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Operator
Good afternoon.
My name is Regina, and I will be your conference operator.
I would like to welcome everyone to the Valero Energy earnings conference call.
All lines have been placed on mute.
After the speakers' remarks there will be a question-and-answer session.
(OPERATOR INSTRUCTIONS) Thank you.
Mr.
Eric Fisher, Vice President, you may begin your conference.
- VP
Great.
Thank you, Regina.
Good morning, or excuse me, good afternoon.
Welcome to Valero Energy Corporation's first quarter 2007 earnings conference call.
In addition to our first quarter earnings results, we'll also cover our expanded stock buyback program that was announced today.
With me are Bill Klesse, our Chairman and CEO, Mike Ciskowski, our CFO, and other members of our executive management team.
If you have not received the earnings release and would like a copy, you can obviously find one on our website.
There are also tables attached to the release which provide additional financial information on our business segment.
If you have any questions after reviewing those, please feel free to contact Investor Relations after the call.
Before we get started, I would like to direct your attention to the forward-looking statement disclaimer that's in the press release.
It says the statements in the press release and on this conference call state the company's or management's expectations or predictions of the future, are forward-looking statements intended to be covered by the Safe Harbor provisions under Federal Securities laws.
There may be factors which could cause our actual results to differ from our expectations, including those that we have described with the SEC.
And with that, I'll turn the call over to Mike Ciskowski.
- CFO
Thanks, Eric and thank you for joining us today.
I'll start by reviewing the quarterly results and then conclude with a few details on our expanded stock repurchase program we announced this morning.
First quarter earnings came in at $1.86 per share.
These earnings were the best we've ever achieved in a first quarter and represent a 41% improvement over the $1.32 per share we earned in the first quarter of 2006.
First quarter 2007 operating income was $1.8 billion, or about $500 million higher than the $1.3 billion of operating income we generated in the same period last year.
First quarter 2007 started with a relatively healthy environment for the industry refining margins in January.
And those margins continued to expand throughout February and March, to finish the quarter at strong levels.
This was due primarily to a mix of solid demand growth, tight supply, and colder weather at the end of the quarter.
As a result, Valero's throughput margin per barrel was $12.06 in the first quarter of 2007, or almost $2 per barrel higher than the $10.11 earned in the first quarter of 2006.
Regarding operations in the first quarter of 2007, Gulf Coast earnings benefited from the crude unit expansion at Port Arthur, which added 30,000 barrels per day of throughput capacity.
This unit was commissioned in January and brings the total plant capacity up to 325,000 barrels per day of sour crude oil.
Now, obviously, the mid-continent throughput levels were impacted by the McKee outage that began on February 15th.
The fire severely damaged the propane deasphalter, or the PDA unit, which uses propane to remove asphalt components from a portion of the feed stocks, where the catalytic cracking unit.
With the PDA out of service at least until the end of the year, achieving full throughput rates will be difficult.
Since the restart on April 15th, we have brought on units and increased throughputs to the current level of around 85,000 barrels per day.
By the end of June, we should be running in the range of 150,000 barrels per day and stay in this range through the end of the year.
Going through some of the key numbers for the first quarter, cash operating costs at the refineries were $3.74 per barrel.
The increase from the fourth quarter was primarily due to lower throughput volumes as a result of the unplanned outage at McKee.
General and Administrative expenses, excluding corporate depreciation, were $145 million, which was in line with the fourth quarter.
Total depreciation and amortization was $334 million.
The $26 million increase from the fourth quarter was primarily due to the completion of capital projects and higher turnaround in catalyst amortization.
Net interest expense was flat at $59 million with the prior quarter.
And our effective tax rate was 33.1%in the first quarter.
This was up slightly from the fourth quarter, primarily due to favorable return adjustments reflected in the fourth quarter.
With respect to our debt position, at the end of March, our total debt stood at $4.9 billion, which compares to $5.1 billion at the end of 2006.
We called in the first quarter $183 million of high-cost debt and we ended the quarter with $1.7 billion of cash.
And then this month, we paid off $230 million of maturing debt.
Capital spending during the first quarter was $680 million, including turnaround costs of $129 million.
Regarding our stock buyback program, in the first quarter, we spent $900 million to purchase 15.6 million shares of our common stock, plus another $275 million in early April to acquire another 4.1 million shares.
Now as to the second quarter operations, turnaround activity is relatively light, so for modeling purposes, you should expect to see Gulf Coast refinery throughputs of approximately 1.5 to 1.6 million barrels per day.
Mid-continent throughputs should average around 525,000 barrels per day, which reflects the scheduled rate increases at McKee.
West Coast throughput should average between 280,000 and 290,000 barrels per day.
And the Northeast system should average in the range of 550,000 to 570,000 barrels per day.
