Seeking Alpha • Oct 11
Vertex Should Improve After Awful Q2, Given Valuation Support
Summary
There are a lot of reasons to be skeptical on Vertex after a dire Q2 showing.
However, these are basically commodity refining assets and I think a $16/share valuation is fair (range $5/share-$55/share).
There is some downside in the worst case with more management issues or very tight spreads, but equally it seems that the shares could broadly double without heroic assumptions.
RBOB spread futures and limited new supply suggest that U.S. refiners may enjoy comfortable margins for some time. The market doesn't seem to want to believe this, but the evidence is there.
Vertex (VTNR) is a hated company. Q2 results were an almost unmitigated disaster. The CEO has sold stock. The company ultimately gave up perhaps $90M of value with its hedging strategy. They reduced Q3 guidance last month. Short interest is running at over 30%. However, in valuation terms there may be an opportunity for those willing to bear various risks and management's credibility issues.
Q2 results were so bad, that Q3 results may offer some signs of encouragement and the company's renewable diesel plans could be a source of further upside in 2023. Importantly, crack spread futures do suggest that the company may be able to maintain an attractive profit stream into 2025 and beyond.
It's worth jumping to the valuation first as that underpins the investment case.
Valuation
Asset Value Notes
Value of Mobile refinery $1,243M 10 x $125M net income (normalized $10/barrel margin with $4/barrel of costs), 95% utilization, 20% tax rate
Super-normal refinery profits in Q3 and Q4 $65M estimate $33M in Q3 (inc. +$13M inventory gain) and $48M in Q4 (hedges roll off) (after tax)
Legacy Assets $140M Value of Safety-Kleen prospective purchase
Biodiesel Conversion $153M 14,000 bpd, $0.75/gallon, 95% utilization
Current net debt less offsetting inventory -$98M debt including inventory financing less $201M inventory and $98M cash
Remaining capex to complete biodiesel plant -$120M estimated cost
Assuming working capital spend to ramp up biodiesel plant -$50M rough estimate
Resulting equity value $1,549 sum of the above
Benefit for convertible debt conversion $1,594 +$45M net value of converts
Resulting valuation per share (inc. convertible dilution) $16.30 97.8M shares outstanding (inc. convertible dilution)
Range of Sensitivities on Mobile Refinery
Since the refinery matters so much, here are some sensitivities to the multiple and spreads (all values assumed convertibles are dilutive, which is punitive at prices below $15/share)
5x PE 10x PE 15x PE
$5 spread barrel ($4 costs) $4.65 $5.71
$6.77
$10 spread/barrel ($4 costs) $9.95 $16.31
$22.67
$20 spread/barrel ($4 costs) $20.55 $37.51 $54.47
Thus, downside is clearly possible if spreads do revert to long-term averages or worse. Still, the futures market and the trends in terms of lack of new capacity and the disrupted European energy market suggest profits may stay high for a few years. If not, where is the incremental capacity that would typically bring down prices?
Q2 Results Were Awful
To say Vertex Energy's Q2 results were a train wreck would be unfair to train wrecks. The company reassuringly guided to robust results after the transformational acquisition of Shell's (SHEL) refinery, then management (the CEO and a director) sold material amounts of stock, then results were well below guidance. Management lost money on hedges and spreads. All this against a less attractive version of the crack spread (2/1/1 vs. 3/2/1).
Crack Spreads Remain Favorable
The main asset on my valuation numbers above is the Shell refinery. Yes, the company has legacy assets and a conversion project, but the refinery is the main variable driving my valuation numbers.
It is therefore important that RBOB crack spread futures are trading in a $13-$27 range (per barrel) through to 2025, with the fluctuations mainly due to seasonality. Note that these spreads have limited correlated to Mobile's spreads (given diesel, jet fuel production etc.), but they give an indication of market direction.
