CVR Energy: Despite Near-Term Headwinds, Dividend Capacity Makes Shares Attractive

seekingalpha06-17

CVR Energy shares have only gained 6% in the past year and have lost 30% in the past quarter amid concerns about crack spreads.Recent financial results were mixed, with lower crack spreads impacting ...

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(NYSE:CVI) have been a modest performer over the past year, gaining just 6%. This performance though has deteriorated over the past quarter with shares losing about 30% from their recent high, amid concerns about the refining cycle. I last covered CVI in March, reiterating shares as a \"buy\" given my long-term optimism around refiners. Since then, performance has been very disappointing with shares losing nearly a quarter of their value. As such, it is appropriate to ask if the buy thesis is fundamentally flawed or if this sell-off creates an even greater opportunity. Seeking Alpha CVR Energy's Recent Financials Were Mixed In the company's first quarter reported on April 29th, it earned $0.04 in adjusted EPS, $0.13 shy of estimates. Now when looking at financial results, I believe it best to exclude results from its fertilizer unit. CVI owns 36.8% of CVR Partners, LP (UAN). In situations where companies own and consolidate the results of a publicly traded entity, I believe it best to exclude the financials and simply value the stake in the entity based on its current market price. At its current valuation, CVI's UAN stake is worth about $3/share. Looking at CVI's standalone financial results. The company has 206,000bpd of capacity across its two refineries. In Q1, throughput was just 196kbpd as it did seasonal maintenance activity. Its petroleum segment had $118 million in operating income on $1.7 billion of sales. Income was essentially cut in half as crack spreads declined by $14.61 from last year to $19.55. This was also a narrowing from $23.66 in Q4 2023. In April, it widened slightly past $20. It has since tightened again, which I will discuss further in the outlook. For refiners, the absolute price of oil and gasoline are not material to earnings and cash flow-though they greatly impact revenue. What matters most for a refiner is how much the spread between crude oil and refined products, as measured by \"crack spreads\", is. Refiners are ultimately a spread business, benefitting from the pricing variance in the raw commodity and processed products, like gasoline and diesel. In 2022 and early 2023, we saw extremely wide spreads as Russian sanctions caused turbulence in product markets. This has since normalized. As you can see below, margins expanded as Russia invaded Ukraine in 2022 to extreme levels. We have now stepped down, and Q1 was actually a bit below 2019 levels for CVR. We have essentially seen this entire tailwind fade away in its most recent quarterly results. CVR Energy Still, while CVR is less profitable in this more \"ordinary\" environment, it delivered reasonable financial results, in part due to cost discipline. Operating expenses were $5 million lower at $164 million. Accordingly, there was $5.78/barrel in operating expenses, down 2% from last year. Still just given tight crack spreads, CVR's refining margin was $14.23 was down over $9 from last year. As such, it generated $171 million of EBITDA from $285 million last year, aided by $91 million of RFS (renewable fuel standards) liability favorability. CVR continues to be quite cash generative. There was $177 million in operating cash flow and $121 million in free cash flow. This was aided by a light cap-ex quarter with a petroleum capex of $36 million. For the full year, CVR targets about $190 million of petroleum cap-ex with two-thirds focused on maintenance needs. I would note there was also about $23 million of turnaround spending. CVR pays a $0.50/share regular dividend, which costs just about $50 million per quarter. Importantly, CVR has a strong balance sheet. Excluding its fertilizer segment, it has about $579 million of cash. It also has about $1 billion of debt ex-UAN. As such, net debt/EBITDA is a very modest ~0.5x. With its strong balance sheet, CVR is well positioned to return free cash flow to shareholders, via its regular dividend and special dividend payouts. Macro Has Deteriorated But Maybe Bottoming Now, the outlook for the company has diminished somewhat, which likely has contributed to the share price decline. On a company-specific level, there was a fire at one of its refineries, which reduced throughput. As such, it expects 170-190k of throughput in Q2, down about 8% sequentially. It expects operations to be normal by the end of Q2. I would note the pre-tax impact of this fire is about $0.20-$0.40/share, and the impact is, of course, one-time, and not something that will reduce earnings on an ongoing basis. As such, it can explain about a 1% price drop. However, shares are down substantially more than that, and I believe a focus on the refining macro is the primary culprit. The benchmark 321 crack spread has declined to $24 from $31 as strong refinery utilization has lifted gasoline inventories. As you can see below, gasoline inventories have begun to rise in recent weeks. This is atypical, as inventories normally fall throughout the summer driving season. Higher inventories, all else equal, reduce crack spreads. I