Refinery cash operating expenses are expected to be slightly higher than the first quarter levels, at about $3.80 per barrel, mainly due to higher expected energy costs.
With respect to some of the other items for the second quarter, we anticipate G&A expense to continue to trend around $145 million.
Net interest expense should increase to about $90 million, due to the financing costs for the accelerated share repurchase, or ASR program, which I will discuss in a moment.
Total depreciation and amortization expense should be around $345 million.
And, finally, for your tax rate, you should use about 33.75% for your modeling purposes.
As to our stock repurchase program, yesterday our board increased the company's stock repurchase authorization to $6 billion from the $2 billion authorization announced last October.
We also entered into a private ASR agreement with JPMorgan in which Valero will purchase its common stock for an up-front payment of $3 billion.
Under the agreement, the number of shares to be held in treasury will be based on the price of the company's common stock on Friday, April 27th.
And then we expect the delivery of the shares to Valero on Monday, on or about Monday, the 30th.
The final price for the shares repurchased will be determined based on a discount to the volume weighted average trading price of the company's common stock during a period of up to four months.
So, at the end of the period there will be an adjustment up or down to the $3 billion payment.
The up-front payment to JPMorgan will be funded with a short-term bridge loan, which we expect to replace with longer term debt financing at a later date.
Prior to the ASR, we had purchased 1.2 billion of shares this year of which 900 million applies against the 6 billion authorized program.
So considering the 900 million of shares already purchased this year, plus the 3 billion ASR, we will have utilized nearly 4 billion of the 6 billion authorization.
We expect to use the remaining authorization to purchase shares in the open market this year.
One of the benefits of the ASR is that for accounting purposes, the shares will be held in treasury up front.
This means for your EPS calculation, you should reduce the diluted share count for the second quarter down to around 575 million shares.
Some more good news is that we've reviewed this transaction with the rating agencies, and they have indicated that they will maintain our investment grade ratings at BBB with S & P and Fitch and BAA 3 with Moody.
Now, I'll tun the call over to Bill.
- CEO
Good afternoon.
As Mike said, 2007 is starting out well and could be another record year.
As outlined in our press release, gasoline and diesel margins have been impressive.
This is largely due to the strong gasoline and distillate demand throughout the first quarter and continues into the second quarter.
On the supply side, imports have been low, and the industry has not been able to increase production to catch up to demand for a variety of reasons, especially unplanned downtime.
This combination of strong demand and constrained supply has resulted in higher refining margins.
We believe that many of these supply and demand trends will be in place for many years, as refineries are much more difficult and complex to operate in the low-sulfur world, which means refining margins should stay higher for longer than most on Wall Street are expecting.
As for Valero's strategy going forward, we continue to focus on improving our financial performance and returns for our shareholders.
As you all know, we have grown the company rapidly through acquisitions over the past ten years.
We've developed an advantage portfolio of refining assets with world-class scale, conversion capacity, geographical diversity, feed stock flexibility, and, most importantly, the brightest and best people that run this hardware.
But many of the assets we acquired were in distressed situations or received insufficient investment from prior owners.
Even though we've made tremendous progress in the refineries we acquired, we know there are significant opportunities to increase profitability through a combination of strategic investments, cost efficiencies, and far more reliable operations.
As we have said, we think that we have at least an internal improvement opportunity that's worth an additional billion dollars in annual operating income.
We are working to capture this self help within the next five years.
Along with our focus on improvement, you should also know that we are firmly committed to the safe and reliable operations of our facility.
And even though our personal statistics look very good, we are pushing for even more improvement, and are developing and implementing a rigorous process safety management program across all of our refineries.
In addition to the obvious personal safety benefits of such a program, we also expect this program will improve plant reliability.
We are also looking at all of our assets to identify ways to unlock additional shareholder value.
We realize that as long-term strategic fit some of our assets may be worth much more to others.
For example, our process to explore strategic alternatives for our Lima, Ohio, refinery continues to move forward.
We've received several very competitive bids.
Within the next few weeks, we expect to announce a definitive sale and purchase agreement with one of these bidders.
One thing to know is that no matter who acquires the plant, all of our employees will be retained at that time refinery.
Going forward, we will continue to allocate our cash flow in a balanced approach.
This includes our capital expenditure budget, which we have said in 2007 is about $3.5 billion, and we expect to meet this budget.
Under our balanced approach to allocating cash, we have continued to return cash to the shareholders by increasing dividends and buying back stock.
We believe this demonstrates our fiscal discipline and prudent use of the shareholders' cash.
Considering the bright outlook for refining, the internal improvements we're making, our focus on unlocking value from existing assets, and the strategic opportunities we have within our refineries, we see that there's a great opportunity for us to buy back more shares of what we believe is truly an undervalued stock.
