I've received several emails and Twitter messages concerning CVR Refining (CVRR), a Carl Icahn-held subsidiary of CVR Energy (CVI) with two refineries in Oklahoma. CVR Refining was a recommendation of mine for its initial public offering at $25, and I received an update with specific recommended trade structures again around the time of its secondary offering. It's time for a further update.
I applauded my readers and followers for their terrific homework and insight into some smaller-cap exploration-and-production ideas in my latest column. But, with the comments I've gotten on CVRR, there's been less diligence. A very specific strategy that I laid out for CVRR has been simplified by most readers, and it has now devolved into a miss. Let's recap.
The initial IPO that I recommended in January booked at $25. After a brief downcycle of syndicate washout of shares, the stock proceeded to explode to above $35 -- and if anyone refused to lighten an initial position during this one, they should be ashamed of themselves.
Much of the initial run in shares was due to the trifecta combo of hot refinery IPO names, the reputation of Carl Icahn and the continuing strength of West Texas Intermediate/Brent crude differentials, as well as the concurrent crack strength. CVRR over-delivered on projected distributions, to boot, for its first two dispersals.
But, in order to deliver such massive distributions, CVRR is incredibly dependent upon these margins -- and during the spring, a pressure on cracks and WTI/Brent spreads developed almost immediately. That saw shares drop under $30, the level where a secondary was announced -- in which, surprisingly, Icahn increased his exposure.
Because of this, I again recommended the secondary with the proviso that shareholders should take advantage of the sharp volatility and sell call options, as well, at the $30 level. The point was that, although I believed then (and still do) in the magic of Icahn, I also believed that spreads and cracks would see further drops and put pressure on shares and distributions. But, with the calls and fantastic current distribution, the payoffs were worth the risks.
Today, CVRR is just slightly below its initial IPO price, with a massive but false distribution following it. There is no doubt that the next three distributions will all be downsized. Management has guided for it, and the spreads continue to be a drag on margins and profitability.
If you've had calls written, you've still managed a better-than-27% yield to the roundtrip from the initial IPO. But, as any reader will properly ask: What now?
Two questions need to be answered: First, is the collapse of the spread margin finished? Second, how much further will distributions be discounted into the future?
I think much of the vicious drop in refining margins is done, though not entirely finished -- and same goes for the increase in run rates from overseas. While CVRR's distributions won't deliver 20% or anywhere near it, its assets are high-quality and will, over time, still easily deliver double-digit returns on capital. Icahn is not selling, so why should you?
My recommendation remains: Keep holding CVRR with call protection on the upside, and over time you'll find that this stock will remain one of your better long-term performers. But don't be surprised if the stock sees lower numbers first.
