Marathon Petroleum Corp (MPC) — Q2 2018 Earnings Call Transcript

Welcome to Marathon Petroleum's second quarter 2018 earnings webcast and conference call. The synchronized slides that accompany this call can be found on our website at marathonpetroleum.com under the Investor Center tab. On the call today are Gary Heminger, Chairman and CEO; Tim Griffith, MPC's Senior Vice President and CFO; Don Templin, President of MPC; Mike Hennigan, President of MPLX; as well as other members of MPC's executive team. We invite you to read the Safe Harbor statements on slide 2. It's a reminder that we will be making forward-looking statements during the call and during the question-and-answer session. Actual results may differ materially from what we expect today. Factors that could cause actual results to differ are included there as well as in our filings with the SEC. Slide 3 contains additional information related to the proposed transaction with Andeavor. Investors and securityholders are encouraged to read the joint proxy statement and registration statement, as well as other relevant documents filed with the SEC. Now, I will turn the call over to Gary Heminger for opening remarks on slide 4.

Thanks, Kristina, and good morning to everyone. Thank you for joining our call. Earlier today, we reported an outstanding second quarter. Our income from operations was $1.7 billion, and we are pleased to report EBITDA of $2.24 billion, which is the highest quarter since MPC became a public company in 2011. The commodity environment and markets in which we operate were volatile this quarter, but our diversified integrated business model created opportunities, and our team executed in capturing those opportunities, which drove these extraordinary results. We often talk about our commitment to creating sustainable long-term value for our shareholders, and this quarter was no different. We maintained our focus on operational excellence as well as our disciplined capital strategy, which enabled the return of capital beyond the needs of our business. This quarter, we returned $1.1 billion to our shareholders, including $885 million of share repurchases. As we look to the second half of 2018, we remain very optimistic about the prospects for our business. Global demand remains strong, and inventory levels are moderate, despite recently high refining utilization levels across the U.S. Additionally, crude differentials appear sustainably wider in many of our markets. In particular, as we look at our optionality in crude slate, we see opportunities to maximize usage of WTI-linked crude. The WCS market continues to face logistical constraints relative to production growth, which we believe should support attractive differentials for our system to capture. We continue to optimize our exports at Galveston Bay and Garyville with the objective of maximizing profitability, and we are well-positioned to benefit from the adoption of slightly softer international bunker fuel regulations in 2020, given the rigid upgrading investments we have made in our business over the last decade. At the same time, we continue to be very enthusiastic about the combination of Marathon Petroleum and Andeavor into a premier, nationwide integrated downstream energy company. There are tremendous benefits to combining these two powerful businesses, which will be well-positioned for long-term growth and shareholder value creation. This combination is expected to generate at least $1 billion of tangible annual gross run rate synergies within the first three years, which is anticipated to drive more than $5 billion of incremental cash generation over the first five years alone.

Thanks, Gary. Turning to slide 5, we reported second quarter earnings of $1.06 billion and income from operations of $1.71 billion. Refining & Marketing delivered strong results with second quarter segment earnings of $1.03 billion, an increase of nearly $463 million over second quarter 2017. We operated exceptionally well throughout the quarter, with record throughput volumes, and we were able to capture wider crude differentials across our system. Within the Midstream segment, which largely reflects the financial results of MPLX, we reported income from operations of $617 million and achieved record gathered, processed, and fractionated volumes, as well as record pipeline throughputs. Our Midstream operations continue to grow, given both their robust organic growth investments, as well as improved utilization of existing assets. While dialogues with investors seem to focus more on one basin versus another, we continue to be encouraged by the growth prospects across all of the regions in which we operate, and in particular, by the continued growth prospects in both the Northeast and the Permian. We encourage you to listen in on the MPLX call at 11:00 AM this morning to hear more about MPLX's performance and the opportunities across the business. On the retail side, Speedway reported income from operations of $159 million. In the second quarter, gasoline and distillate margins were adversely impacted by the overall rise in crude oil. Our focus continues to be optimizing total gasoline contributions between volume and margin as market conditions adjust.