think it is also important to note that inventories remain reasonable on an absolute basis. It is the trend that has caused more concern. EIA As you can see, since March, US gasoline demand has run a bit weaker than last year, a deceleration from earlier, which had been a modest increase. This lower level of demand has caused an uptick in inventories. It is important to note that after being particularly weak in late April and early May, demand has been bouncing back and is nearly back to last year's levels. If we see this rebound continue, that should help to alleviate pressure on crack spreads from the demand side. Moreover, I continue to view a recession as unlikely, and economic growth should support stable to rising product demand, all else equal. EIA Now, if we see OPEC+ go forward with reducing production cuts later this year, that should increase the supply of oil relative to demand. If we see end product demand hold stable and a bit more raw commodity supply, that could also help to put a floor under crack spreads. As written in past articles, refining capacity in my view is the long-term \"bottleneck\" in the oil sector. The US has not built a refinery in over forty years, and given regulations and cost, we likely never will. With spending on refining capacity essentially closed off in the developed world amid the push to greener energy, refining capacity is largely capped. With a world still growing, I do expect modest demand growth for refined products over the next several years. More demand than supply growth should, all else equal, support wider spreads. Spreads are already basically back to 2019 levels. I continue to view pre-COVID spreads as a long-term floor, given these factors; the pain has largely been felt. Energy Stock Channel Markets often extrapolate trends. I believe shares have essentially been discounting continued degradation in the crack spread environment. However, with driving demand picking up, some incoming oil supply, and favorable long-term supply/demand dynamics, I believe this is overly negative. Icahn remains an overhang; M&A is a Question Mark It is also important to note CVI stock can be illiquid because Carl Icahn and Icahn Enterprises L.P. (IEP) owns 66.3% of CVR Energy. IEP shares have continued to be under pressure, and I believe Icahn's ownership continues to be viewed as a risk, amid concerns he could sell shares to manage liquidity. I do expect this to be a structural headwind for CVI. Against this overhang, back in March, CVR announced it was exploring strategic transactions around UAN. Interestingly, on the most recent earnings call, CVR stated there are \"some very interesting and transformative opportunities out there for both our refining business and CVR Partners.\" I would view a sale of UAN as a positive in so far as it simplifies CVI's business and financials. I would expect any proceeds to be used for dividends or a buyback. It was particularly interesting to hear management note there were also transformative opportunities for the refining unit. Frankly, I am skeptical that a transaction would occur. The difficulty in selling Citgo assets makes me believe a buyer is unlikely to emerge for CVI; that said, it is possible Icahn could seek to monetize his stake. M&A is an upside risk, but I view it as unlikely. Conclusion Back in March, I forecast the company having $900 million to $1 billion in run-rate EBITDA, leading to $450-500 million in free cash flow. Given somewhat tighter crack spreads in the near term and lower Q2 throughput, I would expect closer to $400 million in free cash flow. Still, that can support up to $2 in additional special dividends. It has a secure dividend yield of 7.5%, and special dividends could take it to 15%. Shares are trading just 7x free cash flow, which I view as attractive, given favorable long-term dynamics. I still view a $40 price target as the fair long-term value or about 10x free cash flow. However, some clarity on strategic alternatives and a bottoming in crack spreads may be necessary for shares to begin to recover. Since my last writeup, the rally in UAN has lifted the value of CVI's stake by about $0.50. This more than offsets the $0.25 headwind from the refinery fire in Q2. My valuation on CVR Energy has been based on a $25 long-run crack spread environment, which I view as \"normal\" given the structural shortage of refining capacity over the long term. As such, when we saw wide crack spreads north of $30 like last year, I would not expect CVR shares to fully benefit, as there is some excess unsustainable profit. Similarly, I would not use earnings at an $18 crack spread environment to set a run-rate multiple. While we have seen some cyclical pressure on crack spread, they do not change the fundamental market structure. Moreover, peak pressures should be passing, given the factors discussed above. As we see spreads bottom, that should help provide support to CVI stock. Given these factors, I continue to view $40 as CVI's fair value, while recognizing current overhangs may mean it takes longer to achieve this target.  In this case, I believe investors have gotten too negative on CVI. With its large dividend, investors are being paid to wait for a normalization in sentiment. I would use weakness to buy CVI.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444199016"}