October 21, 2024
Trade Idea: CLMT $20.06 (Calumet Specialty Products)
Buy February 21st $23 Calls for $2.70
Calumet Specialty Products (CLMT) is a $1.7 billion specialty products company that has carried a significant amount of debt, making it a relatively risky investment until now. Following a major announcement last week, it has emerged as one of the more compelling risk-reward opportunities in the market.
CLMT operates through three business lines: Specialty Products, Performance Brands, and an 86% stake in Montana Renewables (MRL).
The real potential for growth lies in their MRL stake.
Opportunity = SAF
MRL is a refining complex in Montana that produces both conventional asphalt and has recently transitioned into renewable refining. Currently, its renewable output is primarily focused on Renewable Diesel (RD) with a smaller portion dedicated to Sustainable Aviation Fuel (SAF).
Currently, RD margins are facing pressure due to an oversupply driven by increased domestic production and imports.
On the other hand, only 300 million gallons of SAF were produced in 2023, while U.S. airlines have committed to purchasing 5 billion gallons (!) by 2030 to benefit from tax credits. SAF carries higher margins than RD because it is more expensive to produce and requires specialized equipment.
This expected surge in demand with higher margins presents a significant opportunity for MRL to expand SAF production (if possible). Here's where things start to get exciting...
Loan, Please
MRL had been pursuing a low-interest loan from the Department of Energy (DoE) to expand and upgrade its output to SAF, with expectations of securing a loan between $600 million and $1 billion.
Even a $600 million loan would have been transformational for the company, with analysts projecting MRL's EBITDA to rise to around $400 million. Given industry multiples at 10x, this would value the SAF business at approximately $4 billion, translating to $32 per CLMT share after accounting for debt.
On October 16th, MRL received a surprising $1.4 billion low-interest loan—far exceeding expectations. CLMT also granted the DoE a $150 million equity stake in MRL, signaling a true partnership. As a result, analysts are now projecting as much as a $50 per share target for CLMT, positioning this as a potential home run for investors.
Options Flow
On the loan news, the stock immediately traded higher toward $26 and came straight down to $20 into Friday’s close. Why?
Keep in mind, CLMT only trades 500k – 700k shares per day and there’s been significant CLMT call buying in the name over the last couple of months as the stock rose from $10 in early-August.
There was profit-taking in the Call options after the announcement on Thursday into Friday's expiration. This put a lot of pressure on the stock.
That said, Hedge funds and large institutions have taken bullish options positions in CLMT over the next eight months. On Friday, someone added 10,000 CLMT June 20th $25 - $40 Call spreads for $2.80, increasing the total position to 15,000 spreads. This corroborates the “story” perfectly.
In addition, there have been buyers of 20,000 CLMT January 17th $20 calls, and another 3,000 December 20th $23-$30 Call spreads on Tuesday.
The Trade
This loan is a transformative event for Calumet (CLMT), meaning historical performance may not fully capture the company’s new trajectory. While the stock has already doubled in 8 weeks, the loan provides a clear path to a significantly higher valuation.
However, it is not without risk.
The primary concern is that airlines might lose interest in purchasing SAF, and with Trump's chances of winning the election increasing, there is a fear he could repeal the Inflation Reduction Act (IRA), which supports SAF production.
It's important to note that the SAF business benefits U.S. farmers and blue-collar workers, making a full repeal unlikely. As one law firm pointed out:
“The IRA is not inherently an all-or-nothing proposition––indeed, it gives a potential new Trump Administration the opportunity to prioritize and reshape policies to align with the former President’s agenda to reinvigorate American manufacturing and agricultural interests.”
Additionally, Shell Oil already has an agreement to buy SAF from CLMT. With the DoE now a CLMT partner, Shell may see even more value in acquiring the entire company. Why be a customer when they can own this strategic asset?
The next earnings report is due in early November.
I like the CLMT February 21st $23 Calls for $2.70, targeting a stock price of $35.
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