HF Sinclair Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

HF Sinclair is an independent energy company that produces and markets high-value light products such as gasoline, diesel fuel, jet fuel, renewable diesel, and other specialty products. Operating primarily in the US, the company’s diversified operations include refining, renewable fuels production, midstream, marketing, and specialty lubricants.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

HF Sinclair operates in a complex and cyclical industry, making it difficult to establish a wide moat. However, the company possesses some advantages that provide a narrow level of competitive protection. Therefore, the moat score will be 2/5, the competitive landscape is very tough.

Business Overview

HF Sinclair’s business can be broadly categorized into the following segments:

  • Refining: This segment involves crude oil refining and the production of gasoline, diesel, jet fuel, and other refined products. The company owns and operates refineries in Utah, Kansas, New Mexico, Oklahoma, Wyoming, and Washington. This segment represents the majority of HF Sinclair’s revenue.

  • Renewables: The Renewable fuels segment produces and sells renewable diesel, a type of fuel derived from renewable feedstocks such as soy, used cooking oil, and tallow. This business is mainly based out of Artesia, New Mexico and Cheyenne, Wyoming.

  • Marketing: The marketing business involves the sale of petroleum products, including gasoline and diesel, through branded retail outlets. HF Sinclair operates retail locations under the Sinclair brand and sells its products to independent marketers as well.

  • Lubricants and Specialties: This segment produces and markets finished lubricants, specialty products, and other industrial products, including solvents, waxes, and process oils.

HF Sinclair’s diverse operations span from raw material acquisition to finished product sales. This gives it a wide reach in the oil & gas value chain. However, this also means that they are more subject to different variables.

Industry Trends

The refining industry is impacted by several key trends:

  • Demand for Refined Products: The demand for gasoline, diesel, and jet fuel is closely tied to economic growth and has been significantly affected by the COVID-19 pandemic. The increasing demand for jet fuel post the COVID is improving the economics of refiners.
  • Crude Oil Prices: Refiners’ profitability is strongly influenced by crude oil prices, which are often volatile. The differential between crude oil and refined products is known as ‘crack spread’. The profitability of the refiners is dependent on the high crack spread.
  • Renewable Fuels Mandates: Government policies, including renewable fuel standards, drive demand for renewable fuels. The government continues to increase the renewable blending mandates which is a positive for companies in this business.
  • Environmental Regulations: Increasing environmental regulations and consumer push towards low-emission vehicles and alternate fuel options are a threat to traditional oil and gas companies.
  • Consolidation: The industry has seen some consolidation over the years. However, the oil and gas industry is still fragmented and highly cyclical.

HF Sinclair continues to emphasize their growth plan on increasing the renewable fuel capabilities. It does face some challenges in high labor costs and increase in costs of refining operations due to Russia’s invasion of Ukraine.

Competitive Landscape

The refining, marketing, and oil/gas industries are highly competitive. Key competitors include companies such as Valero Energy, Marathon Petroleum, Phillips 66, and other integrated energy companies. Competition occurs on a basis of price, quality, and reliability of supply. The oil and gas industry faces competition from alternate energy resources as well.

HF Sinclair competes mainly in commodity products where differentiating the product is difficult. In that case, a cost advantage is critical to provide a moat.

What Makes HF Sinclair Different?

  • Diversified Operations: The company’s integrated business model, which combines refining with midstream, marketing, and specialty products provides more stability and optionality than pure-play refineries.

  • Geographic Positioning: A large portion of HF Sinclair’s refining capacity is located in less competitive refining regions, which may provide advantages through lower operating costs.

  • Renewable Focus: The company is pushing into renewable fuel production as a key segment, and trying to benefit from the rising demand and mandates.

  • High Complexity Refining: The refining operations produce complex fuels, giving it an advantage as it is not just a simple refinery but can process multiple complex grades of fuel.

  • Strong Balance Sheet: With reduced debt over the past few quarters, the company has significant financial flexibility to invest into its businesses.

Management has recognized that the company is reliant on macro factors. If crude supply increases in a region that hurts their refiners, that would mean losses as prices of their products will go down with increase in inventory. They also depend on the availability of raw materials at a reasonable cost and the ability to sell finished goods at reasonable market prices.

