Good morning. My name is Mariama, and I will be your conference call operator today. Welcome to the HollyFrontier Corporation management update call. I would like to now turn the call over to Craig
Berry.
Berry, Director of Investor Relations. Thank you for joining us to discuss the transaction we announced this morning to acquire Sonneborn. A slide deck for the conference call can be found through the webcast link provided in the press release and also in the Investor Relations, Events and Presentations section of our website at hollyfrontier.com. Joining us today are George Demiris, President and CEO Rich Valava, Executive Vice President and CFO and Mark Plake, Global Executive of Lubricants and Specialty Products. Before Rich, George and Mark proceed with their remarks, please note the Safe Harbor disclosure statement in today's press release.
We will be making forward looking statements on today's call. There are many factors that could cause results to differ from expectations, including those noted in our SEC filings. Today's statements are not guarantees of future outcomes. Please also note that any comments made on today's call speak only as of today, November 1338, and may no longer be accurate at the time of any webcast replay or transcript rereading. And with that, I'll turn the call over to George.
Thank you, Craig. Good morning, everyone, and thank you for joining us. As Craig mentioned, you can follow the presentation through the webcast. It is also available on our website. We'll run through the highlights of the deck, and we'll take questions after the presentation.
Starting on Slide three, this morning, HollyFrontier announced it has entered into a definitive agreement to acquire Sonneborn US Holdings Inc. And its international affiliate for $655,000,000 or $583,000,000, net of working capital of approximately $72,000,000. HFC expects to fund the transaction entirely with cash on hand and anticipates it will be immediately accretive to both earnings and cash flow per share. We expect the transaction will generate approximately $85,000,000 in annual EBITDA, including approximately $20,000,000 in annual synergies, which we will discuss in more detail in a little bit. This represents a very attractive multiple of seven times EBITDA net of working capital and synergies.
The transaction is subject to regulatory approval and customary closing conditions, and we expect it to close in 2019. Moving to Slide four. Sonneborn is a global producer of high purity specialty products and one of the world's largest dedicated suppliers of white oils, petrol Adams, more commonly known as petroleum jelly, waxes, and sodium sulfonates. Sonneborn has manufacturing plants in Pennsylvania and The Netherlands with a combined processing capacity of roughly 5,300 barrels per day. Both locations have r and d facilities with experienced staff as well as blending and packaging capabilities to distribute premium quality specialty products through a global distribution network.
Turning to Slide five. This acquisition will further our downstream integration and significantly grow the Rack Forward part of our lubricants business. 100% of Sonneborn earnings are attributable to our Rack Forward segment. The acquisition of Sonneborn will significantly expand our specialty products portfolio. HFLSB currently supplies a portion of Sonneborn's base oil feedstock.
This prep provides opportunity for additional uplift from our Tulsa and Mississauga base oils, increases operational flexibility, and allows for feedstock optimization. Sonneborn strengthens our global footprint by increasing processing and blending capabilities in both North America and Europe and expanding our global sales organization and distribution footprint. I'll now turn the call over to Mark Plague to talk about Sonnevor's operations and products.
Thanks, George, and good morning, everybody. Moving to Slide six. Specialty hydrocarbons are highly purified and specialized derivatives from base oils. Sonneborn formulates and manufactures highly purified hydrocarbons such as petrolatum, white oils, waxes, sodium sulfonates and industrial specialties such as metalworking fluids. Sonneborn's operations offer a world scale and flexible formulation platform.
The hydro treating unit in Pennsylvania provides unparalleled flexibility to run a wide range of Group one and two base oils, which gives it a competitive advantage on feedstock. The sulfonation and purification units in The Netherlands have the ability to produce unique product formulations with a high degree of customization due to their feedstock flexibility and advanced processing technology. Their strong global distribution and sales team enables them to efficiently place a broad line of products around the world. Turning to Slide seven. HFLSP is an integrated business with two components, Rack Forward and Rack Back.
The Rack Back component is the process of converting refinery intermediates such as vacuum gas oils and hydrocracker bottoms into base oils. Rack Back earnings and cash flows are similar to refining because it captures the value between feedstock costs and the market prices of base oils. The Rack Forward component is the process of converting nonadatized base oils into an assortment of finished products. This segment captures the value between the base oil market prices and the sales of finished products. The distinction between the two components is whether we are producing base oil, which is rack back, or using base oil as our feedstock, Rack Forward.
