Delek US Holdings Inc (DK) 2018 Q2 法說會逐字稿

Good morning. My name is Don, and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings Inc. Q2 Earnings Call. (Operator Instructions)

Mr. Johnson, the floor is yours.

Thank you, Don. I would like to thank everyone for joining us on today's conference call and webcast to discuss Delek US's second quarter 2018 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President and CEO; Kevin Kremke, EVP and CFO, as well as other members of our management team.

As a reminder, this conference may contain forward-looking statements as that term is defined under federal securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the word believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements. You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations or results may differ materially from results discussed in the forward-looking statements. We undertake no obligation to publicly update any forward looking statement, whether as a result of new information, future events or otherwise.

In addition to reporting financial results in accordance with generally accepted accounting principles, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to our comparable GAAP results, which can be found in the press release, which is posted on the Investor Relations section of our website.

On today's call, Kevin will begin with a review of the financial performance of the quarter before turning it over to Uzi, who will offer a few closing strategic comments.

With that, I'll turn the call over to Kevin.

Thanks, Keith. For the second quarter 2018, Delek US reported net income of $79.1 million or $0.89 per diluted share compared to a net loss of $37.9 million or $0.61 per basic share in the second quarter of 2017. On an adjusted basis for the second quarter, Delek US reported net income of $89 million or $1.03 per diluted share compared to an adjusted net loss of $25 million or $0.40 per basic share in the prior year period. Our adjusted EBITDA was $199.1 million in the second quarter of 2018 compared to $4.2 million in the prior year period. A reconciliation of reported results to adjusted results is included in the financial tables of our press release.

During the second quarter of 2018, results were affected by approximately $60.3 million or $0.52 per share after tax of noncash items. This consisted of approximately $38.5 million or $0.33 per share after tax related to a noncash inventory timing effect between the purchase price of Permian Basin crude oil and when it is realized as finished products are sold. In addition, results were reduced by a noncash charge of approximately $21.8 million or $0.19 per share after tax related to a mark-to-market of our RIN's inventory position. This net long inventory position was the result of the previously announced waiver received for the El Dorado and Krotz Springs refineries in March of 2018. Taking these amounts into consideration, results would have been higher by $60.3 million or $0.52 per share, which would equate to approximately $259 million of EBITDA and $1.55 per share.

On a consolidated basis, line items such as operating expenses, G&A and interest increased on a year-over-year basis, primarily due to the addition of Alon. I would like to note that G&A expense included approximately $2.6 million of transaction costs. Our income tax rate, excluding the noncontrolling interest income of $7.6 million, was 29.1% in the second quarter of 2018. For full year 2018, we expect the combined annual effective tax rate to be in the range of approximately 21% to 23%.

Turning now to capital spending. Our capital expenditures during the period were approximately $54.7 million compared to $15 million in the second quarter of last year. During the second quarter 2018, we spent $33.7 million in our refining segment, $2.3 million in our logistics segment, $2.1 million in retail and $16.6 million at corporate. Our 2018 CapEx forecast is right at $228 million. This amount includes $176.5 million in refining, $18.9 million in logistics, $19.5 million in retail and $13.1 million at the corporate level. This amount for 2018 does not include approximately $75.7 million of midstream projects to enhance our position in the Permian Basin.

We ended the second quarter with approximately $1.1 billion of cash on a consolidated basis and $910 million of net debt. Excluding net debt at Delek Logistics of $732 million, we had net debt of $178 million at June 30, 2018.

We had great financial performance during the second quarter of 2018, but I do want to point out that cash from operations was affected by a combination of both price changes during the quarter and increased sales volumes, resulting in a working capital headwind during the period. We actually had improvement in cash from operations in Q2, which would've been even higher without these working capital headwinds, which we expect to revert and come back to us in Q3.

Our disciplined capital allocation program includes returning cash to shareholders, prudently investing in the operations and exploring opportunities for growth. We balance this program with the goal of maintaining a strong balance sheet through the cycle. To further strengthen our balance sheet, we will reduce our leverage with the upcoming $150 million convertible debt maturity in September. We plan on settling the principal amount in cash and the premium amount with DK shares, for which we have a hedge in place that will result in 0 dilution. You'll note that our diluted share count for the second quarter, there was approximately 2.6 million shares associated with this note.

Next, I'd like to discuss our results by segment. In our refining segment, which was just beginning to feel the benefit of the wide Midland differential in the second quarter of 2018, we reported a contribution margin of $177 million compared to a contribution margin of $16.9 million in the second quarter of last year. The year-over-year increase in the contribution margin is primarily due to the addition of the Big Spring and Krotz Springs refineries from the Alon transaction in addition to improved market conditions. As mentioned previously, there was approximately $38.5 million headwind related to an inventory timing effect between the purchase price of Permian Basin crude and when it is realized as finished products are sold.

