Back in September 2012, I wrote in a Seeking Alpha article that HollyFrontier Corporation (HFC) was an overlooked screaming buy. Since that time it boldly advanced from a share price hovering around $40 to a Mar 5, 2013 high of $59.20. However since that time lowering oil prices, a roiling market and profit taking has forced the price down to a recent close of $42.78. That's almost right back where we started from. So is it hands off HFC for now or is this a good time to pick up some more value?
First let's look at some data. First of all, a chart at the share price action since my last report, just so we can visualize a little better what was going on.
HFC data by YCharts
A sharp rise followed by a steady and depressing slope with no immediate sign of grounding. Next, a quick look at the price action of some of its competitors. I looked at refiners as a group to see how everybody did during this time frame: Valero Energy Corp. (VLO), Tesoro Corporation (TSO), Delek US Holdings (DK), Alon USA Energy (ALJ) and Phillips 66 (PSX).
HFC data by YCharts
While there is variation, these refiners went up to from January through May in following the large market rally at the time, but it has been rocky going since.
HollyFrontier Corporation operates as an independent petroleum refiner and marketer primarily in the central regions of the United States. It produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, liquefied petroleum gas, fuel oil, and specialty and modified asphalt. The company operates 5 refineries with a combined crude oil processing capacity of 443,000 barrels per day. The company was founded in 1947 and is based in Dallas, Texas.
HFC was recently quoted at $42.84 with a 52-week trading range of $31.85-$59.20. It offers a $1.20 annual dividend for a 2.90% yield off a 37.00% payout ratio. By the way, this dividend yield is particularly misleading, as I will get into later.
The stock's price earnings ratio recently stood at 4.68 with its earnings per share of $8.87. The company posted a return on equity of 18.39%. The company ranks third in the Oil & Gas Refining & Marketing industry in terms of Price/Earnings Growth Ratio with a PEG Ratio 2.01. Revenue growth has dropped, but by most measures, their return is phenomenal:
HFC Return on Equity data by YCharts
Refiners are traditionally a high investment, slim return niche of the energy sector. Let's look at a table of some competitors:
Refiners ROE and ROA
To be sure, Phillips, Tesoro and Valero are much larger operators than HollyFrontier. However Holly's ROA is head-and-shoulders above the crowd. One thing the top three have in common is that most of their operations are not on the East or West Coasts, but in the central areas of the continent. There the crack spreads are making for thumping business.
Crack spreads are an estimator of refining margins; crude comes in and gets broken down through a "cracking" process, which refines the oil into gasoline and a wide variety of other petroleum products. The crack spread does not take into consideration all refinery product revenues and excludes refining costs other than the cost of crude oil. However, crude oil is the major variable cost that refiners face, so crack spreads are a good basic measure of how good the refining market is for a company.
Years past a crack spread of $2-3 was not uncommon, while $4-$5 was considered great days.
Crack spreads in different areas used to run in lockstep with each other. However with the race to develop the Canadian Sands, as well as other finds in the Dakotas and other central states caused an infrastructure problem. Most pipelines fed into a central location at Cushing, Oklahoma before being piped to the coast to be refined or shipped overseas. This is a key location since the NYMEX futures contracts are based on data from Cushing.
With oil coming in at levels never before imagined the shipping out became harder. Oil stored at Cushing soared from a typical 15mil - 20mil barrels of oil to well over 50mil barrels by January of this year. As such the price of oil at Cushing became much cheaper than that on the Gulf Coast. Local refineries who could either tap into Cushing oil, or buy oil from local producers before it got to Cushing, could buy it on the cheap. Crack spread for local refiners like HollyFrontier exploded. By October 2011 the crack spread was a mind-spinning $27 a barrel and local refiners like HollyFrontier were rolling in cash.
Crack spreads have eased as refiners and oil companies have scrambled to come up with more and newer ways to transport crude around the Cushing bottleneck. Yet these efforts have lagged the growing oil production.
For example, on April 11, 2013, HollyFrontier and its transportation spin-off Holly Energy Partners, L.P. (HEP) announced that the companies are collaborating to construct a rail facility that will enable crude oil loading and unloading near HollyFrontier's Artesia and/or Lovington, New Mexico refining facilities. The rail project, which will be connected to Holly Energy's crude oil pipeline transportation system in southeastern New Mexico, will have an initial capacity of up to 70,000 barrels per day. Project completion is expected by early 2014.
The price of oil has eased lately in part because the stores at Cushing have been edging downward, from a high of 51mil barrels in April to a June 21 level of just over 49mil barrels. However this also comes at a time of several northern pipeline closures due to floods and spills, while the Midwestern tornado season also caused minor disruptions in shipping crude to Cushing.
In the end, I expect the disconnect between the crude going into Cushing and that going out to continue for at least the next two years, meaning refiners like HollyFrontier will be enjoying big crack spreads into the short and midterm.
And when we look at share price based valuations, there is more good news:
HFC P/E Ratio TTM data by YCharts
The dividend yield has grown to --- 8.06%??? But Richard, you say, in your third paragraph of this article you stated that the yield was 2.90%? True. And if you go look up the dividend on all services I know of they will show a yield of that 2.90% or close to it. Reported dividend yields are based on regular dividends, those that the corporate board has indicated they intend to pay regularly. However HollyFrontier regularly pays special dividends, one-time payouts that vary considerably. In theory you cannot count on them and are due to "special" events, hence the name. Yet every quarter it seems the board issues another special dividend.
They are getting so much cash from the great crack spreads, I'm happy the board is willing to share the wealth with their investors.
The most recent announcement is typical: On May 16, 2013 HollyFrontier Corporation declared a special cash dividend in the amount of $0.50 per share, payable on June 10, 2013 to holders of record of common stock on May 29, 2013. The Board of Directors also approved a regular quarterly dividend of $0.30 per share. This dividend will be paid on July 3, 2013 to holders of record of common stock on June 12, 2013.
And this has been the pattern for the last couple of years. So you have a dividend paying king, which is flying under the radar of many dividend investors because its reported dividend yield for most services drastically under-reports the real yield.
And meanwhile, the company is selling at a microscopic 4.8 price to earnings ratio.
So in my mind HollyFrontier is a tremendous value right now. However with the price still falling I would want to see it stop its downward momentum before I get in. As they say, don't try to catch a falling knife. So HFC is on my close watch list, and as soon as the share price looks to stabilize, I expect I will be buying.
What do you think?
Disclosure: I am long 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.