We now have the $6 billion of buyback authorization, plus the anti-dilution authority that Mike mentioned.
If you assume a share price of around $70 for the 3 billion ASR, and roughly 2 billion remaining authority, we could buy more than 90 million shares of our stock this year, or close to 15% outstanding.
In summary, our strategy is to focus on improving our financial performance, our operating performance and our returns and growing earnings per share.
We recognize the shareholders own Valero, and you should expect us to deliver excellent financial results.
And with that we will open it for questions.
Operator
(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q-and-A roster.
Your first question comes from Arjun Murti from Goldman Sachs.
- Analyst
Thank you.
Just to follow up on the stock buyback plans.
And I think I understand the 2007 program, you're doing 3 billion on an accelerated basis.
You're obviously selling is Lima, and you've hinted that there could be additional things you look at.
As we try and distinguish the kind of ongoing stock buyback and cash return to shareholder component versus what may come with asset sales is there some, I don't know, target debt to cap?
I know rating agencies will look at a more complex analysis than that, but that we should be thinking about as margins stay strong, we're going to return a certain amount of cash back to shareholders, and if we do these other things like asset sales, there can be accelerated programs that tie to that?
Is that how we should be thinking about this, or is it some other means than that?
- CFO
Arjun, this is Mike.
On our target debt-to-cap what we're going to be managing around is a 25 to 30%, and that's a net book debt-to-cap basis.
And so what we have authorization to do today is the 6 billion, which is another 2 billion from the board, plus our anti-dilution.
So we do expect that we will be able to fund that out of cash flow, in the balance of the year and stay within that debt-to-cap range.
- Analyst
That's very helpful.
Do you have the diluted share count at March 31st?
You mentioned the 575 expectation for 2Q.
Do you have a March 31st share count number?
- CFO
The weighted average shares for the first quarter is 615.
- Analyst
That's okay.
- CEO
We'll get it to you, but I think, just so you know, I think it's 607.
But we're going to get it for you.
- Analyst
Any consideration to special dividends, or is the focus clearly on accelerated stock buyback and buyback?
- CEO
I'm sorry, Arjun.
- Analyst
I apologize.
Would you in the future consider special dividends, or are you primarily focused on stock buybacks as the normal course of action?
- CEO
We would consider anything, but what we're doing is what we've demonstrated.
We've raised the dividend two times in '06, then once here in the first quarter, and we've been buying back our stock.
So, it's easy to say that these are the two things that we've been doing.
- Analyst
That's fantastic.
Thank you so much.
- CEO
And then, just so you have it, the answer I gave you on the 607, you asked for the March 31st number, and that's the number we're trying to find.
I think it the's in that range, but we're going to try and find it.
Average for the quarter was 6 15.
- Analyst
I guess it's really the number before the 3 billion is what we're looking for.
- CEO
Okay.
And we don't seem to have it here.
- Analyst
I can follow up.
- CEO
603.
- CFO
Arjun, we just got it, it's 603.
- Analyst
Thank you very much.
Operator
Your next question comes from Jeff Dieter with Simmons.
- Analyst
Nice job on the buyback program.
Bill, I was wondering if you could, with some of the insight you've gained from the Lima sales process and the continued evolution of the industry, how your thoughts are evolving as it relates to portfolio management, the possibility of selling incremental assets, expansions at Port Arthur and Lake Charles, and the discussions you've had over possible European refinery acquisitions, and how you rate those now.
- CEO
Well, on the asset portion, looking at portfolio management, we obviously are going to work on the Lima and finish it up.
And that's where our focus is now.
But clearly, and I've been very open with everybody, that we are looking at our portfolio, and some of those refineries in the portfolio, both from a strategy, from a synergy, how we integrate our entire operation, may have more value in the long run with another company.
And with that I would like to just say that we're working on this and we're looking at each and every aspect.
Moving to Port Arthur and St.
Charles, those are projects that have been in and out of the press because of permitting, people asking us question over the last year.
We have been looking at the hydrocracker and crude coker expansion at both of those facilities.
When you look at Valero, these are some of the real horsepower refineries that are within our portfolio.
We do not have board approval for those projects, but we have placed orders for some of the long lead-time equipment, and we are continuing to pursue that.
We've given out some numbers on this.
If we go ahead with the project at Port Arthur, it would raise it from about 325,000, because you know we completed the crude expansion there in the first quarter, to 450,000.
It would raise the coker to 138,000, and we'd build a 50,000 barrel-a-day hydrocracker that would be geared toward these.
St.
Charles, we raised the coker capacity about 10, we take the crude capacity up to 235.
We again would build a similar hydrocracker at St.
Charles.
Again, focusing on diesel production.