As George mentioned, 100% of earnings are attributable to our Rack Forward segment. Now looking on Slide eight. Sonneborn products are tailor made solution for blue chip customers representing industries such as personal care, pharmaceutical, food, telecom and metalworking. White oils are used to lubricate, smooth, soften and retain moisture across a variety of uses in personal care, pharmaceutical and food applications. Petrolatum's provide lubricity and moisture retention with superior performance and longer shelf life than competing products.
Microcrystalline waxes and blends act as natural bases to harden, lubricate, carry pigments and protect against moisture and lipstick, cold creams, ointments and cheeses. Natural sodium sulfonates are used as detergents, emulsifiers and anticorrosion rust prevention agents. Sonneborn's industry leading research and development and formulation process has resulted in loyal customers with relationships that have lasted many decades. Turning to Slide nine. Sonneborn's diversified specialty product slate complements our existing portfolio while achieving our goal of shifting our product mix from base oils to finished products.
Sales of finished products receive higher margins and are much less volatile than base oils. Sonnemore adds significant scale to HFLSP by growing our Rack Forward portfolio. Now I will turn the call over to Rich.
Thank you, Mark. On Slide 10, you'll see that Sonneborn's business has shown tremendous stability with EBITDA margins averaging 18% since 2015. This provides an uplift to the healthy EBITDA margins of our existing Rack Forward business. We expect this addition of Sonneborn will consistently add between one hundred and five hundred basis points to HFLSP's pro form a EBITDA margins. On Slide 11, you'll see that we have identified $20,000,000 in potential synergies, consisting of $5,000,000 of SG and A, dollars 3,000,000 of logistics savings through transportation and blending cost reductions and $12,000,000 of production optimizing opportunities across Tulsa, Mississauga, Petrolia and Amsterdam.
We are also evaluating several low cost, high return projects that will provide incremental earnings. Example of such a project is a potential expansion of capacity in the sulfonation unit in The Netherlands. Turning to Slide 12. The consistency of Sonneborn's earnings will add stability to HollyFrontier. As you can see, with the exception of a production issue in 2016, Sonneborn has consistently generated 60,000,000 to $70,000,000 per year of EBITDA.
As discussed, we believe synergies over the next few years will drive this number north of $80,000,000 On Slide 13, you can see our ability to fund this transaction with cash on hand, which which is a testament to our strong balance sheet. As you can see, we have plenty of cash on the balance sheet to fund the transaction and maintain a healthy liquidity position and capital structure. We are confident that we will maintain our investment grade ratings from S and P, Moody's and Fitch. Looking ahead, we continue to expect to generate strong cash flow and will follow our capital allocation strategy of first, defending the balance sheet and assets second, paying a competitive regular dividend third, growing our business through both organic investments and acquisitions such as Sonneborn and fourth, returning excess cash to shareholders in the form of stock repurchase. In line with these priorities and our prior guidance of a target of $500,000,000 of minimum cash, we expect to hold $1,000,000,000 to $1,200,000,000 of cash on the balance sheet until closing.
Slide 14 illustrates why specialty product companies trade at higher multiples than refining companies. Some of you are familiar with this chart from our Analyst Day in 2017, which shows historical EBITDA margins and the range of those margins for the Lubricant comp group. HFLSP's Rack Forward business compares favorably to these peer companies in both absolute EBITDA margin and margin stability. With Sonneborn, our pro form a Rack Forward business has an average EBITDA margin of 11% to 16% over the trailing three years. Using twenty nineteen consensus earnings estimates, these comps are trading in a range of nine to 14x.
Take that to Slide 15. We believe that with its margins and stability, HFLSP's pro form a RAC4 business should carry an EBITDA multiple of 11x using an of that margin of 11% to 16%. It takes our pro form a lubricant business valuation to over $3,000,000,000 We expect to average through the cycle annual CapEx at HFLSP of 60,000,000 to $70,000,000 with DD and A of 60,000,000 to $70,000,000 and SG and A of $145,000,000 to $155,000,000 And with that, I'll turn the call back to George.
