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Delek US Holdings (NYSE: DK) is a diversified energy company that refines crude oil, markets refined products to oil distributors, and sells fuel and merchandise to end consumers. The refining segment operates only one independent refinery with a capacity of 60,000 barrels per day (bpd) in Tyler, Texas. As for the retail segment, Delek operates 443 retail fuel and convenience stores in across the Southern U.S. Delek wholesales its refined petroleum products through its own pipelines. Unlike the oil & gas majors like Exxon Mobil and BP(BP) which are vertically integrated, Delek purchases most of their supplies from third parties. Delek’s marketing customers include ExxonMobil, Valero Marketing and Supply, Murphy Oil USA, Truman Arnold, Chevron.

Delek's revenue increased by 739.7% over the course of 7 years, from $549.6 million in 2002 to $4,615.2 million in 2008.[1] This growth is the result of a series of opportunistic acquisitions of downstream energy assets. For example, its net sales increased by 64% in 2006 after the acquisition of an oil refinery in Tyler, Texas. Ever since, the refining segment has taken over as the main source of revenue for the company.[2]

The company's profit margins are exposed to a number of macro-related factors such as the crude oil and other commodities prices, retail fuel prices and the consumer discretionary spending environment. Crude oil prices rose from an average $72.44 per barrel in 2007 to $99.73 per barrel in 2008 and reached $81.9 per barrel in January 2010. The volatility of crude oil prices will continue to adversely affect the company's profitability.[3]

Company Overview

Delek was formed by an acquisition of 198 retail fuel and convenience stores from a subsidiary of the Williams Companies in 2001.[4] Its primary business activities include refining, marketing and retail. Up until April 2007, Delek had completed 501 acquisitions in the retail fuel and convenience stores industry since its inception.[5] The company then expanded its operations to the refining segment by acquiring a refinery at Tyler, Texas in 2005. A year later, it purchased a 34.6% equity stake in Lion Oil Company, an owner and operator of a refinery in El Dorado, Arkansas.[6]. In 2006, Delek entered the marketing segment by purchasing assets from Pride Companies LP and affiliates. [7]

Business Financials

' As of 30 September 2009 2008 2007 2006
Net sales1766.1 million4,615.2 million3,900.9 million3,016.0 million
Operating income53.1 million80.5 million154.8 million151.1 million
Refinery throughput53,773 bpd56,922 bpd56,163 bpd58,128 bpd
Output produced54,092 bpd55,773 bpd54,660 bpd56,583 bpd
Number of convenience stores443458461358

Delek US Holdings Key Figures

Delek had a net sales of $4,615.2 million in 2008, an increase of 18.3% versus 2007. On the contrary, despite the 18.3% increase in net sales, Delek's operating income dropped by 92.3% in 2008, from $154.8 million to $80.5 million. The decrease is primarily caused by the higher costs of crude for its refinery and retail segments.[8]

Net sales for the nine months ended 30 September 2009 stood at $1,766.1 million, a 41.7% drop as compared to $3,957.1 million for the nine months ended 30 September 2008. The drop in earnings partly due to an explosion and fire at the Tyler, Texas refinery in 20 November, 2008 that cut production. The cause of the event is still unknown but several parallel investigations are still underway by the U.S. Department of Labor's Occupational Safety & Health Administration (OSHA) and the U.S. Chemical Safety and Hazard Investigation Board (CSB). [9]

The refinery was offline until May 2009, and the cost to rebuild the refinery amounted to $11.4 million.[10]

Delek finances its operations and capital needs through cash and debt. Due to the nature of the oil business and volatile crude prices, the company requires a significant amount of short-term cash for crude oil purchases. In 2008, Delek's total debt dropped by 19.5% to $286 million and its total cash dropped by 85.4% to $15.3 million.[11] Delek will face challenges in funding its operations and expansions after debt financing ability was suspended for the refining segment due to the fire incident on 20 November 2008. Access towards capital is further constrained by the economic slowdown.[12]

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The refining segment's net sales decreased from 53% in 2006 to 44% in 2007 but increased by 2% to 46% in 2008. The marketing segment increased by more than two times, from 7% in 2006 to 16% in 2007 and this percentage was maintained in 2008. The retail segment accounted for 40% of Delek's total net sales in 2006 and 2007 but dropped 2% to 28% in 2008.[13]

The refining segment's net sales decreased from 53% in 2006 to 44% in 2007 but increased by 2% to 46% in 2008. The marketing segment increased by more than two times, from 7% in 2006 to 16% in 2007 and this percentage was maintained in 2008. The retail segment accounted for 40% of Delek's total net sales in 2006 and 2007 but dropped 2% to 28% in 2008.[14]

