This week, we focus on a manufacturer of specialty hydrocarbon products who has shown outstanding growth this year, and is primed for additional growth. Calumet Specialty Product Partners has increased its profit margins considerably due to the recent declines in oil prices. Its Specialty Products division recently posted a 35% margin increase year-over-year. In Q2 2015, the company posted an astounding 141% year-over-year increase in adjusted EBITDA. Additionally, the company has three expansion projects currently underway which, when completed, will add between $98 million and $122 million in annual adjusted EBITDA. In Q2 2015, the company repaid its 2020 notes early, a total of $275 million, which speaks volumes to prospective bondholders. And in 2014, Calumet Specialty Products made the Fortune 500 for the first time. Therefore we think these seven-year bonds from Calumet, at the indicated price of about 98 and a yield to maturity over 8%, will make an excellent addition to our FX1 and FX2 portfolios.
About the Issuer
Calumet Specialty Products Partners LP engages in the production of specialty hydrocarbon products in North America. It operates through three business segments: Specialty, Fuel Products and Oilfield Services. The Specialty Products segment processes crude oil and other feedstocks into a wide variety of customized lubricating oils, solvents and waxes. The Fuel Products segment processes crude oil into a variety of fuel and fuel-related products, including unleaded gasoline, diesel and jet fuel. The company’s specialty products are sold to domestic and international customers primarily as raw material components for basic industrial, consumer and automotive goods. The Oilfield Services segment manufactures and markets products and provides oilfield services including drilling fluids, completion fluids, production chemicals and solids control services to the oil and gas exploration industry throughout the U.S. Calumet is based in Indianapolis, Indiana and has fourteen manufacturing facilities located in northwest Louisiana, northwest Wisconsin, northern Montana, western Pennsylvania, Texas, New Jersey, Oklahoma, eastern Missouri and North Dakota.
Oil refiners and chemical manufacturers are like a natural hedge to oil prices. As oil prices go down, their cost of goods sold declines and can help to boost margins. This has certainly been the case with Calumet. In their most recently reported quarterly results (ended 6/30/2015), the company’s cost of sales dropped significantly when compared to 2014. In fact, for the six months ended 6/30/2015, cost of sales decreased 30% from the same period a year earlier.
Increased margins can also be seen within two of the company’s divisions. For Q2 2015, the company had significant margin expansion within their specialty products segment – gross profit per barrel increased to $44.22 per barrel versus $32.67 per barrel in Q2 2014, an increase of 35%. In addition, Q2 profit margins for fuel products also increased year-over-year, from ($0.45) per barrel in Q2 2014 to $10.40 per barrel in Q2 2015.
History of Increasing Distributions
As a MLP (Master Limited Partnership), Calumet Specialty Products makes regular distributions to its shareholders. And Calumet has a robust distribution history and has regularly increased its distributions in the past. In 2011, the company paid shareholders $0.475 per unit. The current distribution of $0.685 per unit has held steady the past eight quarters. This breaks down to an increase of 44.2% or a 9.6% increase over the last four years. For bondholders, these distributions should inspire additional confidence in the company’s ability to meet interest payments on its outstanding notes as the distributions represent available cash to meet debt obligations.
Organic Growth Projects
In an effort to expand its operations and increase company revenues, Calumet initiated three organic growth projects. In Montana, Calumet is engaged in a project to increase production capacity at its Great Falls refinery from 10,000 bpd (barrels per day) to 25,000 bpd. This project will allow the company to capitalize on access to local, cost-advantaged crude oil while producing additional fuels and refined products for delivery into the regional market. This project is on schedule to be completed in Q1 2016 and the company estimates the total annual EBITDA contribution from this project to be between $70.0 million and $90.0 million.
Calumet is also making progress on a project that will convert a portion of its existing San Antonio refinery into production of 3,000 bpd of higher margin solvents to meet specific customer requirements. The San Antonio conversion will be completed in Q4 2015 and Calumet estimates an annual EBITDA contribution from this project to be approximately $20.0 million.
Finally, Calumet is progressing on a project that will more than double the production capacity of its Missouri esters plant from 35 million to 75 million pounds per year. This project is slated for completion in Q3 of this year and is estimated to add an additional $8.0 million ot $12.0 million in annual EBITDA. With the combination of these three growth initiatives, Calumet anticipates outstanding growth in its annual EBITDA between $98.0 million and $122.0 million.
Calumet has had a fantastic year, registering handsome year-over-year gains in both Q1 and Q2. In the first quarter of 2015, the company reported a 51% year-over-year increase in its adjusted EBITDA, pulling in $124.9 million in Q1 2015 versus $82.7 million in the same time period in the previous year. The second quarter of 2015 did not disappoint either. Calumet repeated its impressive performance, with adjusted EBITDA of $95.0 million versus $39.3 million in Q2 2014, a stunning increase of 141% year-over-year.
The increase in EBITDA has also improved the company’s ratio of debt to EBITDA, registering 4.3x in its last reported quarter (Q2 2015) versus 7.4x a year ago.
Calumet has healthy interest coverage and liquidity levels. For the six months ended June 30, 2015, the company had operating income of $152.4 million and interest expense of $54.4 million for an interest coverage ratio of 2.8x. Regarding liquidity, Calumet had a total of $423 million comprised of cash and a revolving credit line.
The default risk is Calumet’s ability to perform. The company has had a banner year so far, with increasing margins and impressive year-over-year increases in adjusted EBITDA. The organic growth projects currently underway are slated to add significant annual adjusted EBITDA, and the company has established a healthy record of distribution payments to its shareholders. In light of these factors, it appears the competitive 8.4% yield on these nearly seven year bonds outweighs the risks that have been identified.
A significant part of Calumet’s increased margins has been the recent low price of oil, which the company uses to make many of its specialty products. When oil prices begin rising again, Calumet’s margins will certainly be affected. However, the company also makes fuel products (diesel fuel, high performance fuel). For the six months ended 6/30/2015, fuel products accounted for 40% of the company’s gross profits. If fuel prices rise, specialty products profits may decline slightly, but the difference will be reflected in the increase profits for the company’s fuel products.
Summary and Conclusion
As a producer of specialty hydrocarbon products used in industries ranging from personal care product to automobile lubricants, Calumet Specialty Products has risen above its competitors due to its diversified product mix. The company has had excellent revenue and EBITDA growth this year and with the new organic growth projects coming online within the next six to nine months, the company is primed for its next level of growth. The healthy distribution rate currently paid to shareholders provides a cash cushion for bondholders. These competitive yielding 8%, medium-term bonds are an excellent choice for the savvy income investor looking to diversify with a quality chemical manufacturer. Consequently, we have marked these outstanding bonds for addition to both our Fixed-Income1.com and Fixed-Income2.com managed income portfolios.
Issuer:Calumet Specialty Products Partners
Yield to Maturity: ~8.059%
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Disclosure: Durig Capital and certain clients may have positions in Calumet 2022 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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