Description

Alon USA Energy (ALJ) is a complicated story with numerous moving pieces that I believe is set to unlock significant value for shareholders over the next year.  I am submitting this idea today just ahead of the company’s Q4 and FY 2012 conference call that is scheduled for tomorrow as I believe that the company will have numerous positive things to discuss during its call.

ALJ has three primary assets:

Asset #1:

51M units of its publicly traded subsidiary Alon USA Partners (ALDW) that are worth approximately $1.1B on a post-tax basis (assuming a 500M cost basis and a 35% tax rate). I am comfortable with ALDW’s valuation, particularly given where Northern Tier (NTI) is trading. 

Asset #2:

A 100% interest in a refinery in Krotz Springs, LA capable of running 83K bpd, ALJ’s Krotz refinery has a 44% distillate yield capability, which allows the refinery to capture a much larger portion of the diesel crack when compared to other refineries.  Valero (VLO) for example, has a companywide average distillate yield of only 33% that they are hoping to get to 39% following numerous capex projects.  On page 11 of the most recent Valero presentation ( http://www.valero.com/InvestorRelations/Pages/EventsPresentations.aspx ) you will notice that the diesel gulf crack in Q4 of 2012 averaged approximately $17 dollars whereas the gasoline crack was somewhere around a negative $2 which led to an average LLS gulf crack spread during the quarter of just north of $5.  ALJ’s Krotz refinery likely generated an above benchmark crack spread during the quarter as a result of its high distillate concentration.  Results from the refinery also likely benefited from ALJ’s continued efforts to bring the plant to full capacity and by its ability to successfully deliver 30K of cost advantaged WTI linked crude to the refinery.  For reference purposes, Krotz is likely just now getting close to being able to run at full capacity for the first time since ALJ bought the plant from VLO in 2008.

I believe ALJ’s Krotz refinery is worth 1.2B at a 4x multiple assuming the following:

A) Krotz is fully operational in 2013;

B) Using my base case crack spread assumption (which is about $9 dollars – where the base crack is today and implies no distillate benefit),

C) The refinery receives 30K barrels of WTI at a post rail expense spread to Brent (I believe I’m being conservative here given the fact that the company has a significant amount of rail car capacity that it controls)

Substantial upside to my Krotz valuation likely exists should the company develop any further rail initiatives and/or see discounting in gulf crudes.

Asset #3:

ALJ controls a retail gas station network of approximately 300 stations, 147 of which are company owned and is the second largest asphalt supplier west of the Mississippi.  I believe these assets are capable of generating $35M of EBITDA on sustained basis.  At a 7.0x multiple, which I believe is fair given where peer gas stations are trading this component of ALJ is worth $245M

Conclusion:

Collectively these three assets are worth $2.52B.  On the liabilities front, ALJ’s February presentation listed $493M in net debt, given the consolidation of ALDW’s debt onto ALJ’s balance sheet it is likely that ALJ’s net debt is below $200M.  Capitalizing ALJ’s remaining corporate SG&A (excluding ALDW’s share), I estimate an additional drag of $75M at a 4x EBITDA multiple. Under these assumptions, I show a value to the equity of $2.27B vs today’s market cap of approximately $1.2B, implying substantial upside to the company’s current share price. 

Further upside rests in the company’s California refineries, which I do not believe, should be counted as a liability due to the strong likelihood that rail initiatives will allow these refineries to be restarted and operated profitably.  These rail initiatives have already begun (and will likely be discussed further on the call) which will help to create significant value for ALJ shareholders in 2014.  The success of PBF Energy (PBF) in bringing rail-sourced crude to the East Coast is likely being closely watching by west coast refiners such as ALJ.  For example, VLO has announced the following project to improve the economics of one of its west coast refineries:

http://www.mysanantonio.com/business/article/Valero-plans-30M-Calif-project-4327626.php

ALJ has the following refineries that are currently not operational which effectively act as a call options for equity holders and the company, should rail initiatives on the West Coast prove attractive, which I believe they will given the high complexity nature of ALJ’s CA refineries:

A) A refinery in Paramount CA – 54K bpd

B) A refinery in Bakersfield CA – 70K bpd

C) A refinery in Long Beach CA – 40K bpd

While this is a short write-up, I am putting this idea out there because I believe that ALJ is dramatically mispriced given its current share price.  I believe this mispricing will begin to close following its earnings release and after its conference call tomorrow where I expect the management team will begin to discuss the rapid improvement of Krotz Springs, rail opportunities in California, and its capital allocation policies going forward given its improved financial flexibility.

The primary risk here is changing crack spreads and the various pipeline reversals.  I believe that crack spreads, in particular distillate crack spreads, will remain significantly above historical levels due to surging exports of refined products and surging US crude production which can’t be exported due to executive order.  Concerns about pipelines are certainly important; however, I believe that the WTI/Brent spread will stay elevated through Q4 2013 allowing ALJ to benifit from substantial differentials.

Catalyst