Market conditions, as measured by the Gulf Coast 5-3-2 crack spread, increased on a year-over-year basis to $14.37 per barrel for the second quarter of 2018 compared to $10.86 per barrel for the same period last year. In addition, the refining system benefited from the Midland WTI crude differential to Brent crude that was an average discount of $15.03 per barrel compared to $3.48 per barrel in the second quarter of last year. On a lag basis, the Midland WTI crude differential to Cushing was an average discount of $5.14 per barrel in the second quarter this year compared to $0.83 per barrel in the second quarter of last year. During the second quarter 2018, we estimate that the realized Midland differential in our reported results was approximately $3 per barrel due to this inventory timing effect.

Our logistics segment contribution margin was $45.4 million in the second quarter of this year compared to $31.7 million in the prior year period. On a year-over-year basis, improved performance was primarily due to the Big Spring drop-down that was effective March 1 of this year, an improved West Texas wholesale business and improved performance from the Paline Pipeline.

Contribution margin in the retail segment was $18.6 million. Merchandise sales were approximately $90.2 million with an average margin of 31.7% and approximately 54.1 million of retail fuel gallons were sold at an average margin of $0.24 per gallon. As a reminder, there is no year-over-year comparison for this segment as it was acquired in the Alon transaction on July 1 of 2017.

Contribution margin for the corporate/other segment was minus $11.8 million in the second quarter of 2018 compared to negative $37.8 million in the prior year period. Included in these results was a net hedging loss of $400,000 for the second quarter this year compared to a loss of $30.9 million in the prior year period. Again, as a reminder, the prior year period includes a hedging loss of approximately $31.7 million related to a realized loss on a crude oil inventory hedging strategy associated with Delek US's supply and offtake agreement.

Before I turn it over to Uzi, I wanted to provide some guidance on our crude oil throughput for modeling consideration. During the second quarter, our total refining system crude oil throughput was approximately 290,600 barrels per day, which was an increase from 261,350 barrels per day in the first quarter of this year. For the third quarter, we expect crude oil throughput in the refining system to be approximately 290,000 barrels per day, so essentially flat from Q2. In addition, based on the forward curve on August 6, we expect to purchase our Midland crude at approximately $13 discount to Cushing in the third quarter. Taking into consideration the inventory timing effect we discussed, we estimate, based on the forward curve, that our realized Midland discount in our gross margin will be approximately $10.80 per barrel. I also want to note that backwardation has increased in the market, and we estimate that it will be approximately $1.30 per barrel, which increases our crude oil cost.

With that, I'll turn the call over to Uzi.

Thank you, Kevin, and good morning. It has been just over a year since we completed the acquisition of Alon USA. During that time, the team has done a great job to achieve the objectives we laid out at the beginning. First, we simplified the corporate structure with the acquisition of Alon USA Partner in February 2018. Second, by utilizing our strong balance sheet, our average interest rate was reduced through the refinancing completed in March 2018. Third, value was unlocked by divesting approximately $162 million of noncore assets on the West Coast and completing the drop-down of the Big Spring logistics assets. Finally, our team captured approximately $131 million of synergies on an annualized basis through the second quarter. We are on track to capture approximately $130 million to $140 million of annualized synergies from this transaction, which has significantly exceeded our original guidance of $85 million to $105 million.

We built the premier Permian Basin refining company with access to approximately 75 million barrels annually or 207,000 barrels per day of Midland crude oil, which accounts for approximately 70% of our crude [slate]. We continue to make progress on our initiative to get closer to the wellhead as we gather more barrels to control our crude oil quality and lower our cost. We have added more Midland barrels to the Krotz Springs crude slate as promised in private -- in previous quarters, which has improved overall performance. When we include the expected benefit of the alky unit that is under construction, expected operating results from Krotz should further support the future potential logistics asset drop down to DKL.

We ended this great quarter with a cash balance of approximately $1.1 billion. During the second quarter, we purchased $20 million of our stock and have the total remaining authorization of approximately $160 million. On a year-over-year -- I'm sorry, on a year-to-date basis, we have returned approximately $153 million through June 30, 2018, through dividend and share repurchases. We remain focused on creating long-term value as we balance returning cash to the -- to our shareholders, investing in our business and aggressively exploring our opportunities to develop the next stage of our growth.

With that, Don, would you please open the call for questions?

(Operator Instructions) Our first question comes from the line of Mr. Brad Heffern from RBC Capital Markets.

Uzi, Plains, yesterday, announced slightly earlier timing for Sunrise and Cactus II. Can you just give your thoughts in general on how you see spreads trending and when you think that the transportation issues in the Permian might resolve themselves?