Business Segments

Refining segment (46% of 2008 sales, 43% of 2008 contribution margin)

Delek’s refining segment processes crude oil for manufacturers that produce transportation motor fuels. In 2008, Delek generated total sales of $2,105.6 million, versus $1,709.0 million in 2007. The 23.2% increase was due to higher sales prices in the petroleum goods market. Sales for the nine months ended 30 September 2009 amounted to $528.2 million, a 71.7% decrease as compared to $1,868.4 million for the nine months ended 30 September 2008. [15] The decline is primarily attributed to the decrease in the sales price of petroleum products and the drop in sales volume caused by the suspension of operations at the refinery at Tyler, Texas. Delek made net property damage proceeds of $24.7 million in this event through insurance coverage and resumed operations in May 2009.[16]

Crude oil is the primary raw material for the petroleum refinery segment and crude oil prices continue to be volatile in the energy markets. The average price of crude oil per barrel in 2008, 2007, and 2006 was $99.73, $72.44, and $66.27 respectively. Fluctuation in the crude oil prices is the main factor that affects the company's profit margin in this segment. Delek's refining operating margin in 2008, 2007, and 2006 was $9.29, $11.82 and $11.00 respectively.[17] The volatility of the crude oil prices will remain a critical factor effecting Delek's earnings. Delek completed a series of capital projects called the 'crude optimization projects' in the second quarter of 2009, which Delek hopes will improve its refinery margin by substituting light and sweet crude with less expensive types of crude such as heavy and sour crude.[18]

Retail segment (38% of 2008 sales, 38% of 2008 contribution margin)

Delek’s retail segment markets diesel, gasoline, other refined petroleum products plus convenience merchandise throughout the 443 stores in Tennessee, Alabama, Georgia, Arkansas, Kentucky, Louisiana and Mississippi. The retail segment recorded net sales of $1,777.2 million for the fiscal year ended 31 December 2008, an increase of 12.5% since 2007.[19] Delek's convenience stores operate under a vast of Delek’s brand names like MAPCO Express, and introduced their own MAPCO private label products in the majority of the sites in 2006. However, merchandise sales only account for a small portion of the retail segment's total sales. Fuel sales in Delek’s retail and convenience stores was approximately 79% and 76% of total sales in this segment in 2008 and 2007, translating to 407,597 thousands of gallons and 412,052 thousands of gallons respectively.[20]

Marketing segment (16% of 2008 sales, 14% of 2008 contribution margin)

Delek sells refined products on a wholesale basis in West Texas through company-owned and third party operated terminals and crude oil pipelines. Delek’s marketing segment also provides marketing services to the refined products from the Tyler refinery.[21] Net sales in 2008 were $745.5 million with an average sales volume of 16,557 barrels per day, as compared to net sales of $626.6 million with an average sales volume of 17,923 barrels per day in 2007.[22] Net sales for the nine months ended 30 September 2009 and 2008 was $246.9 million and $633.9 million respectively. The $387 million drop in sales was driven by the drop in fuel price. The average price for gasoline and diesel for the nine months ended 30 September 2008 was $2.97 per gallon and $3.39 per gallon, but it decreased to $1.65 per gallon and $1.63 per gallon for the same period in 2009.[23]

Trends and Forces

Rising crude oil prices and slumping fuel demands continue to impact the U.S refinery sector

Soaring [[Oil|crude oil] prices will continue to assert downward pricing pressure on U.S refiners. In January, crude prices soared to $81.59 per barrel, the highest since October 2009.[24] On the other hand, fuel demands remain slow to pick up in view of the economic recession. As a result, fuel prices have not increased at the same pace as crude oil prices. This is a double whammy to U.S refiners as they are hit by higher costs and slimmer profit margins.[25] Many of the independent U.S refiners like Valero Energy (VLO) and Sunoco (SUN)|Sunoco Inc (SUN)]] have resorted to shutting down some of their refineries in response to rising operating costs and tighter margins.[26]

Crude oil prices rose from an average $72.44 per barrel in 2007 to $99.73 per barrel in 2008.[27]. This increased Delek's operating costs and expenses by 25% in 2008 from $1,542.4 million to $2,018.2 million. As a result, Delek's refining operating margin declined by 27.2% in 2008, from $11.82 per barrel of sales in 2007 to $9.29 per barrel of sales in 2008.[28]

Refining heavy and sour crude in response to the soaring light and sweet crude oil prices

As U.S refiners' profit margins are adversely impacted by rising crude oil prices, refining heavy and sour crude is beneficial as it can be done at a considerable discount to light and sour crude oil. Due to the higher sulfur content in the heavy and sour crude, however, converting heavy and sour crude to finished goods with comparable quality to those produced from light and sweet crude is a challenge for refiners.[29] Adaptating to process inferior crude requires more advanced technologies and investment.[30]

Delek completed several crude optimization projects in the second quarter of 2009. This project will improve its refinery at Tyler, Texas to process a wider array of heavier and sour types of crude in order to take advantage of the discount available. The expenditure for the projects is expected to be approximately $30.6 million.[31]

Image:Crude_oil_projection.jpg‎
Source: U.S Energy Information Administration Independent Statistics and Analysis[32]
Oil demand is expected to increase in the future, mainly driven by developing economies like China and India. In view of the rising sweet and light crude oil prices, demand for heavy and sour crude oil is projected to increase at a bigger percentage than sweet and light crude.

