Description

PBF equity offers an asymmetric risk/reward with ~100% upside for anyone who can stomach the refining vol. Much has changed w/ the biz over the past 12-months, yet the market continues to be focused on rearview mirror … I’m fond of these situations where the puck is clearly tracking toward a narrowly defined direction, yet the market remains skeptical largely due to legacy overhangs (in the case of PBF – historical concerns around overleveraged BS, M&A timing missteps heading into COVID, negative EBITDA during COVID, etc). Since my prior post on PBF debt in late 2021, the biz has shifted from being against the ropes w/ ~$2.25Bln of net debt + an expensive “insurance policy” to survive during COVID … and now is in a position of strength w/ >500MM of excess net cash at YE 22. This is a unique position for PBF and capital allocation clarity (share repos and / or dividend) is very likely in the n-term.

Over the next 6-months, PBF will provide further evidence supporting the global cost curve shift – more importantly, evidence around durability of diesel market being in structural short position. Additionally, PBF equity provides a free but powerful option around its renewable diesel conversion play (market skeptical and gives no credit even though PBF is in final stages of spending $600MM on this plant) as well as capital allocation (i.e. net cash position) that drives the possibility of even better outcomes.

Interestingly, PBF equity is trading at or very close to levels it last witnessed during COVID when the business was at risk. Factoring in the approximate ~$3.25+Bln cash flow generation over the past 12-months (includes daughter entity purchase), implies ~$27 / share of value to the equity or an implied price of ~$6 / share which is v similar to where the equity traded during 2020 during COVID when the biz was on the precipice. The focus for me is now on the equity …  

As a sidenote, prior lengthy threads re: global cost curve and renewable fuels including CLMT and separate thread on VTNR. Re: pecking order, I’d argue PBF is more comparable (and far superior) to VTNR as better refining assets + higher quality Gulf coast RD play w/ a shorter time fuse on highlighting value (not to mention a far superior BS at PBF). CLMT is uniquely different as specialty chemicals assets are less volatile than refining (though cost curve also benefits their positioning) + RD ramp in MT and geographic advantage (on rails, close proximity to Canada and certainty of input supply in region) + SAF positioning make it a v different play than PBF (not to mention liquidity of PBF equity vs CLMT equity which has been long discussed). While all 3 situations have a “global cost curve” thread, CLMT has a much shorter fuse on the RD value unlock (and I believe is open to monetizing all aspects of the biz at the right px). I also believe PBF is getting closer to highlighting this value which I view as an important milestone in how each of these situations can play out … don’t know what to make of Vertex and don’t have a strong view on assessing the asset, team, incentives, etc.

WHY NOW: In recent week(s), PBF equity has traded off alongside other energy and refiners (PBF’s -30%+ over the past few weeks). Drivers include: 1) fears of margins compressing lower (i.e. past-peak and watch out below), 2) regulatory changes that could negatively jolt margins (i.e. Newsom in CA rattling the cage not to mention Europe implementing strange policies … not to mention biofuel mandate changes by EPA that have recently jawboned RINs prices lower and crack spreads in tandem – notably, RIN compression is a net positive for PBF given potential RIN obligation), 3) demand uncertainty (not only in China re-opening or not … but also in US soft vs hard-landing) … and oh, yes, Russian sanctions (what level and what impact) creating lot of noise on trade flows. Putting aside the n-term confusion, key question is what’s changed if at all re: global diesel market – i.e. is it structurally short or coming back into balance.

MARKET VIEW: PBF is a challenged old-school refiner that has coastal assets prone to be vol. The market is currently assuming margins revert back to 7-year (pre-COVID) historical levels (i.e. 2 – 3 / barrel biz). Additionally, the market has no idea what PBF will do re: cap allocation and is likely assuming dilutive M&A vs accretive share repurchases or a dividend policy.

MY VIEW: PBF is in the middle stages of benefiting from the “perfect storm” and diesel is structurally short. Difficult to know if / when Ukraine will abate, but the forward curves suggest multi-year cost curve benefit for US refiners. Even if Ukraine abates, likely a multi-year diversification of energy sources in Europe and diesel will remain in a very tight condition.

DIVERGENCE: PBF greatly de-risked the impairment risk over the past 12-months, having generated ~3.25Bln of cash flow. The current operating environment (low inventory, high ute levels) is conducive for PBF. While difficult to pinpoint what the market is pricing in (see below), believe very little structural advantage is being assumed.

As mentioned in the prior write-up, PBF + refining remains a highly controversial arena, and in some respects, no different than the US fertilizer complex. Ultimately, if you’re constructive on the diesel market staying tighter for longer, PBF is an excellent risk-reward. Additionally (as a free upside option kicker), if you’re constructive on renewable fuels, PBF has an overlooked conversion in Chalmette that might be worth in excess of >$2.5Bln and largely ignored. My guess is PBF management is aware of 1) their net cash position is sub-optimal (cap allocation clarity is coming), 2) they believe their Chalmette facility has lot of upside value (be it to an outside party or for internal purposes given their RINs exposure) and 3) they also have a strong view on the sustainability of margins (i.e. diesel debate).

CAPITAL STRUCTURE: Simplified since the prior write-up and factors in PBFX daughter acquisition.

RD ASSET VALUE: PBF owns a Gulf coast unit that is being converted into RD (~$600MM cost of conversion). Unlike Vertex (long putt), PBF will have a pre-treater and will be opportunistic on inputs. The market is giving very little (if any) credit … more clarity is anticipated in the n-term. While PBF might be in a catch-22 as they no longer need an equity partner (excess cash), I believe they understand that the market is overlooking this biz unit ($2-$3Bln of value) and will be more open to unlock scenarios.

“SO WHAT” - FAIR VALUE: See below, assuming the RD asset is worth $2 - $3Bln, and applying a punitive 3x multiple to various low / mid / high scenarios on the core biz results in 50 – 100 – 150% upside scenarios to the equity. Additionally, not assuming any creative capital allocation moves (i.e. special dividend or M&A) to unlock additional value … but safe to say >500MM of net cash is a unique position for PBF and don’t think they will ignore this variable.

Overall, assuming RD unlock (i.e. partner decision) is an increasingly possibility for PBF, clear path to >100 – 150%. Catch-22 for PBF is that they have enough cash to go-it alone, so the question will be if any partner wants to own a minority stake in this renewable fuels venture. Given scarcity of high quality assets, I believe there is an increasing chance (yet the market probability weights closer to 0).

BASE CASE: Applying a 3x multiple to mid-cycle (be conservative given debate is around “mid-cycle” (assume $3.50 / barrel of improvement versus historical given cost curve) and value RD facility at $2.5Bln, implies $65-$70/ share FV on the equity (vs ~$33 current) or ~100%+ upside

UPSIDE CASE: Assume a 3x multiple to above-mid-cycle (assume $5/barrel structural advantage) and value RD facility at $3.5Bln, implies $85-$90/share FV on the equity (vs ~$33 current) or ~150%+ upside

DOWNSIDE CASE: Macro surprises to downside US faces hard-landing recession. Still think 3x multiple on mid-cycle is defendable ($3.50 / barrel advantage) and $1.5Bln RD value, implies ~$50+ FV on the equity (vs ~$33 current) or ~50% upside

On a probability-weighted basis, get to $60-70/share FV on the equity (vs ~$33 current) or ~100% upside

RISKS: Global cost curve reverts back to historical levels and diesel structural shortage comes back into balance, RD facility never properly valued in the market

Catalyst

Diesel market S/D is the northstar

RD value unlock (will they bring in a partner or not, FCF generation in mid-2023)

Capital allocation updates (dividend, share repo, M&A)