Okay. Obviously, we are familiar with what Plains are trying to do, and let me take it in a couple of stages. First of all, people were thinking that our trucks or our railcars can help eliminate some of the problem. Well, based on our own experience, we tried ourselves to truck some and tried to maybe use our facilities to rail, well, it's almost impossible to do so. So the idea of we can truck millions of barrels probably doesn't exist. The second part is that, to my knowledge, producers hesitate to -- because of what happened in 2015, 2016, hesitate to sign up for a big take-or-pay commitment. So I do think -- we do think that we will see great spreads, at least to the end of 2019. Now if you look at the forward curve, even 2020, first quarter is starting to get weaker. In the last few days, we sold -- actually a week ago, we sold already at minus 2. Now is it going to stay at minus 17? No. But I want to remind everybody that this quarter was based on realized of minus 3. So the EBITDA we achieved is based on realized of minus 3. So we think we are very well positioned to a situation that the differentials will come in. Even though we don't see it happening this month, I -- the trailing month for September is showing on the screen now minus 17, between minus 16 and minus 17, and fourth quarter is getting weaker.

Okay. Appreciate that color, Uzi. And then I guess just thinking about cash usage. You talked about it a little bit in your prepared remarks. But pretty modest repurchase number this quarter. Just given the amount of cash generated. Should I read into that, that you're seeing a lot of opportunities on the M&A front? Or just how do you think about balancing building cash for a potential acquisition versus repurchases?

Well, Brad, we were very aggressive, and this is something we need to balance. We were very aggressive. We did the repurchase of the shares beginning of the first quarter, then we increased dividend. Then we need to continue to feed this thing. This quarter, we decided that we're going to look -- take it on the conservative side and run with it a little bit on the lower side. It doesn't mean anything for the future for us. As a matter of fact, we're looking at -- are thinking of increasing more -- or getting more cash to the shareholders, if you will.

Our next question comes from the line of Manav Gupta with Credit Suisse.

Uzi, so I'm just trying to wrap myself around clean cash flow from operations number, excluding working capital and any inventory issues. I think I'm getting to about $230 million in clean cash flow from operations. I just want to know how much I'm off by.

You are in the ballpark. Kevin, I don't know if you want to take that, but you are in the ballpark. Go ahead, Kevin.

Yes. That's about right, Manav. So we actually have -- we have a cash flow from operations improvement in Q2. If you look at where we ended in Q1 versus what we had in the earnings release last night for Q2, showing an improvement in cash flow from operations. And like we said in the prepared remarks, we did have some working capital changes in the quarter, really driven by increased prices and increased sales volumes. So that number was about $80 million. So yes, $175 million to $200 million is probably about the right ballpark or sort of a "clean cash" from operations for the quarter.

So let's say this -- let's say it's $200 million, and then I take out about $50 million from your CapEx. That's like $150 million in free cash flow in this quarter on a $3 barrel realized Midland-Cushing differential, right? Am I thinking about it right, $150 million free cash flow, just on $3 differential?

On $3 realized, that's exactly right.

So now -- so the question which I'm struggling with there is, now if I take that to $15 and what are your internal models telling you that if I keep that differential at $15 till Cactus II actually comes online, because what Plains is saying is Cactus II is only partial service in 4Q '19, right? So if the spread remains at $15, how much cash are you guys generating for the next 6 quarters in your internal models?

Well, Manav, this even to project something, we just told you that third quarter, very simple, this is realized. This is not -- this is after the inventory effect. For the third quarter, the -- it's already $13. We already calculated the inventory effect because we are -- we can do that. It's -- we already told you it's $10.80 for the third quarter, and we are telling you now that for September, it's at $17. And September is October because there is 1 month delay. So the free cash flow is obviously going to be a very big -- that's the reason we are so optimistic that the numbers will continue to come in very strong. So if we are looking at the fourth quarter right now, it's showing $15, but September is even better than the fourth quarter right now. September is trading so far for the -- and we have another 2 weeks to go, $17, so enormous free cash flow.

I agree. And our projections on both buy side and sell side are indicating that you could exit 2019 with $2.3 billion to $2.5 billion of cash on your balance sheet. That's just too much cash for a person who's known to acquire very strategically in downturns. We are not in a downturn. So why is this such a big cash flow build for the next 6 months?

Well, first, it needs to be up. Second, look what we are doing. We repurchased $153 million in the first 6 months. We increased dividends. We will continue to be aggressive giving cash to shareholders, and we will continue to look at opportunities. I want to emphasize one thing. As we are getting bigger and bigger on the Permian side, more opportunities coming to us on the -- in the Permian area. So don't be surprised if we are looking at other opportunities in the Permian.

Our next question comes from the line of Mr. Roger Read from Wells Fargo.

I was just wondering -- maybe along the lines of Manav there, Uzi, you've talked about, on the logistics side, a lot of opportunities, that refining is probably not where the asset values really line up right now. Relative to the last kind of 2 conference calls where that's been discussed, can you talk about maybe how valuations there are either better or worse or there's more or less opportunity? I think you kind of alluded to it in the last comments there. But maybe what we should think about that way in terms of cash as opposed to potentially, I think as Manav laid out, just buying back all your equity? That's a little tongue in cheek there for you as well, of course.

Well, that's a different discussion. But I think I'm being recorded here, Roger, so I'm not going to answer that one.

Yes -- no, I'm setting you up. I just -- really, on the acquisition front, what do you see out there?

