Oil refiner HollyFrontier (HFC) reported a mixed bag of Q4 earnings on Feb. 20. This was par for the course for the refining industry, which generally saw little change in revenues and big earnings declines over the prior year.
Like many of its peers, Holly posted a very small improvement in revenue from the year-ago quarter, but its earnings absolutely crumbled on a year-over-year basis. However, when compared to what Wall Street was expecting, the company actually beat on earnings and missed on revenue. Ultimately, though, whatever impact this had on Holly's share price was dwarfed by the broader market correction that began just a day later. By the time the dust settled, Holly's stock lost 25% in February.
Here's what investors need to know.
Like many industry peers, HollyFrontier's refining margins shrank in Q4 2019, leading to underperformance. Image source: Getty Images.
By the numbers
| Metric | Q4 2019 | Q3 2019 | Q4 2018 | Change (YOY) |
|---|---|---|---|---|
| Revenue | $4.38 billion | $4.42 billion | $4.34 billion | 0.9% |
| Net income | $81.1 million | $298.0 million | $163.3 million | (50.3%) |
| Adjusted net income | $78.0 million | $278.0 million | $393.9 million | (80.2%) |
| Earnings per share (EPS), diluted | $0.37 | $1.58 | $0.81 | (54.3%) |
| Adjusted EPS, diluted | $0.48 | $1.68 | $2.25 | (78.7%) |
Data source: HollyFrontier. YOY = year over year.
HollyFrontier makes money in three different ways: refining crude oil, selling petroleum-based lubricants and specialty products, and from its stake in midstream master limited partnership (MLP) Holly Energy Partners (HEP). As measured by revenue, refining is by far the largest segment of the company. However, because the company's refining margins shrank so much in 2019, the segment had much less of an impact on the bottom line in Q4 than its outsize revenue would suggest:
Data source: HollyFrontier. Excludes intersegment revenue, as well as corporate, eliminations, and other. Chart by author.
As you can see, the vast majority of Holly's Q4 revenue (more than 85%) came from refining (green); that's pretty standard for the company. However, in Q4, that revenue translated to less than half of the company's operating income. That is unusual: In past quarters, the percentage of operating income coming from refining has been very close to the percentage of revenue.
But in Q4, refining income tumbled, leaving Holly's stake in MLP Holly Energy Partners (yellow) to pick up the slack, accounting for less than 3% of revenue but 42.6% of operating income. On the one hand, it's good that the company has a reliable non-refining income stream that can contribute to the bottom line when times are tough. On the other hand, it shows how dependent the company is on its refining operations for outperformance.
Highlights from the quarter
It was a fairly quiet quarter for HollyFrontier, except for mid-November, when two big pieces of news came out.
The first was the Nov. 15 announcement of a new CEO taking the helm — or rather, an old CEO. Michael Jennings, who previously served as CEO of Frontier from 2009 until its 2011 merger with Holly, and then as CEO of the merged corporation until January 2016, was taking over again from the retiring George Damiris, who had been CEO for the last four years. The official handoff took place Jan. 1.
The only other major piece of news from the company came three days later, when Holly announced it was launching a new 125-million-gallon-per-year renewable diesel project at its Navajo Refinery, expected to be commissioned in Q1 2022. Management estimates a 30% internal rate of return on the project, which will also reduce the amount of renewable fuel the company has to purchase to comply with renewable fuel standards.
Otherwise, the company performed heavy maintenance across its refining system during the quarter, which contributed to lower refining margins. In addition, it's still digesting the February 2019 acquisition of Sonneborn, a manufacturer of specialty petroleum products like white oils, petrolatums and waxes.
What management had to say
In Jennings' first earnings release since retaking the helm at HollyFrontier on Jan. 1, he blamed refinery maintenance for the disappointing fourth-quarter results, then pivoted to optimism about the future, saying, "Looking forward to 2020, we are optimistic that demand for gasoline and diesel will strengthen into the summer driving season, margins for finished lubricants will remain strong and the base oil market will improve as existing capacity absorbs growing demand for premium base oils."
On the earnings call, Jennings noted that his prior tenure as CEO predated the company's underperforming investments in the finished lubricants business. He still seemed to support the move: "These are good businesses and, together with our Group I lubricants business in Tulsa, provide a growing platform for participation in a more differentiated specialties market. The decline in base oils margin over the past couple of years has provided a headwind for this segment, but our product offerings are strong, and I anticipate growth in earnings and value."
Of course, nobody knows exactly where prices for oil and refined products are going to go. So far in 2020, crude oil prices have declined. The coronavirus has thrown the global economy for a loop, and it's impossible to predict what might happen next.
What's next for HollyFrontier?
On the earnings call, Jennings didn't get into many specifics, either:
I expect to execute a corporate strategy that emphasizes continuing operational improvement within our manufacturing operations; capital discipline and return of capital to shareholders; investment in our renewables business to create scale and advantage within feedstock selection and processing; continued growth of our midstream business, particularly in applications where we're able to integrate midstream services presently provided by third-parties.
However, he did make this noteworthy comment as well: "I believe we have attractive organic opportunities to generate growth at HollyFrontier. But these will compete with our goal of providing strong cash returns to shareholders as we consider capital allocation."
HollyFrontier returned $758 million to shareholders in 2019, of which only $225 million was the company's regular dividend. The other $533 million was all share buybacks. Jennings seems to be suggesting that the pace of these buybacks may slow down (although with shares now down 36% so far in 2020, investing in buybacks may be too much of a value proposition to pass up).
By referencing "capital discipline," Jennings may be signaling to investors that he's more interested in long-term stability than short-term stock price moves. That's good for the company and will probably ultimately benefit shareholders. However, with energy markets volatile and prices down, it may be a rocky ride in the short term.
