Description

Fully acknowledge refining is a controversial arena + PBF is a particularly spicy one … not only is PBF hated-on (coastal assets create additional torque), refining is one of the very few areas that still hasn’t shown a significant COVID-recovery begging the question “is it structural”. I’m in the opposing camp and like the credit (9.25% Secured Note trading in ~96 context and 7.25% Unsecured Note trading in ~77 context, both due 2025) + equity in small size. Couple reasons on why now: 1) S/D very tight: fundamental tightness is underappreciated and this winter could get very interesting particularly as we are back to 2019 demand levels, global supply has been reduced and NOW there is a pull for US product in South America as well as less European import pressure on East coast (i.e. global energy crises puts US on very very low cost footing), 2) RIN news is imminent (particularly now that elections have passed by): EPA news around RVOs and ultimately RINs pricing is imminent now that election season is over and has the potential to provide material relief to PBF (as noted below, my base case is D6 RINs go <$0.75 which would likely unlock >$300 - $400MM of FCF that the market currently ignores) and 3) low hurdle set-up: bar is set quite low as market assumes the parent (excluding daughter / PBFX) will generate <$800MM of EBITDA yet I think $1.3Bln+ is a much more likely scenario over the next 12-months (>60% divergence to market) and 4) credit mkts negative on many fronts: not only is the credit market skeptical of earnings power, more importantly it’s skeptical around liquidity and assumes $2.6Bln (ending Q3) will be drained to ~$2Bln and falling by YE (my view is liquidity will likely stay unchanged into YE and improve thereafter given FCF generation of the biz).

If correct on where the puck is moving over the next 12-months on the biz fundies + RINs relief is a n-term event … PBF will generate surprisingly robust “above-mid-cycle” earnings power (well in excess of $1.2Bln at the parent ex daughter/ PBFX) and FCF generation will be >$500MM. Given >$1.4Bln of cash on the balance sheet, decent shot of the company paying down the 9.25% Secured “insurance policy” in mid-2022 and think the company will continue to be opportunistic in buying back the Unsecureds (bought >$230MM in Q3 at ~65 cents and my view is they probably wanted to get closer to $500MM so more to come).  As a result, looking at the credit as a 1-year-to-event, the Secureds provide ~18% (OID + coupon), and Unsecureds ~34 – 42%. Once the balance sheet is “fixed” and the credit signals are clear, think the equity has the potential to trade to $28 / share or ~100% upside (applying a 4x EBITDA multiple to above-mid-cycle EBITDA).

MARKET VIEW: PBF is a challenged old-school refiner that is on the higher end of the cost curve (i.e. coastal assets) and will be forced to shutter capacity as renewables continue to press against demand. The market assumes the biz will remain at 2-STDEV levels BELOW mid-cycle into perpetuity.

MY VIEW: PBF is in the early stages of benefiting from the “perfect storm”, w/ S/D surprisingly tight (already running at ~90% ute levels and 3-4% of global supply has been removed, and back to 2019 demand levels); additionally, given global trade flows, the global energy crises will benefit US coastal assets as less European import pressure and US Gulf assets will be pushing product out to South America further tightening the US market particularly this winter. Lastly, the EPA will issue specific rules in the very n-term which will provide RINs relief for D6 RINs and PBF is the largest beneficiary of this (550- 600MM+ of annual purchasing needs).

DIVERGENCE: PBF has been suffered from COVID for the past 2-years (refining has been one of the notable laggards to the recovery). The current operating environment (low inventory levels, >90% ute levels, and Winter season tightness) will greatly benefit PBF’s coastal assets and evidence of crack spreads expanding in recent months. Additionally, PBF has suffered from a >$500-$750MM RIN headwind over the past 12-months resulting in a DOUBLE WHAMMY of low demand and expense / RIN pressure. The EPA will issue an update providing >$300M of relief to PBF (could be as sizable as >$600MM) according to our math which will directly flow through to FCF generation and debt deleveraging.

The sell-side is pricing in a <$800MM of EBITDA in 2022E for the parent (ex PBFX / daughter) vs my estimate of ~$1.3Bln above-mid-cycle (mid is ~$1.15Bln excluding PBFX / daughter entity). WDO’s estimates are >60% above sell-side estimates (>$500MM of divergence). Additionally, PBF will likely be in a position to pay off its 9.25% insurance policy Secured Note in May 2022 when the call pro steps to 104.625 (cash of >$1.4Bln versus outstanding amount of $1.25Bln).

EVIDENCE SUPPORTING DIVERGENCE: (1) Utilization levels at ~90% (that’s full out), (2) crack spreads expanding as RINs prices have compressed in recent month(s) suggests demand wins out, (3) international energy market chaos suggests ROW is very high cost and will keep their product internal and not ship to US and South America allowing the US Gulf to ship to South America expanding the demand side (could be a >2 – 4% demand tailwind for US producers).

VALUATION / NEW REALITY: As the market grows more comfortable w/ the extreme tightness in the US refining market (and coastal assets in particular) + RINs news is fully digested (our assumption is >$0.50 / gallon of compression which equates to >$275MM - $300MM of FCF benefit for PBF), the credit markets will grow more comfortable w/ FCF positive state and the equity multiple being placed on PBF will likely expand (we conservatively assume 4x EBITDA on mid-cycle but could expand by 0.5x – 1.0x in the early innings). Currently, PBF credit trades at ~1.7x face (1.4x market) and through the equity ~3.0x on our 2022E EBITDA est of $1.3Bln. The biz will likely generate >$500MM of FCF over next 12-months (and possibly >$250MM additional dependent on the EPA announcement).

BASE CASE: Applying a 4x multiple to mid-cycle ($1.15Bln of EBITDA) and valuing the daughter PBFX entity separate + positive RINs announcement (sub-$1 / gallon), get to $23 / share FV on the equity (vs $14 current) and the Secureds likely trade up to ~106 (i.e. anticipate being taken out in May 2022) and Unsecureds trade inside of 10% YTC (>15 pts + coupon)

UPSIDE CASE: Assume a 4x multiple to above-mid-cycle (my estimate is ~$1.3Bln) and surprisingly positive RINs announcement (sub-$0.75 / gallon) , get to >$30 / share FV on the equity (vs $14 current) and Unsecureds likely grind up closer to par (>23 pts + coupon) as path to taking out the Secureds and rest of structure trades more natural (i.e. 1.7x net leverage)

DOWNSIDE CASE: Macro surprises to downside and negative / neutral RINs announcement and market applies a 3.5x multiple to sub-mid-cycle ($950MM EBITDA), gets to $12 - $13 / share (vs $14 current) and Secureds and Unsecureds flop around in / around current levels (offset by coupon)

On a probability-weighted basis, get to $25 / share FV on the equity (vs ~$14 current)

Cap table below:

Catalyst

1) S/D very tight (Q4 - Q1 will be indicative), 2) RINS news (any day now), 3) low-hurdle set up (everyone skeptical), 4) attractive yield and paid-to-wait (~18% on Secureds, ~35-40% yield on Unsecureds into 1-yr event)