Well, first of all, on the Permian, there is a combination of acquisition and organic growth. You see that we set aside around $80 million for Permian, if you will, Permian logistics assets. We're developing our plan here, and as the plan matures, we'll come to the market with that.

I want to emphasize that on the logistics side, still the market is under pressure, as we know. And we'll be the -- out of favor, and we will need to have a hard look on that. Now, we don't want -- and I want to be clear. We do not want to buy something just for the sake of buying something because we have the money. And we tried to be disciplined in the past, but we do want to look at it. So that's a balance. Obviously, we won't surprise you with an acquisition that is 12x or 14x or 16x. That's not who we are. So we just need to remember that this is a combination of organic project acquisitions in -- with the right pricing and returning cash to shareholders aggressively.

Okay. And then retail was an area where -- you originally started the company, you sold off that particular retail operation, but it was a result of years of investment, improving the operation and getting a premium valuation. As you look at the Alon retail, you've had it almost a year now to really kind of look at it, what is the path there? I mean, is that one of the places we should presume some of this CapEx or -- I say is CapEx, cash flow could go, maybe a higher CapEx? Or are there opportunities there? Or is it more of an it's good enough and leave it alone as is?

Well, let me tell you, yesterday -- well, in the last 3 days, I was in Big Spring in Midland. We were in Big Spring in Midland. Just spent 3 days over there. And the area is just booming. On the retail side, as you see, we have record results on the retail side. I actually think that we will achieve record results every quarter now for the next few quarters just because the market is so strong in the areas that we're in. However, the stores that are in the area, including our stores, are sometimes gated stores that need some help and also building some, if you remember, megastores like we did with MAPCO years ago. So that's an area that we are looking at. We are not talking about here hundreds of millions of dollars. It's probably in the magnitude of, call it, 10 stores or 8 stores to start with. So I wouldn't read much into it in the great scheme of producing the amount of cash flow that we are producing.

Okay. And then maybe just the last way to think about that, you've got the 1 convertible debt piece that's going to go away here at the end of the quarter. What else would you do balance sheet-wise as you look forward? I know it's not like a lot of the debt necessarily has any prepayment value. But I was just curious, as you're balancing acquisitions, share repo, stronger balance sheet and for a crude diff environment that, while very favorable for the near term, won't be here forever in terms of cash flow generation. Just how do you look at the overall picture there.

Well, thanks for -- again, for asking about the convertible. That's an opportunity. I neglected to mention that earlier. We will settle the convertible with cash, the $150 million, that's with cash by the end of September. So that's $150 million. Obviously, it won't impact net debt. But in our minds, something that has the potential to be semi-equity, obviously will go away with cash. So that goes without saying. The other thing that we need to look at that creates a lot of noise is the J. Aron facility. One of the facilities expired, the West Coast facility that Alon had expired 2 months ago. Obviously, we didn't renew it, and we moved on with our life. The same thing -- or there are 2 expirations coming in 2020 for El Dorado and then the remaining of the system early 2021. We're looking at it very carefully. At this point, as Kevin, Assi and I talked about that, our intent is to sell that within our means and more traditional facilities. So that's the next step in that area.

The next question comes from the line of Prashant Rao from Citi.

I wanted to circle back on the capital allocation and the sort of the balance sheet cash expectations, and what you guys are seeing out there in the market? Specifically, I think there's, in terms of IMO 2020, I'm surprised nobody has brought up the question yet on the call, but I understand that you guys have a lighter crude slate and the story is very Permian-focused. And that's been the narrative, and that's what's been working. But is there some way that maybe you could take advantage of the expectation in widening out light-heavy differentials? Is that something that you're exploring from a use of cash perspective in terms of investments? Or how should we be thinking about that as the Midland discount sort of tightens back up and transportation problems get -- abate, at least for the intermediate term? I think that might become the next leg of a longer-term cash flow story. So wanted to get your latest thoughts on that.

Absolutely. First of all, just to remind everybody, and I know that you remember that, both El Dorado and Big Spring can go between light, typical WTI that we see now, and medium sour, the WTS or Mars light. So if discount opens up, then the 2 refineries can do it pretty easy. That's their configuration. That -- in that -- on that side. I do want to emphasize that, obviously, we're benefiting from Midland right now, but we are taking few steps around the logistics and around other areas to allow us to capture more when IMO shows up. I want to be -- and maybe I was too conservative when I thought that Midland cannot be minus 17, and now we're at minus 17 all of a sudden. I'm going to be a little more conservative here on the IMO. I'm not sure we will see the benefit that everybody expects as I think more and more people taking the steps. But again, that's -- we need to wait to see if it comes or not.

Okay. [Thought] question then on the synergies target. Just wanted to ask where the -- if there's anything in particular where the upside came from versus your expectations and the raise? You guys have been beating the announced targets, seems like, Q-on-Q for several quarters now. But just in this quarter in particular anything to call out? And then going forward, what else is maybe there as dry powder in your back pocket that maybe we're not counting?

