imaginima
Vertex Energy (NASDAQ:VTNR) remains an inexpensive refiner and their renewable diesel project should add value next year. Still, despite a savvy acquisition, management still has not hit their stride with refinery operations or delivering against guidance.
I wrote recently about how Q2 numbers were a mess, since then the shares have rallied on market sentiment and improved crack spreads. However, Q3 numbers were still somewhat disappointing, as giving up margin through hedging was complemented by giving up margin through backwardation and other factors. Also, $13M of lost sales from Q2 did not appear to boost Q3 numbers to any degree.
I still have concerns about management, their communication continues to be opaque and far more things are coming in below expectations than above with downward revisions to guidance occurring as Q3 ended. The renewable diesel project is now expected to start production in Q2 2023, pushed back from Q1 2023.
A Q4 Bump?
I am hesitant to say this after the disappointment of Q2 and an uninspiring Q3, but Q4 could actually be a strong quarter for Vertex. Here’s how that may play out.
| Q3 | Q4 (est.) | |
| Volume – barrels (supply disruption in Q3 rebounds for Q4) | 6.2 | 6.6 |
| 2/1/1 crack spread (generally improving for industry based on futures) | $34.82 | $40.72 |
| Actual crack spread achieved by VTNR | $13.92 | $20.37 |
| Spread ‘capture rate’ (50% or worse in Q2 and Q3) | 40% | 50% |
| Opex per barrel (improving per guidance) | $4.2 | $3.6 |
| Refinery gross margin (excl. hedges) | $87M | $110M |
| Backwardation costs (set to continue per management) | -$18M | -$18M |
| True gross margin (excl. hedges) | $69M | $92M |
There are a few moving parts in the above:
- Spreads are looking stronger in Q4 and that could be worth about ~$40M even after discounting for Vertex’s historical inability to capture anything close to market spreads (but slightly better than Q2).
- Q3 had some operational disruptions, these were used to service the refinery. These should not recur in Q4, increasing output by about 6% or ~$5M.
- Opex per barrel should reduce in Q4 and that’s worth about ~$4M to profits.
This largely also captures what we are learning about Vertex in their recent reporting too, such as:
- Crack spreads should be discounted from the gulf coast wholesale market for wholesale prices actually achieved.
- Vertex then aims to capture around 50% of that spread (after discounting prices).
- Still, some wildcards should be expected, but I have factored in backwardation costs, which management expects to continue, and there appears to be sufficient incremental margin for Q4 to be a step up from Q3 even with minor negative surprises.
Valuation
As for the valuation, this is what I get:
| Value | Notes | |
| Legacy black oil business | $100M | |
| Q4 refinery cash flow (after tax) | $60M | Based on futures curve/guidance |
| 2023 refinery cash flow (after tax) | $200M | Based on favorable futures curve/spreads |
| 10x multiple on normal refinery cash flow ($53M FCF per annum) | $530M | $8 spread less $3.75 opex |
| Q2 2023 renewable diesel asset (200M gallons a year at $0.5/gallon on 7x multiple) | $700M | |
| Incremental capex and working capital to initiate renewable diesel production | -$100M | |
| Net debt | -$369M | |
| Value of converts | +$45M | |
| Resulting equity value | $1,166M | Sum of above |
| Diluted shares out | 97.8 | |
| Share price | $11.92/share |
Risks
Vertex seems to have a habit of failing to meet guidance, and that could become a pattern.
It seems clear that the Mobile refinery, though operating at a great time for refining, is not particularly efficient.
Reporting is relatively opaque, making it harder to determine the Mobile refinery’s true earnings power, especially after only two quarters of operations
The timeline on the renewable diesel project is slipping and could slip further beyond Q2 2023.
Once the renewable diesel project is complete, capital allocation from management is a concern, they have some debt to pay down, but after that, they could destroy value, especially if they make acquisitions during a period of relatively high industry profitability.
Conclusion
Management is running out of time to earn super-normal profits from their Mobile refinery after two unimpressive quarters, but the futures curve suggests a window remains into 2023 and perhaps 2024, even assuming sub-par operational efficiency.
The starting of renewable diesel operations in H1 2023 should be a catalyst for the shares to re-rate. Vertex offers reasonable value at these levels, though there are valid concerns about how Vertex is managed and what management will do with any excess cash given a stated desire to make strategic acquisitions.