Refiners Have Gone From Hot To En Fuego

Includes: HFC, PSX, TSO
by: Bret Jensen

Readers who have read my columns regularly on RealMoney Pro and Seeking Alpha over the last year know I write often about the huge expansion of domestic oil & gas production that has been underway for over five years now. It is driving some of the most impactful changes to our economy of any event since the internet build out accelerated in the 90s.

It is what I call "The Silent Boom" as it gets much less attention than the internet boom from the media. It is changing the cost equation for manufacturers, meaningfully reducing greenhouse gases as utilities and industrial customers move from coal to natural gas and is resulting in multi-billion infrastructure projects like chemical plants and pipelines being built throughout the U.S. It also has the potential to provide close to $3T in royalties over the next 40 years to a depleted U.S. Treasury if we open up more public lands to the fracking revolution.

The four main ways I have played and prospered from this Silent Boom is through the high yielding energy MLPs in my income portfolio as well as the E&P concerns, oil services firms and the refiners in my value & growth portfolios. The refiners have provided the best overall performance of the four with most of my positions up 60% to 70% or more over the last year. The sector still remains fairly cheap as improved margins and crack spreads have kept EPS rising along with stock performance. Three of the main refining stocks received significant price target raises Monday from analyst firms. Eventually, we will have a pullback in the sector (and a good buying opportunity), but I think we could have another 10% to 20% of upside before that occurs. Here is a quick analysis of the three large refiners that received very positive comments from analysts Monday.

Tesoro (NYSE:TSO) -

Key Upgrade: Bank of America upgraded the shares to "Buy" from "Neutral" and raised its price target from $51 to $66.

3 additional reasons TSO still has upside from $54 a share:

  1. The stock sells for less than 9x 2014's projected earnings and consensus earnings estimates for both FY2013 and FY2014 have gone up nicely over the last month.
  2. TSO has a five year projected PEG of under 1 (.70) and pays a dividend just over 1%. Given its low payout ratio and solid cash flow, I would look for the dividend to increase substantially over the next few years.
  3. The stock sells for under 25% of overall revenues. Credit Suisse has an "Outperform" rating and upgraded the shares in December.

HollyFrontier (NYSE:HFC) -

Key Upgrade: Argus Research substantially raised its price target from $48 to $68 a share. The analyst firm cited the refiner benefiting from high refiner margins longer than many anticipate due to strong U.S. onshore production growth.

3 additional reasons HFC is undervalued at $56 a share:

  1. The stock sells for 7.5x trailing earnings and consensus earnings estimates have moved up better than 15% over the past two months.
  2. The company has a solid balance sheet with approximately $1B in net cash on its books. It has easily beat earnings estimates both of the last two quarters.
  3. HollyFrontier has sextupled its operating cash flow over the past three years. Another refiner with a low dividend payout ratio and yield of just under 1.5%. The company should be able to substantially increase payouts and/or stock buybacks in coming years.

Phillips 66 (NYSE:PSX) -

Key Upgrade - Oppenheimer lifted its price target from $60 to $80 a share stating the refiner is focused on creating shareholders' value through dividend growth and share buybacks.

3 additional reasons PSX can go higher from $64 a share:

  1. The company has easily beat earnings estimates each of its three quarters as a public company. Consensus earnings estimates for both FY2013 and FY2014 have rose more than 20% over the last three months.
  2. The stock has a five year projected PEG of under 1 (.81) and pays a dividend of 1.6%.
  3. PSX sells at under 9x forward earnings and 25% of annual revenues.

Disclosure: I am long HFC, PSX. 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.