Yes. I actually think that -- we have it in front of us. I think we're filing the presentation today. We are seeing investors in the next 2 days pretty much across the board, and I think we're seeing you guys next week. So on the commercial side, the new estimate is between $33 million to $40 million. On the operations side, it's pretty much the same, around $23 million to $25 million; cost of capital, what we reported earlier, $35 million; and corporate, a little more, between $36 million and $39 million.

Okay, fantastic. And just 1 last one, I'm going to take another stab at what Manav was asking earlier. I think previously, you guys have called out sort of a sensitivity on every incremental dollar on the Midland discount, as to what that means in terms of EBITDA. A few months ago, that was around, if I remember correctly, every $1 being $75 million in annualized EBITDA. Would you be willing to call out a specific sensitivity number? Or are things a little too dynamic right now?

No, that's exactly the number, it's the 70 -- for the same $75 million. That's the reason we basically gave you was the -- essentially, it can move a few pennies here, a few pennies there because of inventory end of the quarter. But essentially, we gave you Midland that you can model it for the third quarter, it's $10.80. So if you take that $10.80 times 75 million barrels divided by 4, that's the impact on the core of Midland. If you want to understand the incremental, it's $7.80 times 75 million barrels divided by 4. That's on top of what you saw in the second quarter.

The next question comes from the line of Mr. Phil Gresh from JPMorgan.

I guess I'll just follow up right there. Just to clarify on the backwardation component of that color that you gave in the prepared remarks, you -- that'd just be a modest partial offset quarter-over-quarter of, I think you said, $1.30.

That is correct. That's exactly -- Phil, we wanted to give you a full disclosure. And we see more backwardation in the market versus contango. Like any other refinery, the way we buy, we will suffer from $1.30 setback versus you -- last quarter it was contango roughly $0.20 or $0.15. I think that's probably the model for everybody else. That's how everybody buys crude, but I just wanted to be clear on that.

Yes. No, that's helpful. And then for Kevin, just on the cash flow color that you provided on the working capital. How much would you expect to reverse of what's happened in the first half in the back half? And secondarily, we don't have the Q yet, but obviously, the first quarter had a pretty big headwind on the deferred tax piece. So I just wanted to clarify how you're thinking about cash taxes relative to the book tax rate on a full year basis. Is there some reversal that happens there as well?

Yes. So as of right now, we're expecting the full working capital headwind to come -- to fully revert back by year-end. So we would expect from here on out essentially 0 net working capital changes. And then on the cash tax piece, we're estimating about $40 million cash taxes paid in the second half of the year for full year.

$40 million is for the full year.

Yes. In Q3, that'll hit.

Okay, got it. And then as we think about this capital allocation piece, Uzi, you mentioned the convert paydown. You mentioned you're looking at some M&A opportunities. But obviously, everyone's highlighting here that your cash flow generation probably still would exceed all of these things. So is the -- are the M&A opportunities you're looking at kind of modest in size? Is there any reason that you couldn't extinguish this buyback in the next 2 to 3 quarters anyway, even if you are looking at these other things, given your positioning?

We agree. When we say -- nobody should expect us to write a check of, all of a sudden, $1.5 billion or $2 billion for something. That won't happen. Unless there's a -- well, I shouldn't say nobody should expect that. Unless there's an opportunity, but as it stands right now, I don't see that opportunity knocking on our door. We were very conservative in the past, and we will continue to be conservative maintaining our balance sheet. However, let's be clear. The numbers are pretty big here for upcoming quarters of the free cash flow. So there's no reason to believe that we won't look at it very carefully. Last quarter, we increased the dividend. Before that, we did the special buyback. So there are other means do it outside just going out to the market and buy day-in and day-out, which -- if we see opportunities like that to create value. The shares, today, are at $51. If you remember, we won from Alon a big chunk from Alon Israel, I'm going by memory, in the [mid-$30s]. So just bear with us on -- hey, we want to return cash. We're committed to that. We just want to do it in a smart way.

The next question comes from the line of Mr. Paul Cheng from Barclays.

Uzi, the utilization rate, actually, the last several quarter has been very good. Do you think that is sustainable or that you're just being lucky and don't really have a lot of downtime that -- what have you done maybe somewhat differently, then, to achieve that?

That's a great question. Like as Kevin said earlier, we expect a similar situation in the -- barring something unusual happening, we expect the same thing in the third quarter. I think Fred and the team did a great job improving reliability. We took care of the bad actors. Obviously, in -- a couple years ago, 3 years ago, we had growth projects. But as we completed them, our attention got back to reliability. And as we control the quality of the crude [there and there] to our gathering and checking system, there's no reason to believe that we won't continue performing the way we perform. We do have a turnaround coming for El Dorado in the first quarter of 2019. But until then, we expect to run pretty smoothly.

And how big is the turnaround for El Dorado in first quarter '19?

In terms of dollars or in terms of -- I'll give you both.

In time.

Downturn, probably between 35 and 40 days oil-to-oil. It's a major turnaround. And in terms of cost, we always budgeted $50 million. I would say, call it, $50 million to $60 million. That's the number for the turnaround.

What unit is going to be down?

