The Long and Short

Balance sheet strength at HFC supports ratings in downcycle

| January 15, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

HollyFrontier Corporation (HFC) has a negative outlook on both its Moody’s and Fitch ratings, but its strong balance sheet entering the pandemic should enable the credit to maintain investment grade ratings (Baa3 (n)/BBB-/BBB- (n)) through the downcycle. The credit trades as if it is in high yield territory, with HFC bonds at a considerable discount relative to other refining peers, despite having better leverage than Marathon Petroleum Corporation (MPC – Baa2 (n)/BBB (n)/BBB (n)). Margin improvement in 2021 should bring leverage down to the rating agencies’ threshold of 3.0x, flattening HFC’s 3s10s curve closer to that of MPC.

The agencies will look to rate through the cycle as the company remains committed to its investment grade ratings, cash flow is expected to be positive for 2020, and a strong cash balance of $1.5 billion means liquidity is solid. As leverage falls HFC’s 3s10s curve (Exhibit 1) – which stood at 135 bp in September 2020 and is currently trading slightly wider at 137 bp – should begin to collapse closer to MPC whose curve is roughly 85 bp.

Exhibit 1. Refiner curve (3-year to 10-year)

Source: Bloomberg TRACE, Amherst Pierpont Securities

Mid-cycle leverage strong for the ratings

HFC’s leverage is typically maintained in the 1.5x area or below during mid-cycle conditions and can increase to the 3.0x-5.0x area during down-cycles. Total leverage was close to 4.5x on a last twelve months (LTM) basis ended 3Q20. This is up considerably from year-end 2019 total leverage of 1.4x. Leverage is estimated to end the year in the 4.0x area when the company reports earnings on 2/24/21, assuming adjusted EBITDA of roughly $800 million for the full year. Consensus estimates put adjusted EBITDA margin growth at roughly +250 bp for 2021, which translates to an EBITDA increase of approximately $300 million for the year. Assuming debt stays the same and HFC uses its strong cash position ($1.5 billion at 9/30/20) to fund capital expenditure needs, leverage could decline below the 3.0x threshold communicated by the rating agencies to the 2.9x area. Additionally, debt/capitalization is low at 25% and on a net basis is only 3%.

Comparatively MPC’s leverage is currently very high at over 6.0x, but is expected to be coming down to the 3.0x-3.5x area with debt reduction from the Speedway asset sale. That deal is expected to be completed by the end of 1Q21. MPC’s leverage tends to be much higher than peers on a consolidated basis given the amount of debt residing at its operating subsidiary and master limited partnership, MPLX. As of 9/30/20, total debt at MPLX was just over $20 billion. While HFC has a midstream affiliate, Holly Energy Partners (HEP), HFC only owns a 57% limited partner interest and debt at HEP stands at $1.5 billion.

Liquidity is solid

Including the $1.5 billion cash position mentioned earlier, HFC also maintains an undrawn $1.35 billion revolver which matures on 2/16/2. This puts total liquidity at $2.85 billion. Additionally, the company is expected to be free cash flow positive for 2020. A very manageable debt maturity profile with nothing maturing until 2023, provides HFC with very good headroom to start to fund its renewable endeavors. Furthermore, its debt issuance in September 2020 of $750 million will be used to fund most of the capital expenditure associated with the renewables business. HFC recently reduced its capital budget for 2020 to the $475 to $550 million range, down from $525 to $625 million. This is the second time management reduced the capital budget as original expectations were in the $623 to $729 million range. Capital spend on the renewable business is now expected to be in the $130 to $145million range in 2020, down from $150 to $180 million, with spend in the $450 to $500 million range in 2021.

Commitment to investment grade ratings

Given the large cash balance, management was asked about returning cash to shareholders via repurchases which currently remain on hold. While HFC is committed to its dividend, management noted that cash is prioritized for maintaining investment grade ratings and financing the business. Share repurchases are not expected to resume until demand for their products normalizes and visibility improves. HFC noted that they remain in constant communication with the rating agencies and that a mid-cycle leverage ratio of 3.0x has been communicated to them to maintain the current ratings. That said, they feel that they are in good shape of being at or below that leverage ratio in 2021. Furthermore, the renewables business which they are investing in will benefit margin and cash flow expansion in 2022.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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