Thanks, Don. Slide 6 provides earnings on both an absolute and per share basis. For the second quarter of 2018, we reported earnings of about $1.1 billion, or $2.27 per diluted share compared to the $0.93 we earned last year. The bridge on slide 7 shows the change in earnings by segment over the second quarter last year. The walk highlights the significant increase in Refining & Marketing as compared to the second quarter of 2017. The $463 million favorable variance was driven by positive Midwest and Gulf Coast crack spreads, as well as wider WCS- and WTI-based crude differentials. Speedway's second quarter results were lower than the second quarter last year by $79 million, primarily related to lower light product margins and higher expenses.

Good morning, everybody.

Good morning, Doug. How are you?

I'm doing fine. So, Gary, the S-4s this month provide financial outlooks for both Marathon and Andeavor calculated several different ways. And when you take the most conservative projections in the document and you add in likely merger costs and benefits, it appears that the combined company has an earnings outlook that's way above the consensus, even though you appear to be using margin projections that are both flat – or close to flat and well-below the forward curve during 2018 to 2021. So, my question is two-fold. First, is my premise correct on the combined earnings outlook in relation to the Street consensus or is there a more appropriate way to think about that information? And then second, can you confirm that the margin projections that are in the S-4 were utilized to reach those financial projections? In either way, was there a reason that they're conservative, at least in relation to the forward curve, given the fundamental and IMO 2020 outlook? So, two different questions about the S-4 information.

No. Doug, I think you're looking at it right. And recall, the S-4 is not for guidance, it's really for our business plan, budgeting purposes. And yes, those are the numbers that we used in determining the value of the two companies and for the fairness opinion. You know our company very well. We've always been very conservative in how we look at things into the future. And it does not necessarily mean that that is the value that we see, and with the IMO coming on and even with some upside potential in crack spreads. So this is not meant for guidance, this was meant to value the two companies.

Sure.

And I would say that based on our outlook – and the other thing, Doug, as you look right now at inventories across the globe, we believe that inventories are in very good shape across the entire globe. And I believe that that's going to lead to upside potential as we get into the third quarter here. And as we then embark on 2019, which we think is where we're really going to start to see the upswing in the IMO effect. So those are not for guidance, those were for valuation purposes. And of course in December, we're going to have a big Analyst Meeting, and we'll get more granular at that time.

Okay. But it sounds like you're as constructive as ever on the fundamental outlook in refining and the possible positive effects on IMO 2020. Is that a good way to think about it, Gary?

Absolutely, Doug.

Hi. Good morning, Gary and team.

How are you, Neil?

Doing great. So, Gary, just want to get the latest pulse check on the Andeavor transaction. You've been able to spend more time with the assets over the last couple months. What have you learned about the transaction relative to the $1 billion synergy guidance that you outlined? And does the weakness in California refining margins create any pause? Or does the fact that Midland differential, Salt Lake margins are doing well, and typically there's a lot of volatility in California. Does that not really affect the way you think about the intrinsic value of the assets that you're acquiring?

Well, I'll take the latter part of your question first. You're right. California, just like we've recognized here in the Midwest and the Gulf Coast in the second quarter, can be volatile. But when markets are volatile, if you operate well, have strong operational excellence programs, you can capture the optionality that's available in the marketplace, as we just highlighted in the numbers that Tim went over. So, no, it doesn't change our outlook at all. California is going to have, as they would say in England, swings and roundabouts. And it'll continue to have that, but we expect that. Of course, El Paso, Salt Lake, as you said, the Mid-Continent continues to be strong, and we would expect that to continue. But going back and looking at the integration and as Don reviewed, I would say we have the bit in our mouth and we're ready to go with this integration. We have the HSR approval, waiting to finalize the S-4 and – but I've not seen any negatives, I've only seen positives.

Thanks, Gary. And the follow-up is, I always appreciate your views on the macro. And there are two things we've been thinking about a lot lately. For the first is, gasoline, you cited that same-store sales were down 1.8%. And so I don't know if there was some noise in the numbers or that's some indication of price elasticity. But how you see inventories and the demand picture looking? And the other is, WCS, where the differentials have widened out again, recognizing that there's some turnaround activity in the Chicago area coming up. So just any thoughts on those two topics would be appreciated, and I'll leave it there.

