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Delek US Holdings (DK) Sees Growth Ahead Despite Challenges

Delek US Holdings, Inc. DK is a diversified downstream energy company with an impressive profile of strategically located assets. Its refineries have a combined crude throughput capacity of 302,000 barrels per day. The company also owns approximately 250 convenience stores in Texas and New Mexico locations as well as substantive logistics assets.

The 2017 purchase of Alon USA Energy transformed Delek into a Permian-focused diversified downstream energy company with an opportunity for cash synergies. With 70% of Delek’s refining capacity leveraged to favorable Permian pricing, the company is poised for significant bottom-line growth.

Of late, refiners (like Delek) have been supported by a marked improvement in refined products consumption — primarily gasoline and diesel — on the back of increasing vaccinations and mobility. The industry’s improved fundamentals in the form of constrained supply and robust demand have led to rising refining profitability for the players involved. As a reflection of this, Delek's 'Refining' segment’s contribution margin (refining margin minus operating expenses) rose sharply from just $14.1 million in the second quarter of 2021 to $618.3 million in the April-June period of 2022.

The company’s retail segment also seems to be a bright spot. Since 2016, the unit’s adjusted earnings per store have witnessed a CAGR of 18%. What's more, Delek plans to add another 50 stores by 2025 to double its segment earnings to $100 million. Investors should know that the company is one of the largest licensees of 7-Eleven convenience stores in the United States.

However, as a counter to these strengths, Delek is involved in a proxy battle with Carl Icahn's CVR Energy CVI, the owner of 15% of Delek’s outstanding common stock. CVR is pushing the Brentwood, TN-based firm to separate some of its assets to unlock more shareholder value. On the other hand, Delek sees CVR Energy as a competitor engaged in the business of petroleum refining and marketing that wants to further its own interests at the expense of Delek. We believe that a meaningful stock overhang is likely to remain unless the issue is resolved.

Further, Delek’s financial metrics indicate that its leverage sits toward the top end of the high territory and is a massive negative for its shareholders. The long-term debt burden of the company stood at $2.7 billion at the end of the second quarter of 2022, which translates into a debt-to capitalization of 67.8% — a significant deterioration from 53% at the end of 2019 (before the downturn) and well above the sub-industry’s 36.3%.

Finally, stock prices of oil refining companies are notoriously volatile. As such, shares of Delek may not be suitable for investors who are not comfortable with often substantial day-to-day volatility. In fact, Delek’s beta of 1.15 means that the company is more volatile than the overall market.

In conclusion, investors are advised to stay put i.e., not to add or sell the stock at current levels.

Stocks to Consider

Instead, investors could look at stocks like Marathon Petroleum MPC and Murphy USA MUSA from the Zacks Oil and Gas - Refining & Marketing industry.

Marathon Petroleum: MPC posted robust Q2 results on Aug 2, with earnings per share of $10.61, comfortably beating the Zacks Consensus Estimate of $9.17 and improving from a profit of merely 67 cents per share in the year-ago period. The company’s bottom line was favorably impacted by the stronger-than-expected performance of its Refining & Marketing segment, whose operating income totaled $7.1 billion, ahead of its Zacks Consensus Estimate by 108.4%. The company repurchased shares worth $4.1 billion during the May-July period and has now completed more than 80% of its target to buy back $15 billion in common stock.

Last year, Marathon Petroleum sold its Speedway business to the Japanese retail group Seven & i Holdings — owner of the 7-Eleven convenience store chain — for $21 billion. Apart from providing Marathon Petroleum with a much-needed cash infusion, the disposal of its Speedway-branded gas stations came with a supply agreement per which Marathon Petroleum will provide about 7.7 billion gallons of gasoline per year to 7-Eleven, thus ensuring a steady revenue stream.

Murphy USA: MUSA came up with strong Q2 results on Jul 3, with EPS of $7.53 handily beating the Zacks Consensus Estimate of $5.35 and the year-earlier bottom line of $4.79. The outperformance could be attributed to a rise in the retail gasoline price and a higher retail margin of 34.9 cents per gallon, which was up 23.8% year over year. Meanwhile, Murphy USA’s operating revenues of $6.8 billion surged 51.9% year over year and beat the consensus mark by $389 million, primarily due to improved petroleum product sales.

Murphy USA’s unique high-volume low-cost business model helps it retain high profitability even in the fiercely competitive retail environment. The company, which sells more than 4 billion gallons of retail fuel annually, owns more than 90% of its gasoline stations. This allows Murphy USA to keep its operating expenses low. The proximity of Murphy USA’s fuel stations to Walmart supercenters helps the company to leverage the strong and consistent traffic that these stores attract, thereby driving above-average fuel sales volume.

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