LSR

My MFI investing world is littered with stocks that have imploded. One of note is WNR, which clearly does not stand for "winner". I bought them last August when the long painful slide started around $52. Today they closed under $12. They are no longer on the MFI lists, but I thought it'd be interesting (in a hypothetical way) to see what happened.

I first noticed WNR (Western Refining) in October of 2006 when it was trading under $19 a share and had a lot of insider buying. The stock was in many of my tracking portfolios and virtually tripled by the summer of 2007 to over $60. It was still on the lists when it dropped in August around $50, so I bought it... sigh.

I don't know exactly where they went wrong, but I suspect it was the purchase of Giant Industries (GI). This was another refiner, and WNR bought them when refining was a bit out-of-favor, so I was thinking it might have been a cheap price.

Of course, with the purchase came debt, a four letter word in today's world if there ever was one. About $1.5b in round numbers. Right now, that debt is costing WNR about $100m a year in interest. That seems pretty "cheap", I haven't done any research to see if that was a "teaser" rate.

The problem is that so far they haven't had a whole heck of a lot to show for that debt. Their run rate of revenues pre-merger was around $4b a year. Now it has more than doubled, to say $9b. But the margins have been squeezed. In 2006 they were making about 7 or 8 cents for every dollar of revenues. In the 3rd quarter of 2007 it had dropped to a mere 4 cents and then in the 4th quarter it was under a penny! Think about that, $2.4b of revenues and they made $17m in operating income before depreciation. It doesn't take a rocket scientist to figure out that $17m isn't even going to cover the $25m of quarterly interest expense.

Now I have to believe this is a temporary problem. Other refiners don't have such a tight margin. HOC made over a nickel per $1 of revenues in the 4th quarter, FTO made over 9 cents (wow!) and TSO made just a penny... so it is clearly a function of what kind of oil you're refining and your location.

It is important to note there is seasonality in refining margins, the two upcoming quarters are typically the best. I don't think WNR is not going to be able to service their debt over the year. But it was telling today when HOC and FTO were up over 4% each today for me and WNR was down 1.6%.

Let us look at what they said last quarter:

“We have taken a number of actions to improve the Yorktown and Gallup refineries so that the safety and reliability at those facilities are more consistent with our El Paso refinery. We have also implemented numerous operational changes at the former Giant refineries that will lead to improved performance.”

Actions taken to improve performance at these facilities include:

• Improved Coker operations at Yorktown to 21,000 barrels per day, an increase of about 17% over historical operations. Improving the utilization of the coker will allow for additional processing of heavier crudes;
• Renegotiated and/or terminated higher-cost feedstock agreements. For example, in early 2007, Giant entered into a fixed price ethanol supply agreement for all three of its refineries. This contract was recently terminated and we estimate, based upon ethanol spot market prices in the fourth quarter, that we will reduce ethanol costs by approximately $7.0 million per year at these facilities;
• Hired new refinery managers for both Yorktown and Gallup; and
• Transferred maintenance and engineering personnel to Yorktown and Gallup from the El Paso facility.

Reading between the lines, it seems that things were not going smoothly at Gallup & Yorktown. What to expect for the 1st quarter? I think things will be better, but not stellar. The refining Margin website I track showed mid-co, gulf coast refining margins up 20 to 30% in the 1st quarter. If we assume that WNR can get to 2 cents per dollar that would at least allow WNR to service the debt. I think the other wild card is S&P. They have placed WNR on negative credit watch. I don't know what the covenants of their loan are, but in some loans the creditors can make things unpleasant for you if your rating drops below a certain point. And I don't think I need to tell anyone that this is not the best credit market to be out with hat in hand. I wonder if they have anything that can be sold?

If they can ride out the poor quarters, the 2nd quarter looks much more promising as margins are up at least 50%. Stay tuned.

Addendum: I did skim their 10K. A downgrade by S&P could really hurt. They have a revolving credit facility to buy the oil which they in turn refine. A downgrade could cause that to be more expensive. And they also have covenants on their 1.5b loan. Not meeting certain financial ratios could cause the maturity of the loan to be shortened. I don't think that would be very positive (understatement)