Thanks, Rich. We'll finish up on Slide 16. The map shows our consolidated asset footprint, including Sonneborn's processing and blending and packaging assets in Petrolia, Pennsylvania and Amsterdam, Netherlands. We're excited about this opportunity that exists to combine Sonneborn with our current lubricants business. This transaction demonstrates our continued commitment to the finished lubricants business and is expected to bring outstanding value to our shareholders and to the customers and employees of both companies.
And with that, Mariana, we're ready to open the floor to questions.
Your first question comes from Manav Gupta with Credit Suisse. Your line is open.
Hey, George. I know you guided to $88,000,000 in EBITDA, including $20,000,000 in synergy. I'm trying to understand the factors that could drive this to, let's say, dollars 120,000,000 in EBITDA and at the same time, the risks that could push this to $70,000,000 in EBITDA. Basically, if you could talk about some of the factors that we need to watch carefully to understand the sensitivity of EBITDA in this business.
Well, if you're talking about synergies Manav more than anything? I think
The total EBITDA of 88,000,000, I'm just trying to understand the upside and the downside and what could drive the could be the driving factors to that guidance.
Okay. So with the with the base EBITDA here, as Rich highlighted in his portion of discussion, the EBITDA is is very stable here. And I think that speaks to the nature of the end markets that we're talking about, personal care products, pharmaceuticals, food applications, things that are relatively stable and recession proof. So we think we think, again, the base EBITDA of this business is is very stable, very, very solid. So we don't we don't see much concern or or volatility there.
And then as far as the synergies that we're gonna layer in on top of that, that just speaks of to now having a four facility lubricants network versus the two that we have currently and the synergies that will result from that, as Rich highlighted, on the SG and A side, the logistics side, the opportunity to optimize between, again, four facilities versus two, make the right products in the right processing unit closest to the customer and or closest to the supplier.
Excellent, George. I just had one quick follow-up. The Rack Forward business has worked very well for you. You have delivered stable margins. And this acquisition is basically Rack Forward again.
So from here on, when we look at HFC, do we think when you're growing your PCLI business, even the going ahead acquisitions will mainly be focused on the Rack Forward? Or you are still open to doing some Rack Back acquisitions also?
Well, I think we're open to both segments, but our our higher priority is on the Rack Forward. I think we've been pretty consistent with our messaging here and our strategy in the lubricants business. Again, we like both segments, but we like the the rack forward better because, again, the the margins are higher and more stable over time.
Thank you so much, George, for taking my questions.
Thank you.
Your next question comes from Phil Grasch with JPMorgan. Your line is open.
Hey, good morning, and congratulations on the transaction. First question, I guess, maybe a bit following up on Manav's second question. How do you see the pipeline of opportunities today? Was this the one kind of bigger opportunity that you've been looking at? Or do you feel like you still have a pretty good pipeline of opportunities in the Loops business looking into 2019?
No. We're very pleased with the pipeline of opportunities we're seeing in this space. As we've said before, this business is highly fragmented. It's a lot of small private companies, a lot of private equity companies such as Sonneborn in the space. It's it's such a large global market that we see lots of opportunities across all these segments, finished lubricants, specialty products, waxes, white oils, greases, with diverse customer bases as well.
Again, customer segments like personal care, pharmaceuticals. So that's what we like about this space is a diversity of products and a diversity of end markets that, again, contribute to EBITDA margin profile we've talked about.
Okay. Second question, I guess, this one's for Rich. Rich, I think you made the comment that you want to maintain $1,000,000,000 to $1.2 of cash in the balance sheet roughly, I think, where you ended the third quarter. So I guess that we should interpret from that that you might pause on the buybacks until the deal closes, but then thereafter, seems like you still have a pretty good cash flow profile to perhaps, even after this acquisition, continue to maintain some amount of buybacks moving forward. Is that a reasonable way to think about things?
No. Actually, Phil, I think it's kind of the other way. So we've got the cash on the balance sheet now to fund the acquisition, continue to generate good cash flow across all three businesses, so we'd expect to be buying back stock.
Okay. So do you think you can continue at the 3Q run rate essentially moving forward?
Think we've been pretty clear about the run rate will be largely dictated by what the market gives us at the end of the day. So we'll buy back. Again, we'll target that $1,000,000,000 to $1.2 We do plan, obviously, to spend organic capital on our business as well. But beyond that, we'll go ahead and repurchasing stock.