We think these are very attractive projects for us and we continue to spend both engineering and permitting time on these.
The third question --
- CFO
Europe.
- CEO
In Europe we continue to look for ideas.
We still like an Atlantic Dasin strategy, but I will be honest and tell you we're not working on anything today.
- Analyst
Thank you for your comments.
Operator
Your next question comes from Doug Leggate with Citigroup.
- Analyst
Thank you.
Congratulations, guys, on the announcement.
Couple of things from me.
The billion dollars of improvement over the next several years, I just wanted to backtrack a little to the Premcor, given that Lima, obviously, is going to leave the portfolio pretty soon by the looks of things.
The $350 million of synergies that were targeted there, where are we with that?
Is that included in the billion?
Is it done?
What's the situation there?
- CFO
Yes, the synergy capture is really done, Doug.
We think what we've got there is reflected in the numbers we're currently doing for this would be added in that respect.
- CEO
(Inaudible) conference.
And we said we'd do the billion.
It is made up of energy reduction of maintenance, in the sense of other operating-type costs, and also in gaining some reliability benefits throughout the refinery.
We have a very detailed sheet of this and quite frankly we use the Solomon surveys.
What this does is get to us first quartertile performer over the five years, in these categories.
Mechanical availability.
- Analyst
OK.
Great.
Next question for me is actually on Lima, I guess, because one suspects that you're going to have some kind of announcement in a couple weeks time.
What is the tax basis for that we should look at for whatever the disposable turns out to be so we can figure out what your cash flow is going to look like there?
- CFO
The tax basis, roughly $320 million.
- Analyst
Okay, great.
Last one for me.
You've given us -- just want to get some clarity on the buyback.
The 19 million shares is that net of anti-dilution?
- CFO
The 90 million shares would include the anti-dilution.
- Analyst
So what would you expect the share reduction to be then?
- CFO
Roughly -- what we have in this current forecast is about 100 million shares, including the anti-dilution.
So 90 million net.
- Analyst
90 million is net.
That's great.
Thank you.
Operator
Your next question comes from Paul Sankey with Deutsche Bank.
- Analyst
HI, good afternoon, gentlemen.
I had a somewhat strategic question about the announcement that you've made today.
Firstly, how did you balance your view of the merits of the balance sheet of your investment grade that you mentioned against the merits of the stock buyback?
I guess a follow-on related issue would be -- could you say anything about what kind of planning assumptions you've made for the outlook for margins in making the decision you've made today?
Thanks.
- CEO
On the first question -- I'll let Mike take the second -- but on the first one, our planning, or the way we look at it, we're saying our target debt ration is in this 25 to 30%.
And Mike talked to all the ratings agencies, and they affirmed our rating to do what we are planning to do here.
And so that's our target.
We want the strong balance sheet, we have it.
I've been on the road talking to many of you, these have been the numbers that we have given you when you have asked the question.
- Analyst
I guess further to that, I was wondering how you have thought about the relative merits of the two issues, whether or not you had thought about increasing your rating in view of the buyback.
- CEO
Oh, no, no, we do not want to increase our debt rating from where it's at.
The BBB we're comfortable with.
We just don't feel like the addition -- or the decrease of further de-levering of the company, if you will, to get an upgrade in our credit rating would be the prudent thing to do.
We're quite comfortable with BBB.
We'll manage around the 25 to 30% debt-to-cap.
- Analyst
Fair enough.
- CEO
And I think you remember, Paul, that last year what we wanted to do is get off the bottom of the investment grade.
That was all we were trying to do.
- Analyst
And then the follow-up is, could you say more about what kind of planning assumptions you've made for margins going forward?
- CFO
Paul, We look at the same data you do, forward curve and things like that.
We've got a forecast, you've fought a forecast.
- Analyst
I guess what's interesting, if you could --
- CEO
We look at the forward curves.
We take all of that into consideration.
We're looking at the crude market.
And then we make our judgment here.
But the forward curve in the short-term environment tends to be the basis of what we're doing.
- CFO
We're very comfortable with what we, did obviously.
- Analyst
Right.
And I guess it's notable that the forward curve is quite aggressively (Inaudible) at the moment.
- CEO
That's right, but we think that (Inaudible) will dissipate.
- Analyst
That's great.
Thanks a lot.
I think I'll leave it there.
Thanks.
Operator
Your next question comes from Doug Terreson with Morgan Stanley.
- Analyst
Congratulations, guys.
- CFO
Thank you.
- Analyst
I just had add a follow-up question for Mike on -- origins question, I think, as it relates the new debt.
Specifically, whether or not you have a preliminary expectation for the borrowing cost and the term of that new debt that's related to the share repurchase program or is is it too early?