I'm sorry?

Which units will be down?

The entire refinery will be down.

The entire?

Yes.

Okay. And Uzi, you're talking about one of the reason why you have been able to run better is that you see more and more oil you gather yourself. So what is the percent of oil that now you post that gather by yourself? (inaudible)

I would say that we gather, between West Texas and other places, probably a little more than 2/3 of our own oil.

You stay on the -- so I presume that majority of that you are not gather, is it, now, you see, in Krotz Spring or that is still [spreading].

Some of it -- obviously, Big Spring is the easiest place to do. So Big Spring is most of it. We do get some -- actually, a good portion in Tyler and in El Dorado, and now we start to do the same thing at Krotz, so.

And what is your target for the next, say, 12 to 18 months? Do you think you can get to 80%, 90% or that's too aggressive?

No, no, no. We can. We absolutely can.

Okay. So that's -- and maybe that -- a couple of question for Kevin. Kevin, that -- earlier, that when you say $38.5 million of the inventory timing, is that solely related to J. Aron or that's also including on the [trainman] impact?

No, that has nothing to do with J. Aron. That is simply the inventory timing effect between when we purchase Midland crude and when it actually shows up in our P&L. So there's just a physical lag between -- when we purchase crude, it goes into inventory and then gets processed through the system. And then there's also a FIFO effect on top of that. So if you recall, we've got -- we account for inventory with the FIFO method at every refinery except for Tyler. So you see an additional delay between purchased crude and kind of the realized impact in the P&L due to that effect.

But the FIFO -- you [thought your sensory] is because of J. Aron, right, because you are under LIFO for your company.

Yes. That's exactly right. So we account.

So I'm trying to separate out between the $38.5 million. What is related to FIFO, which is related to J. Aron and what is the other? Do you have the breakdown?

We didn't break it down that way. But it's a combination of both the FIFO and just the physical lag in the way we process crude through our inventory system.

Yes, because I -- the number that I have some difficulty to fully reconcile, earlier that -- according to Uzi, on the spot, the Midland is kind of -- is over $8. And that on the trading month basis, over $5 and your actual realized is $3. So the difference between the spot and what you realized is over $5 and you process over [200] in 91 day, so that should be [$90 million], if we're talking about everything. So I'm trying to understand what the $38.5 million really mean.

Paul, I don't know where we got the $8. There's no -- I don't think that there is $8.

On the spot, I mean, spot price on (inaudible) Cushing is $8, over $8.

You're right. But we buy it -- always we buy it 1 month ahead of time.

No, I understand that. That's why I'm trying to understand what is that $38.5 million.

Okay. The $38.5 million is that -- we buy it 1 month ahead of time, okay. So if you look at the -- not the spot, but the $5 we just mentioned, it's $5 that we bought 1 month ahead of time. Then, we are actually processing the crude 1 month after we actually brought it. So the $5 that we bought, we actually now it takes another month to process it. So if you want to calculate back of the envelope, even though we did give you the number of $10.80, what you need to do is to do the -- not the spot, but the forward-month average, but you need to start 1 month earlier. So for the month of -- for the third quarter, what you need to do is to take June as it was traded in May, July, as it was traded in June and August as it was traded in July, do the average and you will get very close to the number I just told you.

Yes, I think that -- so that means that, that number is basically the difference between the trading month difference and what you realized. Is that fair to characterize like that?

Exactly. Now obviously, that will come back in the future because the system doesn't change. So if tomorrow morning Midland will go from $17 to $15, you all of a sudden see a benefit to that of $2.

And Kevin, I missed when you're talking about the hedging that -- what -- do you have any realized hedging gain or loss in the quarter?

We have a little bit of hedging gain and loss. However, I want to -- that's a good point for me to say, that we do look at hedging of the Midland differential a little bit. We did so far, I would call it, a little less than 10% of the production. It's pretty much -- it fluctuates, obviously. We're talking about 18 months from now. So we are around the money. We don't -- we're going to -- once it starts because we did forward, we will start providing you with the information. But we do look at hedging a little bit of the Midland forward curve.

Right. But how about in the second quarter we saw, did we have any realized hedging gain or loss?

Hold on for a second, let us look at this.

The totals are in our tables at the back of the release.

Yes. So if you look on Page 19 of the release, Paul. $9.9 million of unrealized hedging loss in the quarter.

Right, I'm talking about realized. I saw the unrealized. I'm curious that -- do you have any realized hedging gain or loss?

Why don't we -- we don't have any [problem]. Why don't we look at that number and give it to you. Is that okay?

Yes, that's fine. I -- final, just curious that, Uzi, when people were asking about the cash return, some of your competitors, that they will have a very explicit ways of saying I want to, for the cycle, be 30% of the cash flow or 40%. Is that a policy or strategy that you will adopt or that you think you need more flexibility so this is not for you?