Okay. Very helpful. Thank you.
Yes.
And your next question comes from Roger Read with Wells Fargo. Your line is open.
Hey, good morning.
Hi, Roger.
I guess, let me just ask about Sonneborn. You said the business is real stable here. How have they been in terms of introducing new products? In other words, are we looking at stability and no real change or that stability is built by the fact that they introduced new products and that's maybe not included in synergies, but something we should be focused on down the road?
I think this business has a proven track record of introducing new products, Roger. They work very well with their customers, understand their needs and to customize solutions to those needs through, again, their R and D capability.
And is that something new to the overall organization for you? Or if you compare it to your other Rack Forward businesses, it's very similar that way? I guess I'm just trying to understand maybe the upside value of the acquisition as opposed to just looking at it from a Rack Forward EBITDA only.
Yes. No, I think to your point, this is what Sonneborn's R and D capability brings is very similar to what the PCLI r and d capability brought to us when we acquired that in February of seventeen. So it's it's very similar, slightly different markets and products, but the capability, again, of working with your customer, having them share what their need specific needs are, and tailoring a customized solution through the variety of base oil feedstocks and and processing capabilities. And that's what we're really excited about is being able to bring, again, four facilities versus the two we have now. And we think those opportunities really open up geometrically as you add more facilities and more feedstock options.
Okay. Thanks. And then as we look at the synergies, I would imagine G and A is fairly quickly realized. The other two maybe take a little bit longer. Can you give us an idea maybe of what some of the optimization is?
And is this a twelve, twenty four, thirty six month goal on the synergy front?
Yes. Hey, Roger, it's Rich. So I think your impression is fair. The SG and A synergies will come quickest. I think the logistics synergies will probably take twelve to eighteen months to fully realize.
The optimization synergies will be longer, call it, twenty four months give or take. That, as George has mentioned, right, it's a lot of optimizing feeds and production across four facilities, making the right products at the right plant at the end of the day.
Okay, great. Thanks, Rich.
Your
next question comes from Blake Fernandez with Simmons Energy. Your line is open.
Hey, good morning, folks. Congrats on the deal. Rich, if I can just go back and clarify real quick on Phil's question. I realize you're going to get down to about $400,000,000 post the deal closing. The 1,000,000,000 to $1,200,000,000 of cash, are you saying you need to build back up to that level?
Or are you comfortable holding roughly $500,000,000 of cash on the books?
Yes. So we've said and we continue to believe that all things being equal, dollars 500,000,000 of cash on the balance sheet is the correct number. Given the transaction, effectively, we're saying is we'll add the purchase price to that $500,000,000 That gets you to $1000000000.1.2 dollars We're there right now. So we're funded as far as we're concerned. So again, excess cash over and above that, we'll return to shareholders from here on out.
Okay. So you're okay. In our previous travels, you talked about the fragmentation of this market, and I think you alluded to that. If I'm not mistaken, I think you were marketing products in Europe or internationally before, but this is your first real manufacturing in Europe. And so I'm kind of curious to see if a lot of the opportunities I always thought of it as like privately held businesses here in North America.
Are a lot of those opportunities in Europe as well? I'm just wondering if this is like a launching pad for a broader international kind of growth.
Yeah. I think think, Blake, when our focus is primarily North American, but this this business obviously has both the North American and European components. So I think this this is a logical extension of our of our production capability. But, again, it's not a not our primary focus to broaden into to Europe and Asia. Again, never say never.
When the right opportunities come along, we'll we'll pursue them, but it's not the major thrust of our of our growth initiative to look for international opportunities.
Okay. And if I could just clarify one thing. I know you hit the CapEx mid cycle, 60,000,000 to $70,000,000 Is it fair to assume that, that just lands into 2019 spending?
No. So Blake, that's mid cycle. Obviously, we've got a fairly chunky turnaround every four or five years at Mississauga, which we just had in 2018. So we'd expect a lower capital number in our lubricants business in 2019.
Your next question comes from Matthew Blair with Tudor Pickering Holt. Line is open.
Good morning everyone.
Good morning Matthew.
