U.S. Refiners Don't Look Cheap (Unless We're Going Back to '06-'07 Environment)

In regards to U.S. refiners still being priced for good times, in my view as per EV /Capacity analysis. If you have a bullish near term view on their industry, think we're going back to 2006-2007, then fine. The point I make is that if you think we're going back to a 1999-2002 environment, then U.S. refiners such as Valero Energy (VLO), Tesoro (TSO), Holly Corp. (HOC), and Frontier Oil (FTO) still look a bit overvalued despite their massive declines this year. Original refiner piece here.

I had some useful comments on this U.S. refiner work I did, posted over on Seeking Alpha, and wish to republish comment excerpts here at the Stalwart.

Comment Excerpt: Using complexity adjusted capacity might improve clarity given complex refineries trade at a premium.

Comment Excerpt: One thing you're missing, is that these companies have a lot of "liquid assets" such as oil and refined oil products. In VLO's most recent 10Q, they listed their inventory as including $4.5 billion of refinery feedstocks and products. In addition, the market value of LIFO inventories exceeded their carrying costs by $7.6 billion. So there's another $12 billion in enterprise value that is not reflected in your numbers, although I'm sure this value is smaller since oil prices have decreased since their 10Q report was issued due to falling oil prices.

Yes, but they always have liquid assets such as these. I compare these companies to their own history. Thus in the past they had additional liquid assets as well. There will be some difference, but will it actually be realized? And might it be enough to overcome their high current valuation vs. their capacity, relative to their own valuation history? Or might this liquid asset value just fall with oil prices/ product prices. I think it is not dependable from an investment standpoint to try to add this value and then depend on it as your investment case.

The key point of the piece is that we are comparing companies by a single metric, and comparing them to themselves in the past. It gives I think a clear understanding of relative value to their own histories. Once we try to start guessing what their inventory values will be, and what they were expected to be in the past, for each year from 1998 until 2008, we start adding a ton of variables with a lot of room for error.

There are other assets I have not included in the analysis, which I explain in the piece. Such as pipelines and retail operations. But they had other assets in the past, so to some extent we're comparing like to like.

The point is simply that if we just value capacity, which is the lion's share of the value behind U.S. refiners, and just compare this metric to where they have traded in the past (and in the past they had retail assets, other liquid assets as well, so its pretty much a like to like comparsion), then it seems very clear to me that these haven't bottomed out and are still priced for a pretty strong outlook since their EV/Capacity's are above the highs of many years in the past.

Then the next question then is what your call on the cycle is. If you do indeed believe we are returning to 2006-2007 in the near future, then the refiners might be cheap. But if you think we're going to 1999-2002, or something similar, then probably they are still a bit overvalued.

I also haven't, yet at least, done a complexity adjusted capacity. I explain in the piece why I haven't, though I admit it would be useful. Basically, its based on a lot of estimates, and my goal here is to first keep it simple. If something looks cheap by my pretty austere valuation, then it will be even cheaper once we heap on other harder to value assets and adjust above average facilities, which actually all four of these players have. Note that we would have to adjust their capacity in the past as well, so to some extent it would be a wash. (Though upgrades to facilities might help the current valuation a bit.)

But if I have to heap on somewhat nebulous asset values, which are perhaps a less dependable value, (such as oil inventories at expected market price for example), if I have to add all this in order to make it cheap, then its probably better staying on the sidelines. It means it's not cheap enough.

(Vincent)

Comments

[Shaggieman:]

One component you failed to mention is their asphalt business. If Obama passes bills to fund the highway reconstuction it should help the bottom lines of the refiners that made asphalt.

Jan 06 12:50 PM

[Chris B:]

I'm more concerned about the new refineries in the Middle East, India, and China. Any chance these low-cost producers will begin exporting gasoline directly to the US?

Jan 06 02:11 PM

[Shaggieman:]

I doubt they can make the exotic blends required for CA anyway.


On Jan 06 02:11 PM Chris B wrote:

> I'm more concerned about the new refineries in the Middle East, India,
> and China. Any chance these low-cost producers will begin exporting
> gasoline directly to the US?
>

Jan 06 03:54 PM

[Hamilton:]

Correct me if I'm wrong, but refining profit margins are in the $11-12 per barrel range now vs $3-4 per barrel in 2002. An analysis of this might be more valuable. Additionally, the huge decline in crude prices is freeing up a ton of working capital that can be re-deployed and allows refiners to avoid using expensive lines of credit to purchase expensive inventory.

Feb 26 07:40 PM