- CFO
No, we haven't really decided what permanent financing we're going to put in place, but right now, I mean, issuing long-term debt we can do 10-year debt at under 6% and probably 30-year debt at about 6.2 to 3%.
So approximately 6% if we were issuing the debt on a weighted average basis today.
- Analyst
Okay, good.
And also, do you have an update on the operating status at St.
Charles?
- CFO
Yes.
We have the St.
Charles cat cracker down for an unplanned repair.
It relates to a failure in a large slide valve in the regenerated catalyst system.
We are anticipating just a little bit short of the three-week outage, and we're anticipating the unit will be back in service by around May 7th.
- Analyst
OK.
Congratulations, guys.
- CFO
Thanks.
Operator
Your next question comes from Paul Cheng with Lehman Brothers.
- Analyst
HI.
Good afternoon.
Maybe this is for Mike, for the dilution effect, including option and all the other things, how big of a number we should be taking into consideration on a going-forward basis?
Is it 10 to 12 million shares a year or just a lower number?
- CFO
OK.
On the anti-dilution, it's very dependent on the exercise of stock options.
But what we have in our forecast this particular month is about 10 million shares.
And about -- our base load is only about 2 million a year.
And then above that would be dependent on stock option exercises, as employees exercise those.
But our base load would be 2 and then we're assuming some option exercises for a total of 10.
- Analyst
I see.
And -- okay, that's good.
Bill, wondering if you would be able to share with us some information about [NEMA].
What did that, in terms of the first quarter contribution, operating profit for 2006, what is the contribution?
- CEO
We haven't given out that kind of information here.
So the answer, I guess, Paul, is no.
- CFO
We'll give you some whenever we get to the point we're ready to make an announcement on that.
We'll give you some of that information.
I know you'll need that then.
- Analyst
OK.
And also, the [Inaudible] you come in, in terms of the final bids you receive.
Are those coming from the financial buyers or is more from the operating company?
- CEO
I'd prefer not to do it.
Gene Edwards is running our process.
You know Gene.
And he's going through it.
We have several bids, as I said.
He's charged to get one to the final line.
- Analyst
A final one, just a small one.
On the retail, seems to have lower DD&A and operating costs, I assume that's related to the recent restructuring that you guys have been doing in that unit, so those [Inaudible].
- CEO
You have the right answer.
- Analyst
OK.
Perfect.
Thank you.
Operator
Your next question comes from Roger Read with Natexis Bleichroeder.
- Analyst
Good afternoon, gentlemen.
First question, the $1 billion of cost savings, is any of that related to some of the asset disposals, whether Lima or any of the others that may or may not meet your criteria for disposal down the road?
- CEO
The billion would include all of our refineries, but there is a little room there.
So, if you're really asking, okay, if we dispose of a few refineries, do we need to move the billion around?
The answer would be yes.
But some of these plants, obviously, are smaller than some of the big guys.
And the big guys have all the opportunities.
- Analyst
And have you provided any sort of indication of what sort of capital you would need to spend to achieve the billion in savings?
- CEO
We have not given that number.
- CFO
Whatever capital forecast we give, Roger, will include whatever it is.
It's not additive in any way.
- CEO
It's in there.
- Analyst
And then the only other question I had, given the volume guidance you provided for the quarter, is that all contingent on, obviously, the unplanned and planned downtime we've had thus far in the quarter?
Are you being conservative and, given the challenges, I suppose you and the industry have faced so far this year.
I look at the volumes you put it through last year.
I look at the volumes this year.
It's surprisingly low in the West Coast.
And given the 75,000 additive Port Arthur kind of low on the Gulf Coast, just wondering how you were approaching your view of the market there.
Or your view of the internal operations, I should say.
- CFO
The throughput volumes that we gave that's just based on our turnaround schedule and the capacity.
We do not plan, obviously, on unplanned outages.
So we feel like we can run at these throughput levels.
We're not handicapping the forecast by any type of percentage and some of the outages we've had have been unique occurences.
For example, our [McKee] outage.
I mean, that is not the kind of thing that you would anticipate you would repeat in your operation.
- CEO
Or if our light's gone.
- Analyst
Okay, thank you.
Operator
Your next question comes from Chi Chow with Merrill Lynch.
- Analyst
Good afternoon.
I've got one operational question for you.
At Port Arthur, how has your crude slate changed since the startup of the expansion versus prior years?
- Exec VP
It has incrementally been more of a medium-sour crude edition, because prior to the expansion, our coking capacity was nearly full.
So, the incremental crude that we've run, we haven't needed as much of a heavy component, so it's been more of a medium-sour edition.
- CEO
To give you an idea, though, there was a day here a couple of weeks ago, we ran 275,000 barrels a day [on mine] there.
But incrementally, we're around 250, 260 of heavy sours and then because the coker at 105 we haven't done any work on yet, it's exactly the way Rich described.
