Since my writeup on Delek in April of last year, shares have appreciated by 275% and are trading at a ~30% discount to my conservative estimate of fair value. While I expected the magnitude of appreciation, I certainly did not expect it to happen so quickly.
Why Is It Up?
Two developments contributed to the rapid share movement. First, crack spreads are up a good amount and Delek is making money again. Secondly, and more impactful, Delek was granted favorable rulings by the US Environmental Protection Agency (EPA) on Small Refinery Exemption’s (SREs). These SREs exempt small refiners from the Renewable Fuel Standard which requires refiners to blend renewable fuels into their outputs or to buy credits on the open market instead. Previously, Delek was deemed ineligible for any SREs. This changed in August when Delek’s outstanding 2019 - 2024 SRE petitions were approved by the EPA.
Further to the above factors, management has further delivered on there EOP cost savings plan bringing my 4x mid-cycle refining EBITDA value estimate up to $35/share. Including Delek’s stake in DKL gives us a pre-SRE value of $64.
Turning to the value of the SREs, Delek expects to collect $400M of SRE reversals in the near term. On a go forward basis, assuming 50% of Delek’s future SREs are granted translates to a $234M annual EBITDA uplift. That brings our mid-cycle value up to $50. Adding up the cash proceeds, EBITDA uplift, and DKL stake gets us to a new fair value of $85 compared to my initial $47 estimate. That puts shares at -47% discount to my fair value estimate as opposed to -75% at the time of my writeup. So why sell now?
Why Sell?
I like to underwrite a 3 - 5 year timeframe for shares to reflect fair value. Unlike higher quality businesses, I don’t expect Delek’s fair value to increase predictably over time which further brings down my expected forward IRR. Future SRE grants are also a big uncertainty and one that I’m not willing to try and underwrite, without these Delek trades at a 35% discount to my fair value. Lastly, I owned my entire position in a non-taxable account so capital gains were not a consideration.
Delek is still pretty good value here, however, I’m expecting higher forward IRR’s from other ideas like ODET/Bollore and Magnera.
Disclosure: This newsletter does not provide investment advice. Information presented is for informational purposes only and should not be considered a recommendation to buy or sell securities. The author may or may not own the securities discussed.