Technology is key to meet stricter environmental regulations

Today, more than half of refined products are produced from heavy and sour crude, and its share is expected to increase in the future. As heavy and sour crude have higher sulfur-content than sweet and light crude, the environmental requirements for converting inferior crudes to products are more stringent.[33] In response to stricter regulations such as emission caps and low-sulfur fuels laws, US refiners are being forced to invest in more technologically advanced facilities.[34] In 2005, the American Petroleum Institute estimated the industry invested $47 billion on such investments.[35] Delek expects to spend approximately $13.0 million in order to comply with new regulations in 2009.[36]

Competition

Delek competes with the major oil & gas companies like Exxon Mobil (XOM), ConocoPhillips (COP), Chevron Corporation (CVX) and BP (BP). These oil majors are usually vertically integrated, with operations in exploration, production, refining, and marketing segments. Other smaller competitors include Murphy Oil (MUR) and Marathon Oil (MRO), which also produce, refine and market petroleum products. Since these companies do not have to depend on third parties for crude oil, they have cost advantages compared to independent refiners like Delek.

Other independent refineries like Valero Energy (VLO), Tesoro Corporation (TSO) are direct competitors of Delek's in the refining and marketing segments. Both Valero and Tesoro's technologically advanced refineries have the capacities to refine heavier and sour crude, allowing them to take advantage of the volatile sweet light crude oil prices. Delek recently completed similar initiatives called the crude optimization projects to produce more inferior crude to improve profitability.

' Sales Refinery Capacity Production (Oil) Number of Retail Stations
Delek US Holdings$4,615 million0.06 million bpd56 thousand bpd482
Valero Oil (VLO)[37]$119,114 million2.6 million bpd2,636 thousand bpd973
Tesoro Corporation (TSO)[38]$28,209 million0.67 million bpd625 thousands bpd879
Murphy Oil(MUR)[39]$27,441 million0.15 million bpdn/a1,025
Marathon Oil[40]$77,193 million1.02 million bpd1,168 thousand bpd1,617

2008 Industry Metrics

References

  1. Form 10-K DK 2006
  2. Form 10-K DK 2008 pg 37
  3. Form 10-K DK 2008 pg 44
  4. Form 10-K DK 2008 pg 3
  5. Form 10-K DK 2008 pg 3
  6. Form 10-K DK 2008 pg45
  7. Form 10-K DK 2008 pg 2
  8. Form 10-K DK 2008
  9. Form 10-Q DK 3Q 2009
  10. Form 10-Q DK 2009
  11. Form 10-K DK 2008 pg 38
  12. Form 10-K DK 2008 pg 19
  13. Form 10-K DK 2008 pg 39 & 40
  14. Form 10-K DK 2008 pg 39 & 40
  15. Form 10-Q DK 2009 pg 36
  16. Form 10-Q DK 2009 pg 4
  17. Form 10-K DK 2008
  18. Form 10-Q DK 2009 pg 18
  19. Form 10-K DK 2008 pg 51
  20. Form 10-K DK 2008 pg 11
  21. Form 10-K DK 2008 pg 10
  22. Form 10-K DK 2008 pg 37
  23. Form 10-Q DK 2009 pg 41
  24. Business Week: Winter blast sends oil prices to 14-month high, January 2010
  25. Market Watch: Another refinery bites the dust, November 2009
  26. Market Watch: Valero Energy shutting down Delaware refinery, November 2009
  27. Form 10-K DK 2008
  28. Form 10-Q DK 2009 pg 39
  29. PRLog: Global refining industry is in the face of increasing demand
  30. U.S EIA: Changing trends in the refining industry
  31. Form 10-Q DK 2009
  32. U.S EIA: Changing trends in the refining industry
  33. PRLog: Global refining industry is in the face of increasing demand, April 2009
  34. Form 10-K DK 2008
  35. CorpWatch: US: No new refineries in 29 years, May 2005
  36. Page 21
  37. Form 10-K VLO 2008
  38. Form 10-K TSO 2008
  39. Form 10-K MUR 2008
  40. Form 10-K MRO 2008
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