- Analyst
Okay.
Are you bringing in more of the heavy Canadian at this point this?
- Exec VP
Yes, we've increased the bid here over the quarter, and I would tell you that now we're running somewhere around 90,000 a day.
- Analyst
90 of Canadian and the rest of heavy.
Is it more [maya], as you talked about?
- Exec VP
Yes.
- Analyst
Great.
Then, last question, can you give us your thoughts on how you see this summer season shaping up here for the industry on supply and demand?
Just as you mentioned, Bill, there has been a lot of down time, imports are low.
Actually looks, quite frankly, a little bit scary on the supply situation.
Any comments on that end?
- CEO
We think we're going to have a good season because demand is there.
On the other hand, the [ARBS] wide open, so we should certainly in some of these areas.
But I would think you need to assume that Whiting will come back up, Toledo will come back up, obviously McKee is coming back up.
We'll get St.
Charles back up.
And so these plants will produce more, but we have the high demand season through the summer, so we're expecting good cracks all the way through.
And I think we're going to have a really terrific year.
I don't think it's scary unless there is some really unanticipated event that happens.
I was asked a couple hours ago, did I see $4 gasoline.
I'm not talking about California.
But, I mean in the rest of the country and my answer would be "no" without some way unanticipated event.
It also led to the question, "Well, what if we had another hurricane like Rita?" Well, of course, that's a major event, but if the industry itself is going to supply the market.
But will have good cracks.
- Exec VP
Bill, can I correct here?
The answer on the Canadian crude, you said a heavy sour Canadian, didn't you, Chi?
- Analyst
That's right.
Like a cold lake or something like that.
- Exec VP
Yes, that's the wrong number.
If you use a number somewhere just under 20 for the heavy and then we're somewhere around 55 to 60 on the sweeter crude.
- Analyst
OK, is that like LLS?
- Exec VP
That would be Canadian, like Hibernia.
- Analyst
Great.
Thanks a lot.
Operator
Your next question comes from [Darrien Sturges] with Banc of America Securities.
- Analyst
Hi, guys.
Just to follow up on the conversation about the summer and the supply issues - obviously, people are noticing that maintenance and outages in the U.S.
are taking a little bit longer, whether it's due to a greater awareness of safety or labor or what have you.
Do you have any sense that this is a global issue and that we're going see similar issues going forward in Europe and it might affect the import number?
- CEO
We're going to let Rich answer first and then Gene will add if he would like.
You can talk about turnarounds and what you see.
- Exec VP
Sure, the experience we're seeing -- to one factor, with the advent of these very low sulfur fuels, 30ppm gasoline, 15ppm sulfur diesel, there are a lot more [hydro treating] units on the back end of the refinery production.
To the extent that they go up or down, it does complicate throughput throughout the refinery and be able to make on-spec product.
And so I think in this tier-two, ultra-low sulfur fuels environment, refinery operations have been more complicated and therefore throughput I think is restricted when you have outages more so than we've seen historically.
In addition, the other factor that we are seeing is the productivity of maintenance services is not what it was in our view.
There's been a tremendous demand for labor, really sustained in the post-hurricane period.
There are comparable demands in the power industry.
Western Canadian demands on construction, and I think we're seeing a productivity problem in the field and we're seeing extended turnaround durations.
So these are factors that I think are different than what we've seen in the last few years, and we don't see them abating any time soon.
- Exec. VP
As far as the rest of the world, I think the demand continues to grow for gas and distillate.
Distillate is probably a little bit better supply, just because Asia and Europe had warm winters.
We had a pretty warm winter with the exception of some late cold which spurred our demand on.
The biggest factor that I see, there's a lot less gasoline imports coming in.
It mainly [blend] stock.
So autos [cause] of tighter naptha is in the making of chemicals throughout the world.
And we're not seeing near as much naptha come in for the blenders to blend up to independent (Inaudible) that we saw last year.
The numbers are down remarkably from last year.
I think the counter balance is the higher production we've seen out of our own refineries.
It's just less imported blend stock.
And that's what's kept the market tight here and kept the gasoline inventories low last year.
We just reran our numbers this morning on our projections for the rest of the year on inventories.
It looks like gasoline supplies are going to stay at the lower end of the range, particular on a days' supply basis.
Demand being up and inventories probably being a little less than last year.
All-in-all, the projections still look pretty good.
- Analyst
Sounds great.
Thanks, guys.
Operator
Your next question is from [Sebastian Williamsky] with Sanford Bernstein.
- Analyst
Hi.
I just have a quick question in terms of costs.
In your earnings release and just now, you were talking about several factors which are driving the increased downtime in the industry.
I was just wondering to what extent these trends are starting to flow through to your operating cost per barrel.
