Description

Summary:  Vertex Energy, Inc. (“Vertex” or “VTNR”) is a motor oil collector/recycler that has transformed itself by acquiring a Shell refinery in Mobile, AL.  For those that have read the recent write up on Calumet Specialty Products (“CLMT”), it a is very similar thesis (refining/other business adding renewable diesel), but trades at a material discount not only to CLMT, but REGI/DAR as well.  Given the acquisition closed this month, it is very much off the radar of most investors. Nonetheless, there is a clear and definable value from Renewable Diesel today as well as a recent strategic transaction that underscores the value in the market.  I believe there is 90-200% of upside based on where the comps currently trade.  Based on an assessment of each of the comps (more detail below), VTNR’s Renewable Diesel business currently trades at 2.6x EV/EBITDA (vs peer range of 5.2x-9.3x) and $3.05/gl (vs. peer range of $6.80-$12.51). Net net, I believe this opportunity exists today largely because it is a brand new publicly traded business with poor analyst coverage.

Source: Internal Estimates, Bloomberg

The source of value creation originates from the refinery Vertex acquired from Shell for $75mm. With the help of a Danish E&C, Holdor Topsoe, they will be converting the refiner’s hydrocracker, at a cost of $85mm, to produce ~210mm gallons of Renewable Diesel (RD). Holdor Topsoe is the same E&C company that the MPC, PSX, CVR, and CLMT are using to convert their refineries. While this looks like a home-run deal, we have “ESG” to thank as we believe Shell was a forced seller (see below).  To frame the opportunity, the pro forma EV here is $910mm. Based on current RD spreads and 2017-2019 crack spreads, the implied FCF Yield and EV/EBITDA is 20%+ and ~3x, respectively. While we do not assume current crack spreads are sustainable, it is worth noting the business trades at a 36% FCF yield or ~2x EV/EBITDA today. With that said, there is further upside from 1) the windfall profits from the current crack spread environment and 2) the potential divestiture of the motor oil business which was scrapped in early 2020 (https://ir.cleanharbors.com/news-releases/news-release-details/clean-harbors-signs-definitive-agreement-acquire-used-motor-oil).  Both options could add an additional $1.50/share of incremental value to the stock.

Source: Internal Estimates, Bloomberg, CLMT presentation

Who is Holdor Topsoe and are they credible?

The E&C company hired, Holdor Topsoe, is a Danish company that specializes in carbon reduction technologies. They provide technology from everything related to chemical processing, hydro processing, emissions management, etc. More importantly, they are the leading E&C company when it comes to hydrocracker conversion. Their Topsoe HydroFlex technology is used in the production of Renewable Diesel (“RD”) for many different companies:

1.      Marathon Petroleum conversion (https://blog.topsoe.com/marathon-petroleum-corporation-confirms-successful-test-run-for-us-refinery-producing-100-renewable-diesel-based-on-topsoes-hydroflex-technology)

2.      Phillips 66 conversion (https://blog.topsoe.com/phillips-66-confirms-start-up-of-renewable-diesel-production-using-topsoe-hydroflex)

3.      Calumet (https://blog.topsoe.com/calumet-chooses-haldor-topsoe-for-renewable-diesel-project-in-pacific-northwest)

4.      CVR (https://blog.topsoe.com/cvr-energy-inc.-subsidiary-selects-haldor-topsoes-hydroflex-technology-for-revamp-to-renewable-diesel-production), etc..

In Calumet’s latest investor presentation (source: investor relations website @ Calumet) they lay out the capital costs/bbl for various RD projects. As can be seen in the exhibit below, the 3 lowest capital cost projects – Rodeo/PSX, Great Falls, and Mobile/Vertex – are all Holdor Topsoe hydrocracker conversions. I therefore believe this is a credible construction partner and see very little risk of cost over-runs.

Source: CLMT presentation

How were they able to get such a great deal?

Ultimately, Shell was a forced seller. In 2018/2019, Royal Dutch Shell started getting pressure from the Dutch government to cut its carbon emissions. There has been significant coverage on the topic (https://www.climatedocket.com/2019/02/12/shell-netherlands-lawsuit-climate-change/ OR http://climatecasechart.com/climate-change-litigation/wp-content/uploads/sites/16/non-us-case-documents/2019/20190405_8918_press-release.pdf). In the Spring of 2020, Shell took action to meet some of the ambitious targets set forth on emissions (https://fortune.com/2020/04/16/net-zero-emissions-shell-oil-industry-gas/). In doing so, they announced the planned sale of various refineries in the US and abroad – a) 149kbpd Puget Sound, Washington refinery, b) 90kbpd Mobile, Alabama refinery, c) 240kbpd St. James Parish, LA refinery and d) few refineries in Canada and Denmark. They successfully divested the WA refinery to HollyFrontier for $350mm and sold the Alabama facility to Vertex for $75mm. They could not find a buyer and closed the LA refinery, but had evaluated converting the refinery to RD. Ultimately, Shell ended up re-domiciling to the UK (https://www.reuters.com/world/uk/shell-proposes-single-share-structure-tax-residence-uk-2021-11-15/) after the pressure they were facing became a burdensome legal obligation (https://www.bbc.com/news/world-europe-57257982).

Vertex was able to acquire such assets at an attractive price because a) Shell was a forced seller, b) Shell did not want to make the conversion on their own (it would not help Shell’s overall goal in reducing carbon emission) and c) the bidding started in the summer of 2020 when, based on the prevailing crack spreads at the time, we estimate the refinery was losing $40-$100mm of FCF/year.

Source: Bloomberg, Internal Research/Estimates

What is the company worth?

