Outlook 2013: Refiners Are Still In The Sweet Spot

Includes: HFC, TSO, VLO
by: Bret Jensen

Refiners had a stellar year in 2012. Consistently wide crack spreads allowed these companies to produce robust profits, increase dividends and grow operating cash flow substantially. Most stocks in the sector wound up more than 50% in the year as a result. The huge amount of oil production coming from the shale regions that will continue to expand should provide the refiners with a cheap feedstock for the foreseeable future. Given the amount of drilling that has shifted to oil and liquids from natural gas (because of low NG prices) over the past 12 to 18 months, it might even accelerate in 2013. In addition, no major refiners have been built since the 70s and given the bent of the current administration that is unlikely to change until 2016 so overcapacity is not an issue. Finally, no major capital expense growth is on the horizon, leaving the companies plenty of cash flow to increase stock repurchases and/or significantly increase dividend payouts. Hard to believe a sector that once sold for less than book value less than a decade ago has such a bright future ahead of it, but 2013 should be another year of positive returns for the refiners. Here are three cheap refiners that still have upside as they ride these trends.

Valero Energy Corporation (NYSE:VLO) is one of the largest refiners in the world. The company operates through three segments: Refining, Ethanol, and Retail.

4 reasons VLO is still cheap at under $37 a share:

  1. Despite being near 52 week highs, the stock still trades at just over 7x forward earnings a discount to its five year average (10.6).
  2. The company has easily beaten earnings each of the last three quarters and consensus earnings estimates have risen nicely over the last three months for FY2013.
  3. Valero has grown its operating cash flow some 250% over the last three fiscal years and sells for just over 4x operating cash flow. It also sports a five year projected PEG of under 1 (.98).
  4. The stock pays a 1.9% dividend and the payouts have grown substantially in the last two years. Given how cash flow is increasing, I would look for these payouts to grow significantly over the next few years.

HollyFrontier (NYSE:HFC) operates as an independent petroleum refiner and marketer in the United States. The company operates 5 refineries with a combined crude oil processing capacity of 443,000 barrels per day. 4 reasons HFC is still a bargain at $44 a share:

  1. Holly is even cheaper than Valero at just over 6.5x forward earnings, a discount to its five year average (9.3).
  2. The company has a robust balance sheet with net cash of approximately $1B (over 10% of market capitalization).
  3. The company's refineries are well positioned to process the cheap crude coming from Canada and the shale regions in the United States.
  4. The company has targeted $350mm in cap-ex in 2013. Given the company's operating cash flow was over $1B in the last twelve months and its cash balance of $1B, Holly should easily be able to increase stock buybacks and/or dividends substantially over the next few years. HFC yields 1.8% currently.

Tesoro Corporation (NYSE:TSO) operates seven refineries and approximately 1,400 branded retail stations. 4 reasons Tesoro still has upside from $42.50 a share:

  1. Consensus earnings estimates have risen more than 30 cents a share over the last three months for FY2013.
  2. The stock is cheap at just over 7x forward earnings six times operating cash flow.
  3. The 16 analysts that cover the stock have a $53.75 mean price target on Tesoro, Credit Suisse has an "outperform" rating and a $60 price target on TSO. The shares yield 1.4%.
  4. The company just bought BP's California's refining and marketing assets for $500mm, a substantial bargain. This should provide earnings and profit growth in the years ahead. The stock has a low five year projected PEG (.49) as well.

Disclosure: I am long HFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.