Oil Refiners: Is There a Value Play?

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Refining companies with the majority of their operations on the Gulf Coast of the United States have been in the driver’s seat for profits during the past several months of 2013. Access to cheaper U.S. crudes has lifted some refiners’ margins. But just as with real estate, it is all about location, location, location.

It is worth citing again the comment from Valero Corp.’s (NYSE: VLO) chief executive officer when the company reported third-quarter results:

Fortunately for Valero, U.S. and Canadian light sweet crude oil discounts relative to Brent have been improving versus the third quarter, particularly for WTI in the U.S. Mid-Continent and LLS on the U.S. Gulf Coast. Discounts for medium and heavy sour crudes on the U.S. Gulf Coast have also improved compared to the third quarter. Valero has substantial capability to process these discounted crude oils, which provide cost advantages versus many of our global competitors.

It is difficult to overstate the importance of refinery locations, at least in the near-term. As railroad transportation out of Canada, North Dakota, and south Texas improves, and new pipelines get built, the location premium will fade away. In the meantime, though, it’s salad days for some refiners.

Phillips 66′s (NYSE: PSX) stock rose nearly 40% in 2013. Shares closed at $77.13 Tuesday, and the consensus analyst price target is around $77.50, indicating that the stock is virtually fully valued. Shares have traded in a range of $50.12 to $77.29 over the past year, with the high coming on the last day of trading in 2013. With a fiscal year 2014 earnings per share (EPS) estimate of $6.70, the stock is valued at 11.15 times expected earnings.

Marathon Petroleum Co. (NYSE: MPC) saw its stock rise 43% in 2013, closing at $91.73 on Tuesday in a 52-week range of $60.04 to $92.73. The consensus target price on the stock is around $94.00, indicating a potential upside of just 2.5%. Fiscal 2014 EPS are currently estimated at $8.48, and the forward price-to-earnings (P/E) ratio at that level is just under 11.

Valero’s shares closed at $50.40 on Tuesday, after setting a new 52-week high of $50.54. The stock’s 52-week low is $31.12. The consensus price target is around $50.40, so Valero shares are also fully valued. Estimated EPS for the 2014 fiscal year are $4.91, and the forward multiple at that price is 9.9.

HollyFrontier Corp. (NYSE: HFC) shares closed at $49.69 on Tuesday, in a 52-week range of $38.98 to $59.20. The consensus price target on the stock is around $52.20, implying a potential gain of 5%. The consensus EPS estimate for 2014 is $4.45, and the forward P/E ratio is just short of 11.

Tesoro Corp. (NYSE: TSO) shares closed at $58.50 on Tuesday, in a 52-week range of $39.85 to $65.75. The consensus price target on the stock is around $70.00, implying a potential gain of nearly 20%. The EPS estimate for fiscal 2014 is $6.43, and the forward multiple is 8.79.

There is a clear leader among these stocks when it comes to potential share price gains in 2014. But aside from small refineries in North Dakota and Utah, Tesoro is a west coast refiner that depends on Alaska North Slope and imported crude, both of which are priced at a premium to West Texas Intermediate (WTI). That situation may be reversed in the next several years, but for now the company’s forward multiple is more representative of its potential than is the high implied gain.

HollyFrontier had a good thing going when North Dakota and Canadian crude was priced at a significant discount to WTI and the company’s mid-continent refineries could get the better pricing while competitors on the Gulf Coast were paying Brent prices that were even higher than WTI prices. Those days are over, and HollyFrontier is pretty fairly valued at its current price.

Of the big three refiners, all are essentially fully valued. Whether these refiners can continue to operate at 90% or more of capacity and produce diesel fuel and gasoline for export at significant margins due to the lower cost of WTI will be their story for 2014. Barring a significant unexpected shock to the price of crude, all three should see share price gains this year. Of the three, Valero, which is wholly independent, could have the most potential because the stock does appear to be undervalued relative to its expected EPS for the year.

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