July 28, 2012 - 2:06am EST by
2012 2013
Price: 19.42 EPS $0.00 $0.00
Shares Out. (in M): 58 P/E 0.0x 0.0x
Market Cap (in $M): 1,130 P/FCF 0.0x 0.0x
Net Debt (in $M): 210 EBIT 0 0
TEV ($): 1,340 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • Refiner
  • Peak Earnings
  • Oil Price Exposure


Thesis Summary:
DK is US based owner of 2 inland refineries in West Texas and Arkansas, with combined capacity of 140 Kbpd and 9.0-9.4 Nelson complexity. DK’s refineries have recently experienced a period of unsustainable high profitability which resulted in substantial stock outperformance on the back of both high product crack spreads and historically wide discount on WTI oil caused by the lack of takeaway pipeline capacity out of Cushing. The stock is trading at 6x peak earnings, which is expensive for a refiner, and as conditions in mid-cont normalize, I expect both DK’s profitability and multiple to revert to normal levels. In the normal environment DK should earn just about ~$0.50/sh and get 4-5x of that, implying a low single digit valuation. This drastic dislocation will become apparent to the market participants as catalysts outlined below materialize
Short Merits:
DK is extremely levered to WTI/LLS spreads. WTI/LLS spread is set to narrow as Cushing, OK inventory pressure is lifted: WTI has been trading at a high discount ($10-$20) to waterborne crudes for the second summer in the row as result of increased domestic production from unconventional sources and the lack of takeaway capacity. The amount of takeaway capacity which is currently ramping up or under construction is sufficient to alleviate crude inventories build up in Cushing:
Project Owner Description Completion Full Ramp-Up Capacity (kbpd)
Seaway reversal (incl. capacity upgrade) Enterprise/Enbridge Cushing, OK and USGC (Freeport, TX) Q2 2012 Q1 2013 400
Seaway twin line (formely "Wrangle") Enterprise/Enbridge Cushing, OK and USGC (Freeport, TX) Q1 2014 Q3 2014 450
Keystone XL lower leg Transcanada Cushing, OK to USGC (Nederland, TX) Q3 2013 Q2 2014 830
EOG rail project EOG/NuStar Bakken, Eagle Ford and Wolfcamp to USGC (St. James, LA) Q1 2012 Q1 2013 70
Hess rail project Hess Bakken to USGC (St. James, LA) Q1 2012 Q4 2012 55
        Total: 1,805
By mid 2014, the incremental takeaway capacity will reach 1.8 mb/d, which will be sufficient to bring the inventory back to the mid-90mmb level and compress the differential to the marginal pipeline tariff ($4-$6 on Seaway). In fact, we can expect lower spreads by the end of 2012 as the last barrels that Seway dumped into Cushing before it was reversed are being worked through.
The impact on DK's profitability would be rather drastic. Unusually wide WTI/LLS spread has resulted in unusually wide product crack spreads. In the last 2 quarters, US GOM 3-2-1 WTI crack spread was averaging $20-$25, while LLS cracks were averaging ~$10, allowing DK to earn .76/sh in the quarter. If WTI was trading "normally" with $4 discount to LLS, other things (slates, utilization, etc.) equal, the company would have earned .11/sh as WTI crack spreads would approximate $8.
The company is massively overearning and its profitability, and valuation, is poised to revert to a lower level.
  • DK generates lots of cash and likes to pay itself special dividends every now and than.It has recently filed for an IPO of its infrastructure assets (comprised of a few service pipelines connecting its own facilities) which, if successful, may bring another $120m in cash net of fees. I am assuming they will use it to meet an upcoming debt maturity, but a dividend is not out of question
  • Potential manipulation from a parent company. DK is majority owned by its Israeli parent under the same name, via a Hungarian holding company. Needless to say this structure is ripe for potential manipulation
  • Liquidity in the stock is not great
Capacity by crude slate (kbpd)  
El Dorado 80
WTI/Inland 25
LLS Oil 45
Other/Maya 10
Tyler 60
WTI/Inland 50
LLS Oil 10
Other/Maya 0
Crack Spread Calculation  
LLS 105.0
Differential (LLS - WTI) 4.0
Conventional Gasoline (MOIGC87P) 2.6
Heating Oil (NO2IGCPR) 2.5
Implied 3-2-1 Crack Spread US GOM 7.7
El Dorado  
Utilizarion % 95%
Utilizarion kbpd 76.0
Refining Margin $/bpd $7.8
Direct Cost $/bpd ($4.0)
Refining EBITDA $19.85
Utilizarion 87%
Utilization kbd 52.2
Refining Margin $/bpd $7.7
Direct Cost $/bpd (5.0)
Refining EBITDA 12.9
Total Refining EBITDA 32.8
Marketing 8.0
Retail 6.0
Corporate & Other (1.0)
Depreciation   (19.0)
EBIT 26.8
Interest Expense (12.5)
Pre-Tax 14.3
Tax at 34% (4.9)
Net Income 9.4
SHO 85.5


LLS/WTI spread narrows as the year progresses, resulting in lower profitability for DK
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