Delek US Holdings, Inc.’s DK share price rally makes the stock an investor favorite. Shares of the company have rallied a whopping 114% over a year, outperforming its industry's growth of 51.4% and the Zacks S&P 500 Composite's rally of 18.6%.
The stock has been in the investors’ good books of late, courtesy of its refining strength, diversified operations and shareholder-friendly moves. With a market capitalization of around $4.6 billion, Delek’s average volume of shares traded in the past three months was 1.81 million.
Let’s take a detailed look at the factors that are driving the performance of this downstream operator.
Wider Permian Differentials & Alon Buyout Boost the Refining Game
Delek’s extensive downstream operations within the Permian Basin bode well for the company. The buyout of Alon USA Energy, Inc. in 2017 has strengthened the presence of Delek in the Permian Basin, with an increased access to Permian-sourced crude, making the firm one of the largest buyers of the crude among independent refiners.
As we know, Permian is battling with infrastructural bottlenecks and the situation has been reaping profits for refiners. Shortage in the Permian takeaway capacity in the face of exponential production growth has led to widening differential, forcing producers to sell their crude at a sharp discount. With 70% of Delek’s refining capacity leveraged to lower Permian pricing, the company is getting access to cheaper crude, which in turn is boosting its refining margins.
Notably, the crude differentials averaged $15.03 per barrel in the second quarter of 2018 compared with $3.48 in the prior-year period. As such, margin contribution from the refining segment was $177 million compared with $16.9 million in the year-ago quarter. The improvement reflects higher crack spreads, wider divergence between Midland WTI and Brent crude oil pricing, along with the addition of refineries following the Alon acquisition. The acquisition is also expected to lead to annual synergies of $130-$40 million in 2018.
Diversified Operations Provide the Desired Cushion
Stable cash flow from logistics and retail segments diversifies Delek’s earnings streams, and helps to buffer the refining business, in case it becomes weak.
Delek’s midstream subsidiary, Delek Logistics Partners, L.P. DKL also offers the company additional growth potential. In particular, Delek’s regular asset dropdowns to its midstream partnership, Delek Logistics, provide it with a steady and growing revenue stream, while increasing equity participation in the subsidiary. Notably, margin contribution from the logistics segment in the last reported quarter was $45.4 million, up 43.2% year over year. The strong results were driven by contribution from the drop down of Big Spring refinery logistics properties, better gross margin per barrel in west Texas and improved performance from the Paline Pipeline.
Further, the retail segment — which came into being following Alon buyout — is also a major growth driver, with operations spanning across a network of 300 branded retail outlets under brand names like ‘Alon’ and ‘7-Eleven’. Margin contribution from the retail unit in the last reported quarter was $18.6 million.
Commitment Toward Shareholder Returns Buoys Optimism
Delek is regarded as a investor-friendly company owing to its commitment toward dividend and stock buyback programs. On a Year-to-date basis, the company has returned $153 million to its shareholders via dividends and repurchases. Notably it, announced two back-to-back quarterly dividend hikes of 33% and 25% in the fourth quarter of 2017 and first-quarter 2018, respectively.
The company ended the second quarter of 2018 with a cash balance of $1.1 billion and has roughly $160 million remaining under the current share repurchase authorization. It remains aggressively focused on tapping into lucrative growth opportunities and delivering meaningful returns to its shareholders.
Is Further Upside Left?
Delek seems to be one of the better-positioned companies at the moment as it is expected to continue benefiting from wider Permian Basin crude differentials, since the pipeline crisis is not expected to ebb anytime soon. Also, with no major turnaround activity expected for the remainder of 2018, the refining segment is likely to be the needle-mover of the company. Moreover, it has raised its synergy targets from Alon acquisition, further boosting investors’ confidence. The company has a VGM Score of A and its 2018 earnings are expected to grow 293.7% year over year.
Wrapping up
We believe that Permian is the biggest driver of Delek’s growth across all segments. Especially, widening Permian differentials will continue to be a major tailwind for the company. However, the Zacks Rank #3 (Hold) company has a huge debt of around $1.8 billion (representing a debt-to-capital ratio of more than 51%), which may decrease its financial flexibility to some extent. However, we believe that Delek will be able to overcome this headwind on the back of its strong diversified operations and strategic initiatives.
Key Picks
Investors interested in the energy space might consider some better-ranked stocks like Tc Pipelines, LP TCP and Petrobras PBR, each flaunting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
TC Pipelines’ 2018 earnings are expected to grow 18.67% year over year.
Petrobras delivered an average positive earnings surprise of 10.37% in the trailing four quarters.
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