- CFO
I would say that we are factoring in the higher cost of contract services into our annual budgeting process.
We've seen that I think more dramatically on the construction side for new facilities, but we do incorporate those kind of inflationary impacts in our annual budgeting.
It would be difficult for me to quote a cents-per-barrel figure of something like that, but we do capture it.
- CEO
But we paint productivity down 30, 35% from pre-hurricane, and so if you think about some of the cost components and turnarounds and you think labor component, costing us in that kind of area as opposed to just straight operations.
- Analyst
Okay.
That's very helpful.
And just a quick second question on retail demand.
What kind of demand growth level are you seeing on a like-for-like basis at your retail stores right now?
- CFO
We're synched-up completely with what we're seeing in the broader market.
I think we're seeing gasoline demand year-to-date up just under 2% across the country, and ours is up a little bit more than that.
I believe we're up 2.1%.
- Analyst
Great.
Just a quick linked question, I guess.
Internally, what estimates do you have for the lower efficiency of ethanol-blended gasoline versus the old [reformatted] gasoline?
- Exec VP
Two-thirds ethanol versus gasoline.
You look at E-10, where it's 10% of the blend, you probably lose about 3% there.
- Analyst
Okay, great, thanks very much.
Operator
Your next question comes from [Nikki] Decker with Bear Stearns.
- Analyst
Good afternoon.
A couple of conceptual questions.
In talking about acquisitions, it sounds to me that you've taken yourself out of the acquisition market, between the buyback plan and your 25 to 30% debt-to-cap target.
Is that fair?
- CEO
No, I don't think so.
I tried to be very consistent here.
I've said to people, "We're not going to overpay." Then you'd say to me, "Well what does that mean?" So I'm going to tell you we're trying to be very prudent.
We're interested in certain assets, but we also know we have a lot of internal opportunities.
And so what we're doing here with the management team now is focusing very hard internally, but we're keeping our ear to the ground and we're always opportunistic and we're still very strong financially.
Our cash flow, as every one of you on the call have pointed out to us, are just excellent.
So we're in the game.
- Analyst
Okay.
Thank you.
And secondly, you talk about organic growth opportunities.
It's curious that your projects are focused on diesel production.
Any reason why you wouldn't be more focused on gasoline?
- CEO
Sure.
But I'm going to let Gene answer.
- Exec. VP
Well, you look at the extra ethanol that's going to be coming into the pool over the next several years, that's going to take up a lot of the demand growth for gasoline.
Plus, I think with the higher prices, probably new cafe standards, more efficient vehicles, maybe some dieselization of SUVs, all those factors, we see gasoline growth slow into maybe more the 1% range, maybe slightly less than that, just depending on the economy.
Where diesel demand is going to continue growing at a much higher clip, probably 2% per year just based on the economy and the things I just mentioned, dieselization, and there's not an issue to reduce miles per gallon on diesel vehicles.
- CEO
And it's a worldwide business also.
Diesel is growing rapidly in different parts of the world.
But I said when we do the speeches that initially ethanol basically replaced MTBE in the system.
And then we have said we're going see 400,000 barrels a day of ethanol this year, going to 600,000 barrels a day for next year.
So just trying to take an average.
Looking at those numbers it's already above the mandated number of 7.5 billion gallons a year.
So it's doing what Gene said.
Some of the growth in the gasoline business, as we have more people, more cars, and all of this, is being consumed by ethanol.
So, as we look at it, our hydrocrackers will make some gasoline, but they just will make more diesel.
So it's a good opportunity for us to push a little more diesel is production.
- Analyst
On the worldwide front, Bill, is there reverse [arb], if you will, where you have opportunities to send product to areas that are distillate short?
And is that part of the strategy?
- CEO
Yes, Nikki, absolutely.
We already do today many times send some diesel out of the Gulf Coast to Europe.
Of course, we have Aruba, where we send diesel or components to Florida's Gulf Coast.
We've actually sent some to Canada and to Europe, and then the other issue, quite frankly, and it's Mexico and south.
We sell into Latin America, South America, both some gasoline components in the market, but frankly we've been sending diesel fuel.
So it's, in our business, the regions are many.
There's a lot of differences in the regions, and transportation and time always equalize.
- Analyst
What about Corpus Christi?.
Are you able to send cargos like you used to, of gasoline, to the West Coast?
- CEO
Not as easily with the rules.
Gene.
- Exec. VP
Yes, the freight rates are very high, shipping rates are tight on shipping things out there.
You always look at the --
- CEO
I said it was our baseline, was part of the problem.
- Exec. VP
Yes, just the baseline on making RNG in the non-California refineries and making car models meet their specs.
It's difficult to send our components from the Gulf Coast, because it screws up -- I'm sorry -- it messes up our baseline on the nonrefinery refineries.
