The company has consistently said that they want to sell the refining assets and go back to being a pure
play specialty chemical business that sells branded lubricants, customized white oil, waxes, base oil, and
specialty solvents. They have been saying this for a couple years now, so why is it going to happen in
the next 18 months? Management team has also consistently said that they want divestitures to be
deleveraging transactions. Now that we have the 2018 reported financials, it is clear that management
team knows that specialty EBITDA will be quite low on a TTM basis. Calendar 2018 specialty EBITDA
came in at about $166mm excluding LCM/LIFO. So if they sold the refining assets for the midpoint of
$450mm and $75mm, they will be left with a net debt of $1532mm-$153mm cash less $525mm sales
proceeds = $854mm which equates to a net debt to remainco EBITDA of 5.3x. Yes, it will be pure play
specialty EBITDA, but it will be hard to try to roll the 2021, 2022, 2023 debt coming due with a high
leverage ratio like 5.3x. We believe that the management team wanted to extract the cashflow from the
fuel refinery for an additional year and show the 2019 results which will not have non-recurring items
like turnaround activities, ERP implementation cost, acquisition cost, etc. We believe that Calumet’s
2019 specialty EBITDA is on target to do $200-225mm. If we fast forward to when the company reports
Q3 2019, we will generate another $50mm of FCF. The net debt will likely be reduced to $804mm. With
a denominator of $200-225mm of specialty chemicals EBITDA, this will imply a 3.6 to 4.0x net debt to
EBITDA. A lot of the MLP unit holders would like the company to start paying a distribution. Frankly, we
prefer the company to get leverage to sub 3.0x before they turn the distribution back on.
The key question going forward is will the debt capital markets allow the company to roll the debt. We
have spoken to many smart distressed debt investors. When we bring up potential liquidity induced
bankruptcy a la General Growth Properties style, we essentially got called a “lunatic” for even imagining
such a possibility. The view is that the debt will be rolled and the key question is at what coupon rate.
The debt currently trades at roughly an 8% yield. It is easier to refinance the debt on a secured basis.
But that would prime the unsecured that are coming due in 2022 and 2023. Thus management team
would like to access the unsecured market in 2019 if possible.
Business Description - Fuel
So what does Calumet do? On the fuel refining side, they source crude oil and turn it into gasoline,
diesel, asphalt etc. It is important to point out that Calumet owns a strategic asset in Great Falls,
Montana just across the border from Canada’s oilsand fields. Over time, we have grown to appreciate
the strategic value of this asset. It is well known that there isn’t enough takeaway capacity to handle
the Western Canadian Select crude produced by the Canadian E&P companies. A lot of the crude leaves
via rail to the Gulf coast in the US. Hence, this facility can capture a $20 spread between WCS to WTI.
Its refining spread is essentially the cost to ship a barrel of oil from Alberta to the Gulf via rail. We do
not like the capital intensive fuel refining business given that it requires a lot of capital and occasionally
the refineries blow up. But there is a lot of NIMBYism dynamic in owning a fuel refinery and there has
only been five new refineries built in the US since 1998 adding 231,000 barrels/day of capacity while US
crude production has surged from 6.25mm barrels/day in 1998 to almost 11mm barrels/day. Nobody
wants a giant crude refinery in their backyard. This is the reason why banks will finance fuel refineries
and why they get sold in bankruptcy auctions. While they trade for low EBITDA multiples of 4-5x, they
are not like shipping assets.