Financials

HF Sinclair’s financials are complex due to the company’s diversified operations. Here’s a breakdown with justifications:

  • Revenue: Revenues are primarily dependent on crude oil prices and crack spreads. In Q3 2023, revenue dropped 13.2% on Q2 2023. This is a function of volatile oil prices. The revenues have decreased 26% Y/Y from 2022. This means the company is highly dependent on commodity pricing which may cause volatility.

  • Profitability: Profit margins have had volatility due to rising oil prices, followed by high volatility due to refining output and margins. Net profit for Q3 2023 has also decreased drastically.

  • EBITDA Margins: EBITDA margins stood at 5.7% in Q3 2023. This shows the drop in profitability for the company, from Q1 when it stood at 13.2%. Also, the company’s EBITDA margins have more than halved from 2022, when the number stood at 13.4%. This demonstrates that even companies with cost advantages might suffer if the price is not favourable.

  • Return on Capital (ROIC): Their ROIC is extremely volatile. ROIC for Q1 2023 is 18%, while it dropped to 4% in Q3. This indicates that the business requires high capital to operate. However, management is confident that ROIC will rebound in the future. The volatility in ROIC demonstrates their reliance on the state of commodities market and the need for strong competitive advantages that could protect it.

  • Free Cash Flow (FCF): In 2022, the company generated $2.4 billion in free cash flow. It is expected to drop in 2023 due to reduced margins. Free cash flow should increase in 2024 when the company’s production increases with new facilities and their margin profile gets better.

  • Debt: The company’s long-term debt is $4.7 billion. Their interest expenses for Q3 2023 totaled $200 million. However, due to the large cash reserves of the company, it doesn’t raise much liquidity concerns.

These financials show that HF Sinclair is more of a cyclical, commodity-driven company than a secular growth company. The company’s financials are very volatile and dependent on macroeconomic conditions which is beyond the control of the management.

Understandability: 3 / 5

While understanding the basic operations of an oil refiner is straightforward, the details of their derivative use, hedging positions, and the many complex government regulations that affect the refining industry make understanding it a level-3 difficulty. Investors might not need all of that detailed information, but its useful to understand for better investing.

The company also operates a trading book for crude oil and gasoline, which may be confusing for someone new to the business. The accounting standards for the business are complex as well, and may take a while to fully grasp for retail investors.

Balance Sheet Health: 3 / 5

HF Sinclair’s balance sheet is mostly in a good shape. They have a considerable amount of cash at hand, which can protect them during any periods of economic downturn. The company has also been focusing on lowering debt, but it still stands at $4.7 billion, which is a concern. They also carry a lot of inventory which can be a liability during times of lower demand.

The company has to work towards improving its capital structure. While the debt levels are decreasing, there is more than $4.5 billion debt on its balance sheet. Any large economic downtrend may make the company more vulnerable to defaults. The liquidity position is also not the best, so it needs to reduce its reliance on debt and improve its liquidity reserves.

Recent Issues

  • Lower Margins: Refining margins have been volatile, which directly impacts HF Sinclair’s profitability. This has been a cause of concern for management. Management is working towards getting profits up.
  • Integration of S&N: The company’s management has indicated that it has successfully integrated S&N and has realized a lot of cost synergies. However, as discussed earlier the effect of S&N’s higher-cost margins is showing up in their financial statements.
  • Environmental Concerns: There have been significant concerns regarding carbon emissions and climate change. This has added significant costs to operations.
  • Oil Price Volatility: Volatility in crude oil prices adds uncertainty to operating income for all divisions.
  • Refining capacity in US: There have been many instances over the last decade where refining industry has been overbuilt. This means any new capacity from competitors may hurt profitability.
  • Increase in working capital: There have been recent increases in working capital which are expected to reduce in the coming quarters.

Overall, management seems confident in the business’ operations and their ability to manage all external risks.

Conclusion

HF Sinclair is a business operating in a highly competitive, commodity industry. Its performance and stock prices are highly dependent on commodity prices, so there will be volatile earnings. Although HF Sinclair has a diversified business, including some moats, their earnings are also highly sensitive to industry conditions. In order to make long-term returns as an investor, the main idea is to patiently wait for their financial performance to stabilize at much higher levels, while buying their stock at a lower price.