- CEO
We have a little issue.
What Gene is telling you, it gets into our baseline on toxics and how you manage that in that each individual market.
But to answer you, we can still load ships, send them to California from several of our refineries.
We actually send (Inaudible) other blend stocks out there.
However, there's been issues around the Panama Canal, the lead time in getting shipped, the market in California is always backward when we have these spikes, so we have those issues.
So we haven't done as much of sending a finished car gasoline to California as we have in sending components, sending some blend stocks out there.
And we have done that.
- Analyst
So that the $20 barrel [arb] doesn't tempt you?
- CEO
Of course it does, but you have issues -- you really -- on this baseline, there are issues and we're not going to explain it very well to you here because I don't think any of us understand it exactly, but we do send blend stocks to that market and we have done that.
- Analyst
Great.
- CEO
Remember it's always backward.
Big time.
- Analyst
Thank you.
Operator
(OPERATOR INSTRUCTIONS) Your next question comes from Mark Gilman with Benchmark Company.
- Analyst
Guys, good afternoon.
I had a couple things.
- CEO
Hello, Mark.
- Analyst
how are you?
- CEO
I am fine, thank you.
It's great to hear from you.
- Analyst
And it's nice to talk to you, too, Bill.
Regarding the accelerated buyback, can you quantify what the discount is that's implicit from the market price average?
- CFO
No, I can't give you the discount.
I'll say that it's meaningful to the [vwap], or the weighted average price.
- Analyst
Mike that weighted average price over a four-month period is when?
What four months?
- CFO
It's beginning on Monday for four months, up to four months.
It doesn't have to be four months.
If JP can cover their short in a shorter period of time, then it it's through that period of time.
- Analyst
Is there an implicit interest rate that you might assign to this transaction?
- CFO
No.
- Analyst
Because it's really a borrowing, isn't it?
- CFO
No, we're actually retiring shares.
- Analyst
I understand that.
But you're --
- CFO
Oh, I'm sorry.
On the bridge?
- Analyst
No, not on the bridge, but on the transaction itself.
- CFO
Not really.
- Analyst
The present value to it?
The value of retiring the shares currently against --
- CEO
We will say if you're asking us, we've had many different answers.
So.
I'm going to give you a couple here.
You pick your own.
If you add price earnings rations eight times.
So, hey, that's 12%.
We've also talked to a lot of people that buying our stock, and we put together some forecasts ourselves.
We think it's somewhere 15 to 18% risk-free returns here, to be buying our stock as we look at it.
You will have your own expectation of the return on the purchasing of the stock.
But we have done that kind of work here to make a determination as to what we thought risk-free return was.
- Analyst
OK.
Of an operational nature, the gasoline yield systemwide is down a bit from what it the's been running.
I'm sure that McKee is a part of that, but certainly not all of that.
The distillate yield is pretty much unchanged.
Is there something else going on that's either intentional or not intentional as it relates to that change in the yield pattern?
- Exec VP
We were in max-distillate mode during the first quarter.
So that has something to do with it.
Then we did lose 50 a day of gasoline production out of McKee.
- CFO
McKee is a high-conversion gasoline refinery, so it probably had the higher gasoline yields on average.
Additionally, when we had the crude topper fire at Texas City, it also took the cat cracker out with it it because we burned up an instrument cable run that serviced that area.
And then lastly, we had a -- oh, about a 12-day outage of the cat cracker in St.
Charles in March of this year.
So we have had some lost cat runs, then the McKee refinery, of course, has a good level of gasoline conversion on it's sweet crude operation.
- Analyst
Are you in a max gasoline mode now, Rich?
- Exec VP
I'll tell you what, we are producing more gasoline.
I don't know that we're in max gasoline.
- CFO
I think jet fuel is still above naptha price, so, in a crude (Inaudible) you're still going to be maximizing jet fuel as opposed to naptha.
I think the other factor, Mark, is that the blend sites I talked to earlier, those get added to the gasoline production.
When you divide that by total crude throughput, last year all these extra blend stocks inflated the percent yield of gasoline divided by crude.
If you're not getting it today, so that effectively reduces that yield.
If you back that out of those numbers, I think you'll find that the yield just on true refineries is real similar to what it was last year.
- Analyst
Okay.
Just one other one, accounting related.
I assume that you're not impacted by the change in turnaround accounting as a result of deferring and amortizing.
- CFO
No.
- Analyst
Is that correct, Mike?
- CFO
That's correct.
- Analyst
OK, thanks very much, guys.
Operator
There are no further questions at this time.
- VP
Great.
Thank y'all very much.
If you have questions, feel free to call us.
Operator
This concludes today's conference call.
Thank you for your participation.
You may now disconnect.