That's a great question, Paul, and I'm going to answer it very directly. Some of our peers that doing a great job creating value for shareholders are much bigger companies than us, and they are not based on growth or acquisition. And we feel that the value we create to our shareholders is by a combination of growth as well as returning cash. So we want -- while we want to return cash and be aggressive when we have access to [active] cash flow, like now, we still want to maintain dry powder, if you will, to make sure that we can be nimble and to continue to grow our company, like we did with the Alon acquisition or, before that, the El Dorado acquisition.

Our next question comes from the line of Mr. Paul Sankey from Mizuho Securities.

The next question comes from the line of Mr. Neil Mehta from Goldman Sachs.

So first question I had, given how big your gathering business has become, you guys are on the spear tip of what's happening in terms of Permian oil production. Given what you've seen in terms of the differentials, have you seen any slowdown in terms of activity from your producing customers or suppliers?

Actually, the opposite. The way the system works, and I'm getting here a little technical, but I'll do it anyhow, at the beginning of every month, we get projection of production from producers, and we do business with many, many of them. So once we get that production plan, that's how we plan our purchases. And every month, you -- by the end of the month, it comes whenever it comes because they won't slow down or speed, but they'll just go with the flow. While in the first quarter, what we saw -- the first quarter, what we saw because of the, if you remember, the freeze in West Texas, huge slowdown. Well, now we are in the middle of the summer, and it's just booming. And every month, what we see from producers is that they call us and say, "Okay, I was wrong. Take a little more -- can you take a little more oil?" And then obviously, once they do that, then you see, towards the end of the month, the differentials are tanking and that leads to the weakening of the following month, so absolutely no slowdown.

Okay, that's helpful. And in terms of Brent-WTI, we spent a lot of time talking about WTI-Midland, but you guys are also levered to the Brent-WTI differential. Cushing is really great. Basically, the effectives tanked bottoms here at this point. I mean, how do you see that playing out from here as either spread between Brent-WTI? One would think that we'll start to see Cushing inventories built back up, and just curious on your latest thoughts there.

Well, you're asking a great question, Neil. I want to emphasize one thing before I answer just on Brent-TI is that we look at Midland-Brent, which is obviously in excess of around $20 right now. And if Midland continues to do what it does, then Brent cannot go back to $15 in our mind. However, I do think that there's an opportunity -- we do think that there's an opportunity for Brent-TI to widen a little bit in the fourth quarter and in the first quarter despite Midland being in such a discount. So if you will, I would add probably $1 or $2 to the current discount between Brent and TI.

The last question I have is on Krotz. Historically, this has been a problematic asset for Alon. This quarter you beat us on operating expenses to the downside, and it looks like it ran pretty well on realized decent margins. Could you just talk about where Krotz is in terms of the turnaround? Is this a sustainable type of run rate that you can drive performance from the asset? And what type of crudes you're able to bring into the facility? Because that's, historically, I think, in the area, the greatest problem, which is just getting discounted crudes into Krotz.

Neil, I'm going to say, privately, I told you a year ago, that either we fixed Krotz or we'll do something with it. And we put a lot of effort, energy and sweat into this thing, bringing crude to the refinery, and then also increasing netbacks. Obviously, we have space on Colonial now, RINs are cheaper. So Krotz is enjoying that as well because of the synergies. We combined the space between the 2 companies. And let me just remind you that Krotz has actually a positive yield, not negative yield. So when prices for crude go to $70, $55, all of a sudden Krotz shows improvement. We still have a ways to go. I want to be clear. First of all, reliability. We are working on it. We still have a little tweaking even though we do have a great refinery we manage over there. The second thing is the alky. The alky is a big project. We need to complete it, and we need to commission the unit. Sometime early or in the first part of next year, that would bring another -- probably, in today's market, more than what we said, $35 million to $40 million. We'll stick to $35 million or $40 million but -- of EBITDA, and then we need to get ready to -- for IMO and maybe the opportunities that are around that and blending of different things as Krotz has that opportunity as well. So I wouldn't be surprised if Krotz will continue to perform well for us.

The next question comes from the line of Mr. Doug Leggate from Bank of America.

This is Kalei on for Doug. So on the E&P side, there's been a few deals announced where producers are trading longer-term margins for nearer-term flow assurance. Wondering if there's any opportunities for DK to participate here, where a deal could potentially prolong the wider spreads for a duration?

Well, if you do something like that, you do it away from the market. We do have several deals that we do cash deals and not paper deals. But we haven't done anything behind 2019. So if you ask about long-term behind 2019, we have not done it.

Okay, got it. And I just wanted to expand on one of Paul's earlier questions. Can you just expand a little bit on the $3 Midland differential in the quarter. I understand the accounting and the impact on the reporting of the spread capture there. But it looked like it could've been higher. So my question was, was the buying of the crude perhaps weighted towards the front end of the quarter where the spreads were a bit tighter?

No.

And are there any issues that we should be watching out for when we're modeling out for 3Q?

