment, retail gasoline prices lag by 1-3 weeks, which can add tremendous profitability to refining operations. In a rising crude price environment, the lag can exert a slight drag on profits but is far less pronounced. Since management sees upside bias to the oil market in 2015 and for other reasons, Executive Chairman Tom O’Malley expressed on the recent 2014Q4 conference call that the company is not currently evaluating retail operations.
Regulatory and Compliance Headwinds
Headwinds due to regulatory and compliance costs are the only significant threat to PBF Energy’s ability to create long-term shareholder value. Clean and renewable energy standards will undoubtedly weigh on profits, but more substantially, the EPA’s continued indecisiveness casts a cloud of uncertainty under which management must continue to operate.
The EPA’s Tier 3 gasoline program seeks to lower fuel emissions and fuel-sulfur content; this program will require significant capital spending and will result in higher fuel prices.
PBF’s profit margins are currently under pressure from Renewable Identification Numbers (RINS, i.e., cap-and-trade renewable energy credits) expenses. Under the EPA’s Renewable Fuel Standard program (RFS2), obligated parties (e.g., refiners, blenders, and importers) are required to surrender RINs to the EPA in order to fulfill their proportion of the total Renewable Volume Obligation (RVO). RINs are attached to renewable fuel production volumes (1 gallon of biofuel = 1 RIN). RVOs are assigned to obligated parties in proportion to their respective conventional fuel (i.e., gasoline and diesel) production volumes. Since PBR Energy has no ethanol or other biofuel capacity, it must buy RINs from other bio-refiners. Although RINs prices bottomed out in 2013 due to anticipated easing of RVOs, price have since skyrocketed due to prolonged delays in the EPA’s 2013 and 2014 final RVO mandates. As a result, PBF Energy has had pay out significantly more for RINs than it anticipated. PBF’s 2014 RINs expenses came in at $115.7 million (versus $126.4 million in 2013 and $43.7 million in 2012). Executive Chairman Tom O’Malley equates RFS2 to an “in excess of $4 billion tax on the American public on energy products“.
New renewable fuel standards are scheduled to roll out which will require obligated parties to forfeit other types of RINs. Particularly alarming is that the bulk of new RINs are earmarked for cellulosic biofuels, the production of which is experimental at best. I believes that RINs prices must increase in order to rationalize the economics of cellulosic biofuels.
Figure 4: RFS2 Biofuel Mandate
Source: Renewable Fuel Standard (RFS): Overview and Issues. Congressional Research Service Report R40155. March 14, 2013
Notes to Figure 4: D3-D7 correspond to matching RINs; D6 generally generally refers to corn-based biofuels (i.e. ethanol).
In spite of facing multiple cyclical and secular headwinds, PBF is poised to create shareholder value. On valuation alone, the stock offers a wide margin of safety (between price paid and value received). More importantly, management is executing its long-term strategy on multiple fronts. Continued accretive distressed asset acquisitions, rationalization of refining and logistics assets, asset drop-downs to PBFX, and growing returns of shareholder capital (contingent on expanding free cash flows) are all likely upside catalysts.
Management has proven itself to be very adept at acquisitions. On the 2014 Q4 conference call, CEO Tom Nimbley spoke about the possibility of continued acquisitions when and where they make sense. If past is prologue, the team is definitely capable of spotting and executing accretive deals. For example, Petrobras’ (PBR) Pasadena, Texas refinery, with its 100+ MBPD crude distillation capacity and a robust Nelson Complexity Rating of 16.6, may be up for strategic review. Reports indicate that Petrobras, which has been under pressure lately, plans to sell $13.7 billion in assets through 2016. Perhaps Petrobras would be more willing than usual to part from its Pasadena refining system? Although I do not know any specifics as to PBF’s targets of opportunity, an acquisition such as this, if made at the right price, would be a proverbial feather in the cap.
