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Summary

  • The refinery sector is getting hammered Wednesday as regulators have decided to allow some exports of ultralight oil.
  • This is a huge over reaction for a variety of reasons outlined below and is a great entry point for longer term value investors.
  • Valero is a great buy here due to its valuation and is already getting a significant amount of sales from exports.

Any investor that thinks the market is mostly always rational should take a look at what is happening in the refinery sector today. The stocks of these refinery plays are getting hammered today with some down more than 10% at midday.

The trigger for the sell-off is that yesterday regulators allowed Pioneer Natural Resources (NYSE:PXD) and Enterprise Products Partners (NYSE:EPD) permission to ship ultralight oil to foreign buyers. This is a huge over reaction for several reasons:

It was a narrow ruling that applies to very small amount of current exports. Yes, it will spark other similar requests from other companies but their outcome is uncertain

Second and most importantly I have a hard time believing this administration is going to open up this spigot all the way given its previous policies on fossil fuels. After all this administration has delayed the Keystone pipeline decision for over five years which would further exports of refined products from inputs from Canada. It also has roughly doubled permitting time for E&P development projects and put a one year drilling moratorium in the Gulf of Mexico. I just don't think the lid is going to come up much further on oil exports in the near term.

The oil markets seem to be echoing this view. If commodity investors believed the administration was moving to increase oil exports in a big way, we should see the price of West Texas Intermediate (WTI) shoot up and significantly close the gap with the Brent benchmark. As of this article, WTI prices are only up 35 cents a barrel; hardly a big move.

This tells me the action in the refinery sector is overdone and presents a good longer term entry point. To keep things simple I have picked up shares in North America's largest refiner, Valero Energy (NYSE:VLO) at $50.25 a share which represents better than a 10% decline from where the stock began the day.

Valero is already the biggest exporter of refined products in the country and gets 20% to 25% of overall sales from overseas sales already. The company's refineries on the gulf coast are ideally positioned for exports. More importantly, the shares were already reasonably priced before today's downturn; now they are downright cheap.

At today's price levels, the stock is priced at under eight times forward earnings. Consensus earnings estimates for both FY2014 & FY2015 have gone up nicely over the past three months. Finally, the company's earnings power is consistently underestimated by analysts. Valero has easily beat bottom line earnings expectations for six straight quarters. Over the past year, it has beat consensus by an average of 15%. The shares also yield ~1.9% after today's decline.

In a market I consider slightly overvalued, these are the sort of "gifts" I look for to take advantage of to outperform the market.

Source: Valero: Buy The Dip