Rich, you mentioned that $500,000,000 is a good run rate on cash going forward. What about the debt side of the equation? As you add these specialty businesses that provide more stable EBITDA, would you be, I guess, interested in levering up?
No. I think where we're at right now is we feel comfortable with our debt profile today. We intend and expect to maintain our investment grade rating. To your point, as we add more stable businesses and cash flows, it gives us some more flexibility going forward. So we'll continue to reevaluate.
But right now, no intention to add additional debt.
Okay. And then I think it was Slide nine that showed approximately, let's call it, 53,000,000 in EBITDA for this business in 2016. In 2017, it jumped up to $70,000,000 Could you talk about the drivers behind that move? Was it more related to changes in feedstock, base oil pricing or more related to changes in, I guess, end market demand and pricing?
No. This is actually a pretty easy one, Matthew. In 2016, Sonneborn did have a production issue at their petroleum facility. They had a fire, and they were not able to produce for a period of time. So that drove the dip you saw in 2016.
So hence, we really view this as kind of the legacy of the last year as a 60,000,000 to $70,000,000 a year run rate EBITDA business.
Is there any turnaround, I guess, planned turnaround impacts in these numbers here?
Not really, Matthew. The way these are turnarounds are not these units don't really turn around the same way as you would think a refinery would. So the way we think about it is maintenance capital, this business should run 8,000,000 to $12,000,000 a year pretty ratably without much production volatility year to year.
Got it. Thank you very much.
Sure.
Your next question comes from Jason Gabelman with Cowen. Your line is open.
Yes. Hey, guys. I have a question about the product mix. So I believe white oils are kind of in the middle of the margin profile for specialty products. Are the other products that you list on Slide eight and specifically the PetroAladdin, are those kind of higher margin, lower margin or similar to white oil?
And just as a follow on to that, you list a handful of products that you can produce. Is there a challenge in managing the product mix to kind of realize the maximum potential margin on these products?
So I'll I'll take the first question. I I think the best way for you to think about these Sonneborn products is that they're the next step forward or downstream in the value chain for white oils and waxes. So the petrol atoms are are are products from white oils and other feedstocks. And similarly, the microcrystalline waxes that Mark mentioned, they're shown in the middle of that slide, the the microcrystalline waxes. Those are next logical step downstream from the wax products that we make from both Tulsa and Mississauga.
So, again, that's what we really like about this business. It shores up existing product lines and then, again, takes us the next step, the the next logical step downstream with these with these value chains.
Got it.
Again And then Sorry.
That's Sorry. Yeah. And then on the mnemonic mix part of the question?
Yeah. I think this this business, again, is similar to PCLI. It makes a a variety of of products, a lot of SKUs. There is a challenge to managing it, but these as with PCLI, Sonneborn has demonstrated the capability to be able to manage the diverse product portfolio and the diverse set of customers, and their ability to manage that manifest itself in the high stable margins that we see in these businesses. So, yes, it's challenging, but, again, it's very doable, and the end product is a great margin profile.
Got it. If I could just ask a follow on on the feedstock side. It looks like on Slide seven, you guys are kind of short base oil feedstock. I'm not sure if I'm reading that correctly, but does this increase your shortage in base oil to feed the specialty plants? And if so, how are you thinking about kind of the base oil feedstock market moving forward over the next few years?
Yeah. So we're still net long base oils even with this acquisition. So the purchases that are coming in are specialized purchases that we don't make either at Tulsa or at Mississauga, or if they are products that we make in Tulsa and Mississauga, that's one of the reasons why we made this acquisition is to forward integrate those base oils. The finished products is part of our strategy of forward integrating again. So, you know, I don't think this acquisition has a material impact on on our view of the base oil market.
It does allow us again, as we mentioned earlier, to pull through some of our Tulsa and Mississauga base oils through this business, and we'll we'll continue our strategy to, again, forward integrate.
Great. Thanks a lot.
Thanks, Thanks, Jason. Thanks, Jason.
Your next question comes from Doug Leggate with Bank of America. Your line is open.
Thanks. Good morning, everybody. Apologies. I'm sitting at an airport. Can you hear me okay?
Yes, sir.
Good stuff. Thanks. So guys, I wonder if you could help me with the tax, the after tax cash flow because, obviously, bringing an international business into the mix, what does the $65,000,000 of EBITDA translate to as a kind of average cash flow number after tax?