I'll be very, very strong. We buy our crude ratably. Obviously, we play with it a little bit, nothing that you'd pay attention to. We try to beat the spread just a little. Second, we do not -- and I was asked that question many times in the past. I'll be very strong. Whatever you see on the screen, this is what we get. Not even $0.01 less. As a matter of fact, sometime, because the gathering, a little more. But let's just leave it to that. Third, I don't know how you play -- you got to that it's weaker than what you expected. It's very simple. If you take -- as I said, the formula is very simple because we have inventory for 1 month and we buy 1 month ahead of time. So if you take May and you look at what June was traded in May and then you take what July was traded in June and then you take what August was traded in July, you do the average of the 3, you will get to the -- around -- there's little noise but around the $10.80 that we provide you. If you do the same exercise, for the second quarter, you take what April was traded -- I'm sorry, what March was traded in February, what April was traded in March, what May was traded in April. Do the average of the 3, you will get to the $3 roughly.

And last question, just on the refinery turnaround in 2019. If spreads are as wide as we think they're going to be, would you consider pushing that out to the following year?

No. And I tell you why. It's very simple. If you remember, we have a system of 207,000 barrels a day. The refinery will be down 75,000 barrels that we will play around with crude to have as much advantaged crude going or cheaper crude growing to the -- through the system. So while it is going to be down, we will try, and in the past, we were successful for the most part, moving that cheap crude into the system somewhere else.

The next question comes from the line of Mr. Silvio Micheloto from Mizuho.

Silvio?

Can you hear me?

Mr. Sankey, welcome back. I'm so excited.

Yes, I'm sorry about the earlier nonsense. We're trying to get used to the new phones here at Mizuho. Uzi, there's only one question I can possibly ask you, which is, have you considered taking Delek private?

As you probably know, many times, yes. However, first, we want to continue to grow. So if there's an opportunity for us to buy something cheaper than us then we probably shouldn't do that. However, as we look at the screen, we know that we are pretty cheap right now compared to our peers. So I wouldn't say this is something that was considered seriously lately. But if the opportunity comes, we will be nimble to do so.

Yes. It feels like you've got a lot of good opportunities in the Permian. I guess these are gathering type -- what is the nature of the opportunities there, just industrially?

This is pretty much what we're looking at. From organic standpoint, we did a lot of work. People want to deal with the refiner directly, and people want -- there will be opportunities in the Permian. Don't be surprised if there will be some announcement over the [last] few quarters.

You've been a bit coy on the buyback, but I get the feeling it's not because of the scale of the -- or rather it's not because there's huge acquisitions out there. It's just that you're being somewhat circumspect. Can you remind us, you tend to have a view of the intrinsic value of Delek. Well, can you talk a little bit more about buyback, just to give us more to think about?

Well, honestly, the buyback is now a key component. We were on the light side this quarter as we were looking at different options. But if -- and there's no reason that it's more mature because we see the cash flow coming in. As it comes in, we -- there's no reason to believe that we won't be more aggressive. I do want to leave, as I said in the past, Paul, and you -- and we know each other for many, many years, that I -- we want to leave some dry powder if an opportunity arises.

The next question comes from the line of Mr. Matthew Blair from Tudor, Pickering, Holt.

So Plains mentioned last night they may expand the Red River pipeline by 100,000 barrels a day. It seems like additional WTI barrels into Longview would be a positive for DK. Could you just talk about this opportunity here? And would you consider being a shipper on the expanded line?

Well, I won't be going specifically on specific lines here, that's not going to be professional. But we do, as you know, have a big hub in Longview. You're absolutely correct. So opportunities to bring more barrels to the hub and then, by definition, lowering the cost of the hub makes sense. I'll leave it to that, Matt.

Okay. And then 2 questions on hedging. So one, on this Midland timing impact. Shouldn't you have inventory hedges in place that would really account for this gap between when you purchase the crude and when it -- and when you actually run it? And then two, you mentioned this approximate 10% mid-Cush basis hedge. Was that a negative in 2Q for you?

I'll answer the second question first. No, the answer is no. There was no -- well, if -- I'm going by memory. Well, no, the answer is no, not negative and not positive. On the inventory, we can. But being a bigger company, it doesn't make sense to spend money on something that doesn't mean much besides accounting, because the cash will come anyhow. Why to spend money on inventory or hedging something that is completely paper. The moment -- if next month the differentials will go from $17 to $15, all of a sudden, there will be positive impact and not negative. So why to do that? It creates some noise, which we probably need to work on it from an accounting standpoint. But spending money on something that is accounting, I don't know. I'm not sure that's something that we should do.

And the $38.5 million timing impact, so that cash benefit showed up in your CFO in 2Q, right?

Right.

This concludes our question-and-answer session. I would now like to turn the call over to the presenters for their closing, presenters?

Thank you, Don. I'd like to thank everybody for their great interest in us this morning. Thank you for the support, both analysts and investors. I'd like to thank my colleagues here around the table with the great support that they gave me and give the company. I'd like to thank the executives and the Board of Directors. But mostly, I'd like to thank each one of the employees of our company that make this company so great.

Thank you. We'll talk to you in the future. Bye.

This concludes today's conference call. Thank you for your participation. You may disconnect.