Vertex Energy: Transition To Traditional Refiner Hasn't Been Smooth

With Vertex Energy (NASDAQ:VTNR) dealing with some hiccups with its renewable diesel project and crack spreads narrowing for its conventional refining business, it might be best to wait on the sidelines with the stock for now.

Company Profile

VTNR operates in two segments. Within its Refining and Marketing segment, the company operates the Mobile Refinery in Alabama, where it processes crude oil and turns it into refined products such as gasoline, jet fuel, and diesel. The company acquired the refinery in April of 2022. It also has related logistic asses, such as storage and a bulk loading terminal. The refinery processes both heavy and sour crude.

VTRN's Black Oil and Recovery segment, meanwhile, is involved in the recycling and re-refining of used motor oil and other petroleum by-products. The company buys used oil from places such as oil change stations and auto repair shops and then sells to customers as a feedstock or replacement fuel for industrial burners. The company has facilities that can re-refine oil into marine cutterstock, although at times it has been economically unviable. During this time, it uses these facilities to pre-treat its used motor oil feedstock before shipping it to its Marrero plant that produces vacuum gas oil (VGO).

Opportunities & Risks

VTNR is going through the process of transforming itself from a re-refining company to a refinery company. In May 2021, the company agreed to purchase the Mobile refinery in Alabama from Royal Dutch Shell (RDS.A) for $75 million. At the time, the company said upon the conversion of the refinery's hydrocracking unit to produce renewable diesel that the refinery could produce $3 billion in revenue and $400 million in gross profits in 2023.

This project was expected cost an additional $85 million to complete. The project was neither on time nor on budget, with renewable diesel production starting in Q2 of this year and the project costing over $110 million.

Shortly after the refinery acquisition, in June of 2021, the company agreed to sell its 69 million gallon a year used oil refining Marrero facility in Louisiana and its 20 million gallon a year Heartland facility in Ohio to Clean Harbors (CLH) for $140 million. The facilities were projected to generate more than $100 million in revenue and at least $15 million in EBITDA. That valued the sale at just over 9x EBITDA.

However, the deal was scrapped in January of 2022 following a review by the U.S. Federal Trade Commission. VTRN then turned around and sold its Heartland facility to GFL Environmental (GFL) for $92 million in cash in February of this year. Given that his was the much smaller facility of the two that VTRN was originally selling for $140 million less than two years earlier, this looks like a really good price.

The company continues to own the Marrero facility and some other legacy assets. We'll see if the company eventually looks to dispose of it or other assets. I wouldn't necessarily extrapolate the value of Heartland into Marrero, but there does appear to be some nice value there. So there is an opportunity the company could lower debt with some additional asset sales.

As of now, though, the company's big bet is on renewable diesel with its project now complete and starting to produce the renewable fuel. However, the company has backed off of earlier predictions, and the economics are still up in the air at this point, as the company ran into some economics on the initial feedstock it planned to use. However, the plant was built to support 8 different feedstocks, so it is currently looking to shift feedstocks.

When asked if the company still planned to produce 8,000 barrels of renewable diesel a day, CCO Douglas Haugh answered the question on its Q2 earnings call, saying:

"No. To be clear, we're going to vary the production rate based on a couple of factors, the biggest of which is margin opportunity. So if there's very, very attractive margins, we will max rates within safe limits, of course. And then we're finding the optimum rate on each blend and each mix that we feed to the unit, which is going to take some trial and error. We need to ramp the unit up and down to do that against each blend that we want to optimize with. So that's why we're -- and I appreciate the earlier question as well, but that's why we're not providing the same throughput guidance yet on the RD [unit] that we have for the conventional. So we hope to do that in the future. We hope everybody understands that we're past commissioning and we run at design rates. We know that unit can do it. Now it's what's the operating envelope that's available to us to optimize with. I think there's certainly some opportunity for fourth quarter [to provide guidance], but I would feel much more comfortable with next year I think heading in. We've fully got the system run in. We've got the optimization plan done. We know what our conversion rates are at each of those blends. And then we can get much firmer guidance, and we'll have a little bit more forward look on the feeds at that point because we'll know what our recipes are going to be with more certainty going forward. So we'll actually be buying those feeds on a forward basis much more consistently, so that will give us our run rate forecast a lot more stable than what we have right now."

At this point, there should be a lot of potential with renewable diesel, especially with government credits. The company also has a product supply agreement with a California-based subsidiary of Idemitsu Kosan. However, given its commentary, things are not going to be quite as smooth as it originally expected.

Outside of renewable diesel, crack spreads and dynamics for VGO will also play a big role in the company's results both on the potential upside and downside. Traditional crack spreads were extremely wide last year, and not surprisingly, have come down this year. They were still well above historical norms in the first half of the year, but have come down significantly recently.

This is a big risk for the business at this point, as crack spreads are the biggest driver of a refining business. In fact, VTNR had to lower its guidance ahead of its Q2 report as a result of lower crack spreads and a weak capture rate, as a result of volatile fuel prices.

The company also carries a fair amount of debt, with net leverage of 3.6x at the end of Q2. For such a cyclical business coming off peak crack spreads last year, this is something to be aware of in the future, especially since the company's operating cash flow through the first six months of this year was -$111.4 million. Now that its renewable diesel unit is running, this should begin to improve. The sale of the Marrero used oil refinery could potentially lower debt as well.

Valuation

VTNR trades at a 17.3x EV/EBITDA multiple based on the 2023 EBITDA consensus of $48.6 million. Based off of the 2024 EBITDA consensus of $149.9 million, it trades at around 5.6x.

The company is not projected to post positive EPS until 2025.

It's projected to see revenue grow 6% in 2023 and 15.5% in 2024.

VTNR's stock generally trades at a premium to other refiners and environmental clean-up companies as well. Much of this is due to an expected large contribution from its renewable diesel operations down the road.

Conclusion

While VTNR put out a nice blue sky story with its acquisition of the Mobile refinery and subsequent renewable diesel upgrade capacity, it's been a bit stormy for the stock. With crack spreads down in its conventional business and with the company running into some issues with its initial planned feedstock for the plant not currently being at an acceptable conversion rate, the road ahead remains cloudy.

The company has found some lower cost feedstock blends to run through its plant and it was built to be able to use 8 different types, but let's see how the plant running on these feedstocks in action first, as the company hasn't had a smooth ride so far with the plant.

In addition, the company has a fair amount of leverage, sitting at 3.6x, and the company is currently burning cash. With conventional crack spreads falling, its leverage can quickly rise if its renewable diesel unit does not live up to expectations.

As such, I think there are too many question marks around the stock to invest at this time. I'd keep monitoring the name to see how things progress for the company.