So Doug, the way I'd answer that question is it's going be a pretty low tax basis in this case. The tax rate is roughly similar, so we have no change in our overall tax rate guidance. So you think about $135,000,000 of EBITDA, pay 20%, 25% tax on that number. And then back out the we talked about maintenance capital 8,000,000 to $12,000,000 a year. That's going to get you 40,000,000 to $50,000,000 of
free cash flow a year.
Okay. So the implied cost of capital is 7%, something like that as an annuity?
It'd be are you trying to get to a
free cash flow deal? Or
Yeah. I'm I'm trying to think. So if it does about so $40,000,000 of free cash on your acquisition price, because if I assume this is like an annuity, I'm trying to back into an implied yeah, an implied earnings yield for this thing.
Yeah. So I think before any synergies, yes, you're talking 6% to 7%. Obviously, we expect to generate synergies and growth beyond that.
Good stuff. My follow-up, just very quickly, is on the range I think it's on Page 15, the range of multiples for the the peer group. What what what's behind the variability there? It's about seven times through 15 times. What what what do you see as the attributes of those different businesses that drive such a wide range of multiples?
And what do you think is the right I know you said 11 tenths of an average, but where in that range do you see the quality of this business sitting, the high end or the low end? And I'll leave it there. So
Doug, I think we'd say mid- to high end. I think if you look at this peer group, obviously, the low end of this range is driven by balance sheet issues, not by the business itself. So I think
you can kind of if
you think take the attitude of throw out the high and throw out the low. And then the high end of this range, that's a pretty closely held company at the end of the very excellent business, but it's got some technical issues that probably drive at least a portion of that multiple. So again, in our mind, you throw out the high end, you throw out the low end, that gets you that range of nine to 14x. We think our business is mid to high end of that range.
Great stuff. And sorry, guys, if I could squeeze one last one. And just on the debt of the acquisition, is that higher cost or lower cost than you guys? And would you intend to refinance that? And I'll leave it there.
So
we'll be getting the business debt free, cash free, Doug.
Okay. Great stuff. Thanks, guys. Appreciate it.
Yes. Thank you, sir.
Your next question comes from Paul Cheng with Barclays. Your line is open.
Hey, guys. Good morning. Good morning, Paul. I I joined a little bit late, so you may have already addressed it. Rich and George, anytime when you do a a reasonable sized acquisition, it's going to take some management time and integration and all that.
So from that standpoint, do you think at this moment, you have your hand full and you're not going to make a similar sized acquisition like that or that you think your management capability is still capable for you to take on this kind of acquisition within the next twelve months? Or do you think that it's going to be maybe every two or three years if opportunity come for this kind of acquisition? So I'm trying to understand that how you look at the time you take for you to feel comfortable that you can take on additional asset.
Yeah. Let me answer the question this way, Paul. I don't view management and integration constraining our ability or desire to do future acquisitions. And I think we have a a good management team now. I think we're acquiring some excellent talent with this acquisition.
And I think between what we have now and what we're what will be coming to us with Sonneborn, I think we can quickly and efficiently integrate that business. And I think our pace of future acquisitions will be dictated by what we see in the marketplace. If we see something that's attractive like Sonneborn or PCLI, I don't think we'll be afraid to pull the trigger and do another deal while we're integrating Sonneborn in the in the HFC family.
George, is is the Sonobor acquisition, do you intend to keep it as a stand alone business to one year, a case, or that is really going to be fully integrated and with the rest of your lubricant business? And do you have maintain different system or how long did those is going to take for you to to fully integrate?
Yeah. I think we're gonna fully integrate this this acquisition into our HFLSP business. I think it fits real well in in that portfolio, and I think it's it's it's it's well suited to bring into the fold again. I'll let Rich comment on any back office system issues that he might see.
No. I think we spoke about this a little earlier. We'd expect to realize some SG and A synergies pretty quickly, but we don't see any issues or hurdles with the integration.
There are no further questions at this time. I will now turn the call back over to the presenters.
Thank you all for joining the call
with us this morning. As always, if
you have any questions, please feel free to reach out to Investor Relations.
This concludes today's conference call. You may now disconnect.