Sure. When you look at the Speedway same-store predictor to total gasoline demand, that metric has worked very well in kind of a flat, kind of normal market. I am not alarmed at all by the down 1.8%, and that's for – that's month-to-date. In the second quarter, there was some volatility as well. But during that period of time, we've had mainly an up crude market. Recently, crude prices have been off a little bit. But in a very strong, as you say, the price-elastic market in a very accelerated crude market, you're going to deal with Speedway and where we sit trying to get that cost to the street and being one of the leaders in trying to get that cost to the street, it's going to cost you some volume. But when things simmer out, I look at where margins are on the street right now and we're really starting to be able to reap the benefits of the position we have in the retail space. So that doesn't bother me at all. Let me ask Mike to talk about – Mike Palmer to talk about the WCS market.

Yeah, Phil. The WCS outlook continues to be really good. And from a big picture standpoint, basically what's happened is that the Canadian producers have done a nice job of increasing production, but they've outrun the capacity of the pipelines and that's – as you know, that's a difficult thing to change. It's going to take some time before the pipelines come on. In the meantime, I think that they've been working with the rails to try and clear volumes, that's fairly expensive. So, as we look forward, we continue to believe that the outlook for heavy Canadian, which WCS is the proxy for, continues to look very good.

And Neil, let me – to your point, let me add a couple of other points. If you look at the U.S. stocks of both gasoline and diesel, gasoline is pretty much right on line with where we were last year, but after a little softer diesel as well as the entire distillate fuel stocks are at the bottom, if not below the five-year average, which I think bodes very, very well for the business going forward. And if you look at the turnarounds that are planned in the Mid-Continent, Mid-West here in Q2 – Q3, and then as we look at the Gulf Coast turnarounds possibly in Q4, I think inventories are going to remain for both gasoline and distillate, inventories are going to remain in check through the year, which bodes very well for the business. But as we look into 2019 and where we believe inventories will end up with the balance of this year, it should put us in a really good position moving into 2019 as well.

Hi. Good morning.

Hey, Phil.

First question is just – I guess this is kind of an occasion question. As you guys are working intensely on closing the Andeavor acquisition, Gary, would you say that this would preclude you from looking at any other opportunities that might be available? And I'm thinking perhaps on the Midstream side, not necessarily on the refining side, to the extent that there are opportunities in the Midstream market. Would you be looking closely at this?

Well, I would say, Phil, even though we have a very large transaction going, we don't take our eye off of the entire industry and the entire horizon of what's going on in the marketplace. So, yes, we continue to evaluate almost everything that is available and a lot of things that probably aren't available. So, we will look, I wouldn't say that that means that we're running to the finish line with anything at all.

Well, Phil, I think the approach is going to be consistent. We've been pretty disciplined around the notion that to the extent that we've got cash and capital that are beyond the needs of the business, our inclination is to sort of get that back to shareholders. The authorization numbers that you cite, I think might be a little bit stale. I think we're probably north of $5 billion of authorization from where we sit today, in fact maybe closer to $6 billion. So, again, that authorization was one that we pursued with the board around the time of the announcement just as frankly, because we know that once this business comes together, as Don referenced, and I think we continue to feel very good about the incremental cash generation from the combination is going to be substantial. And so, I think a big source of where that cash is going to go is likely going to be back to shareholders and likely in the form of share repurchase. So, I think our approach from here forward frankly is going to remain consistent.

Yes. Good morning, and congrats on the quarter, really well done on the refining side.

Thanks, Roger.

Just digging in here, I was wondering, Gary, if we could get a little more commentary, maybe dig just a little bit deeper on kind of the outlook here in the back half? I think Q2 is going to be good across the board. Outlook for Q3, margins are a little weaker, which isn't surprising. Last year's Q3 was great. As you look at the turnaround schedule for the industry, I'm guessing that's what gives you the confidence on the positive inventory outlook as we get towards year-end or is there something else you're seeing as well?

No. I just looked at where the inventory is situated today, knowing where the turnarounds are in the Mid-Con, Midwest in Q3. They'll start up in probably early-Q4 down to the Gulf Coast. But inventories are in check across the board, and I think – and you're right, last year, the latter part of Q3 was very, very strong due to the dislocations in the market based on the storms that hit the country. Let's hope and pray that we don't have those storms this year. But we are going to be up against some pretty strong numbers from last year. But nevertheless, inventories are in good shape, turnarounds are to be heavier in Mid-Con, Midwest than probably in the Gulf Coast. I think that bodes well especially when you look at, as I said earlier, on the global macro demand picture, I think that puts us in a very good position, puts the industry in a good position.

