New Catalyst for Western Refining

12/31/2013 7:00 am EST

Focus: MLPS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Our latest recommendation is a tax-paying corporation that has decided to acquire an existing MLP, instead of starting one from scratch, to shelter some of its assets, explains Igor Greenwald, editor of MLP Profits.

Western Refining (WNR) operates refineries in El Paso, Texas, and Gallup, New Mexico, with a combined throughput capacity of 153,000 barrels per day.

The refineries run largely on sweet crude and are well-placed to buy it at a discount from producers in the Delaware basin of west Texas, which is part of the Permian basin.

On November 12, Western Refining announced an agreement to pay $775 million to the private-equity sponsors of Northern Tier Energy (NTI) for the general partner interest in that MLP, along with the 38.7% of its limited partner units not held by the public.

The deal will give Western Refining control of Northern Tier's 89,500 bpd refinery in St. Paul Park, Minnesota, along with related pipeline and distribution assets, as well as, a chain of retail filling stations.

Curiously, Northern Tier backers, TPG Capital Management, and ACON Investments, sold out at a 6% discount to the price of their LP units on the eve of the announcement, with control of the GP thrown in for good measure. This caused WNR's share price to spike 9% on the news.

It has continued to rally since, to a record high above $40 a share, before pulling back a bit. Yet WNR still trades at a 3.3 multiple of its Enterprise Value to EBITDA, well below NTI, as well as industry leaders.

One way to shrink the gap would be to drop down WNR's own refineries into Northern Tier's variable distribution MLP, where they would likely fetch a more generous valuation based on their distributions.

Western Refining appears to have bought low on a lucrative refinery, benefiting from discounted Bakken and Canadian crudes, and yet its own refineries are valued even lower, according to a UBS analyst who expects the merger of WNR's refinery assets with NTI's inside an MLP.

Even if this move doesn't happen, Western Refining will have diversified on the cheap and will remain Northern Tier's general partner.

Though both entities reported disappointing third-quarter earnings, the current market environment is looking healthier now that the discounts on domestic crude have widened and gas prices firmed.

As an added bonus, short interest in WNR stood at a massive 33% of float, as of November 15. The short covering in this name has likely just begun.

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