There are a few ways to approach valuation. Prior to the refinery acquisition, VTNR was a recycler of used motor oil. They collect, aggregate, and refine/transport motor oil. In 2016-2019, they generated a cumulate FCF loss of ~$25mm. To get the deal done they needed to a) raise capital and b) find an off-take partner for the hydrocarbon inventory. They issued $155mm of converts in the Fall of 2021 and partnered with Macquarie (for a cost of $10mm/yr) to fund the inventory purchase. Post deal close, VTNR has ~98mm shares outstanding (assuming FULL conversion of converts/options/warrants), $125mm Term Loan, $155mm of converts, and ~$110mm of cash (Note: Enterprise Value calculation below assumes full conversion of the converts and warrants). We also bake in $85mm of capex costs associated with the conversion of the hydrocracker to the production of RD. All in, that puts the current Enterprise Value at ~$920mm.

Source: Internal Estimates, Bloomberg 

The $85mm capital investment through Holdor Topsoe, the company should get to ~150mm gl/yr of run-rate RD capacity by Q4’22 and ~215mm gl/yr of run-rate capacity by Q2’23. Based on today’s RD economics the EBITDA/gl for this project is ~$1.20 assuming an 8.5lbs/gl of soybean or $1.60 assuming 8.0lbs soybean/gl. We chose to use the conservative conversion and hence modeled $1.20/gl of EBITDA for the RD side. With respect to the refinery assets, based on a 2017-2019 crack spread environment, these assets are generating ~$25mm of EBITDA and very little FCF, but based on current crack spreads they are generating an estimated ~$175mm of EBITDA and $150mm of pre tax cash flow. Regardless, based on historical profitability of the refining assets, EBITDA/FCF here should be ~$280mm/$180mm in 2024 for a FCF yield of ~22% and an EV/EBITDA of ~3.3x. For illustration, based on current crack spreads, FCF yield is ~36%. Note that our EBITDA/FCF assumption assumes very little contribution from the motor oil business. As a reference, they walked away from a deal to sell ~90mm gallons of recyclable oil capacity to Safety-Kleen for $140mm. While concerns on the regulatory backdrop was cited, we believe Vertex could get a much better deal in today’s environment. From discussions with ex Safety-Kleen employees, I believe the market for recyclable motor oil has picked up steam given scarcity of virgin products and these assets could garner $200mm+ in today’s market. Moreover, Safety-Kleen, is the leader in this industry, but companies like GFL Environmental or Heritage Clean could be interested in the assets as well.

Source: Internal Estimates, Bloomberg

With underlying earnings power/FCF well established, let us take a look at how to think about valuation:

1.      Chevron/REGI Transaction – On 2/28/22, CVX announced the acquisition of REGI for ~$3.2bn. REGI established itself as a producer of biodiesel that made a hard pivot into the production of RD. REGI is expected to make $500-$600mm in EBITDA in 2025 once they are done with their Geismar expansion. This puts this deal at 5.8x 2025 EV/EBITDA on headline figures. However, there is another $800mm of Geismar capex left so the actual headline EBITDA multiple should be ~7.3x (Enterprise Value of $4bn after adjusting for an incremental $800mm of Geismar capex). Post Geismar, REGI should be producing ~335mm gallons of RD and ~400mm of biodiesel. According to Wolfe Research, Chevron is assuming $1.50/gl of RD margins and ~$0.10 for biodiesel. After backing out the implied value of the biodiesel business, I believe CVX is paying $3.6bn for REGI’s RD assets which amounts to ~7.2x 2025 EV/EBITDA or $11/gl of RD. Given REGI’s feedstock being 70% waste oil/cooking oil/corn oil/tallow, it is fair to assume REGI should trade at a premium. Conversely, keep in mind that a) REGI’s figures are based on 2025 estimates, that we believe have with much higher risk of cost overrun and b) REGI’s EBITDA is based on RD spreads in mid-January while RD spreads have come in. Nonetheless, currently, VTNR is trading at 2.6x given our assessment of 2024 EV/RD EBITDA and $3.05/gl. Based on this deal, I believe upside on EBITDA is 104-135% and on gallons is 153-204%.

Source: Internal Estimates, Bloomberg

2.      Darling (DAR) –DAR is a leading RD provider in the states and likely has the best feedstock advantage of all the players (they control rendering sites, used cooking oil distribution, etc.). Like REGI, DAR is in the middle of adding to their RD capacity and has about ~$900mm capex left for their DGD 3 project. Therefore, we must adjust DAR’s EV upwards by ~$900mm. Second, we back out the value of their feed/fuel business using a BG multiple on 2024. Ultimately, based on DAR’s 50% share in their RD project we find that DAR is currently trading at 9.3x EV/EBITDA on 2024 and $12.51/gl (both assuming 50% share). Using a similar approach as we did with REGI, I believe upside on EBITDA is 165-196% and on gallons is 178-230%.

Source: Internal Estimates, Bloomberg

3.      CLMT: Calumet is a good comp to how other investors are valuing a credible RD player prior to construction completion.  CLMT has refining cash flow today and is adding significant RD capacity using the same E&C company.  When backing out the value of refining and giving them credit for non-RD gallons produced in 2024/2025, I estimate the implied EV/gallon to be $6.80.  To the extent VTNR is valued at this EV/gallon, it would suggest fair value of $16-$17/share.

Source: Internal Estimates, Bloomberg

Disclosure: At the time of publication, the author of this article holds a position in VTNR.  This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  Any projections, forecasts and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

Completion of RD conversion and awareness of RD value within recent acquisition