Yeah. Actually, on the OpEx side, there's really two components in there. One is the wage inflation that we're experiencing as a result of the low unemployment rates that we're seeing in the country now. And that's just putting competition for that labor at the store level for us, and we're having to move hourly rates up in order to attract that labor. And I think to your question, I think what we're focused on is we look at a number of technology investments that we're making both outside and inside our store to become more efficient, so we can reduce the labor costs or control the labor costs to the point where we're competitive in that regard.

Hey, guys. Good morning.

Hi, Paul.

Hey. Gary, on the integration, you guys already done quite a lot, but of course there's a limitation before you close how you can actually really fully cooperate. So, what's the extent that how much you can actually do? And also, have you been able to look at across your IT system, because I mean you'll need good information in order for you to good decision. So how big is the – or that how comparable or incomparable between the two companies? How much work do you need to do on those?

Paul, this is Don Templin. So I think the integration activities are moving along very well as I said in our comments. And one of the things that we're very focused on is delivering the synergies that we articulated when the combination was announced. We think that's a very important part of the value proposition. And you did rightly point out that there are some limitations on the information that we can look at and the Andeavor folks can look at, because we're still competitors. But one of the things that we're using is we're maximizing to the extent possible cleanroom and clean teams. So we actually are putting information into a data room, having clean teams look at that data, so that on day one – when we go to close day one, in five minutes we can go after synergies. So we feel very good about the progress that we've made.

Thanks, guys. My question is on your page 99, Amendment Number 2, S-4. You have synergy CapEx of $98 million in year-one, $226 million in year-two, and $240 million in year-three, dropping to $0 in year-four. So if you could give us some idea on which projects do you plan to undertake in year-one versus year-two and year-three? And why is the CapEx more backend loaded and not frontend loaded? So basically, why is year-three $240 million and year-one $98 million? Why not the other way around?

Yeah. So if you look at – this is Don again. If you look at our synergy capture, and we were targeting roughly $0.5 billion in year-one, and that escalates or grows into $1 billion run rate in year-three. So in year-one, if you looked at sort of the components of the synergies that we are anticipating to achieve, a number of them are around cost synergies and synergies around our sourcing and procurement activities. In the backend of the synergies are typically things related to refining and systems – optimizing our system and also optimizing kind of a ramped-in approach around our retail business. So those capital expenditures are very much tailored to the type of synergy that we're expecting to capture. Cost and optimization sort of in year-one, and enhancements to the asset base that we have as we go on into year-two and three.

Hey. Good morning, everyone. In your reported product yields for 2018 year-to-date, you show your refinery is producing a 16% allocation to feedstocks and special products. Could you remind us what goes into this bucket? Is it things like high-sulfur VGO or Vacuum Tower Bottoms? And in an IMO world, do you believe this part of your product slate will be advantaged or disadvantaged or perhaps no impact?

Yeah. This is Ray Brooks. Let me take a first stab at that. When you talk about our product slate that we produce, I think you're leading to how much rigid fuel oil do we make and is that going to be problematic in the post-IMO world. We make a little bit of a bunker fuel out of our Galveston Bay refinery. We're looking at ways from an infrastructure standpoint how we, in the next year-and-a-half, can minimize that. So, I don't see that being a huge impact from us. But when you talk about our product slate and I don't know exactly what you're looking at, we've got gasoline, distillate, but then LPG, aromatics, asphalt, coke and pitch products. So, that's a balance of what we're looking at.

Yeah. This is Mike Palmer. So, if you look at Q1 of 2018, we were at 265,000 barrels a day of total exports, and that was about 48% gasoline and 51% diesel, just a little bit of asphalt in that number, I think around 1%. And then, in quarter two, we were at 311,000 barrels a day, and that was about 29% gasoline, 67% diesel, and then about 4% other, which again is primarily asphalt I believe, so predominantly light products. The export market continues to be very good for us, and we continue to optimize our product slates. We did see with Mexico – Mexico, as you know, has brought back Salina Cruz, one of their refineries that was down last year. So, that has certainly had an impact on how much gasoline that they are importing. But across the board, I think in Latin America, things still look very good.

All right. Well, then operator, if we don't have any other questions in the queue, I'd like to thank everyone for their interest in Marathon Petroleum Corporation. Should you have any additional questions or would like clarifications on topics discussed this morning, we'll be available to take your calls. And with that, thank you for joining us this morning.