The team has also shown great initiative in rationalizing existing refining capacity through logistics projects. PBF’s East Coast refineries are able to process virtually any kind of crude, but have been historically constrained to waterborne feedstocks via the Delaware River. Even though PADD 1 demand exceeds production capacity, East Coast refineries have historically lacked access to cost-advantaged crudes since 1970s, resulting in prolonged structural disadvantages versus Mid-Continent and Gulf-Coast counterparts. However, PBF’s aggressive investment program in a “crude-by-rail” logistical infrastructure promises to close the gap by adding much lacking optionality through access to cost advantaged crudes.
Improved optionality allows PBF’s East Coast refining operations to reliably capture pricing differentials as they appear. Moreover, the Volcker Rule has caused major financial players to depart from commodities trading; as a result, the arbitrage trade has begun to reemerge. The fruits of an improved rail system have begun to reap fruits in the fourth quarter in which the refining margins of PBF’s East Coast refineries strongly exceeded the New York Harbor Brent 211 Crack. Management stated in the 2014 Q4 conference call that improved margin capture is expected to be a sustainable benefit going forward.
Asset drop-downs to company sponsored MLP, PBFX, provides PBF with a tax-advantaged vehicle to raise relatively cheap equity to fuel future growth projects. PBF’s management has been particularly aggressive with asset drop-downs versus peers; PBFX currently produces $62.8 in annual distributable cash flow and boasts a distribution yield of approximately 5.4%. Management guides that PBF retains another $100 million in “MPL-able” EBITDA. Even though PBFX is less than a year old, it boasts a far more mature distribution than most other refiner MLPs.
The MLP thesis has garnered a lot of investor enthusiasm; refiner-sponsored MLPs trade at a significant Capital to EBITDA ratios than their sponsors (see Table 5). Although PBFX currently allows management to drop assets at higher multiple, the ability to unlock value depends on prolonged enthusiasm which I would not rely on as being sustainable over the long-term. For an in-depth analysis of why MLP drop-downs may not be the holy grail of value creation, please refer to my previous SA Article, Dropping It Like It’s (Not That) Hot: VLO’S MLP Strategy In Focus.
Table 5: Key Valuation Multiples for Refiner/MLP Pairs
|Company||Price to Com. Equity (MRQ)||EV to EBITDA (TTM)||Distrib/Divi Yield (TTM)||Distrib/Divi Coverage Ratio, EBITDA (TTM)||Interest Coverage Ratio, EBITDA (TTM)|
|PBF Energy Inc (PBF)||1.5||11.6||3.98%||3.3||3.3|
|PBF Logistics LP (PBFX)||-6.6||65.3||3.24%||0.8||7.4|
|Phillips 66 (PSX)||1.9||10.6||2.60%||3.9||15.1|
|Phillips 66 Partners LP (PSXP)||74.3||38.7||1.73%||1.6||28.2|
|Valero Energy Corp (VLO)||1.5||4.4||2.05%||12.1||16.3|
|Valero Energy Partners LP (VLP)||5.2||32.8||1.78%||1.6||98.2|
Notes to Table 5: Peer-group aggregates consist of the following Sponsor/MLP pairs: PBF/PBFX, PSX/PSXP, VLO/VLP, DK/DKL, HFC/HEP, TSO/TLLP, RDSA.L/SHLX, WNR/WNRL, MPC/MPLX
Increasing return of shareholder capital is certainly a strong driver of stock returns. The current annual dividend of $1.20 per share represents an approximate 30% payout of expected 2015 EPS. Although the dividend is robust at these levels, I believe that opportunistic stock buybacks will be a much stronger driver of shareholder value. Management knows that the company’s assets trade on the cheap. To the extent in which PBF can reinvest in refining capacity more cheaply by buying back shares, I believe it will. As of the most recent 2014 Q4 Conference Call, CFO Erik Young indicated the company is authorized to purchase an additional $155 in shares under the current repurchase program. More importantly, I believe that the company’s cash flow generating potential supports this sort of aggressive capital reinvestment.
I am highly confident that PBF is undervalued at current prices. The management team is experienced, aggressive, and displays the “outsider” type of mentality that I love. I believe that the team can continue to drive long-term value by simply continuing on its current course and that the company’s stock price should eventually reflect the true economic value of its robust asset base.
Disclosure: I am LONG PBF