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Crack spreads are at record levels. Oil prices are in the crack spread sweet spot. Oil prices are as high as many will tolerate, yet they are not so high that sellers are trying to cut into the crack spread in order to keep the prices of gasoline and heating oil down. The 5 year chart of the crack spread shows the crack spreads have spiked past the highs of 2007 and 2008. The same refiners who benefited in 2007 and 2008 should benefit (and are benefiting) today. The price of oil is unlikely to spike hugely higher as it did in 2008. The weak economic conditions virtually preclude this. This means that the crack spread may stay wide for quite some time. It means that refiners should benefit longer term. It means the low FPE’s of such stocks as (NYSE:VLO) Valero Energy Corp. (6.56), (NYSE:WNR) Western Refining Inc. (7.81), (NYSE:HFC) HollyFrontier Corp. (8.95), and (NYSE:TSO) Tesoro Corp. (7.94) indicate very real long term bargains.

The chart of the 5 year crack spread (Bloomberg):


(Click to enlarge)

The financial fundamentals of these stocks tend to reinforce the above reasoning. The data in the table below are from TDameritrade and Yahoo Finance.

Stock

VLO

WNR

HFC

TSO

Price

$26.18

$20.61

$73.93

$24.44

1yr. Analysts’ Price Target

$33.93

$20.50

$72.92

$28.54

PE

28.18

71.31

18.32

14.94

FPE

6.56

7.81

8.95

7.94

Avg. Analysts’ Recommendation

2.4

2.5

2.1

2.5

This Year EPS Growth Estimate

115.40%

2,672.70%

325.80%

1,217.20%

Next Year EPS Growth Estimate

14.30%

-6.70%

0.00%

-4.90%

This Year Revenue Growth Estimate

29.90%

8.10%

39.40%

26.40%

Next Year Revenue Growth Estimate

8.90%

11.50%

24.70%

14.00%

5yr EPS Growth Estimate per annum

9.00%

50.00%

20.00%

18.40%

EPS misses in the last 4 quarters

2

3

1

1

Avg. EPS beat % in the last 4 quarters

-2.15%

-59.425%

+14.40%

-5.00%

Stock Price Appreciation % YTD

+10.23%

+91.19%

+76.95%

+29.72%

Price/Book

0.98

2.65

5.09

1.05

Price/Cash Flow

5.88

11.31

10.7

5.34

Beta

1.10

0.59

0.69

1.23

Short Interest as a % of Float

2.61%

37.53%

7.09%

11.43%

Cash per Share

$7.25

$0.13

$5.15

$5.09

Market Cap

$14.93B

$1.87B

$3.92B

$3.48B

Enterprise Value

$18.63B

$2.91B

$4.49B

$4.68B

% Held by Institutions

76.17%

61.91%

91.65%

86.14%

Total Debt/Total Capital (mrq)

33.96%

60.33%

37.88%

36.66%

Quick Ratio (mrq)

1.03

0.92

0.92

0.73

Interest Coverage (mrq)

2.09

1.51

10.1

5.21

Return on Equity (ttm)

7.41%

3.78%

31.94%

7.43%

EPS Growth (mrq)

227.50%

138.60%

398.44%

166.88%

EPS Growth (ttm)

243.47%

104.64%

566.57%

165.25%

Revenue Growth (mrq)

42.26%

-3.96%

24.13%

41.65%

Revenue Growth (ttm)

29.08%

7.27%

44.79%

23.64%

Annual Dividend Rate

$0.20

--

$0.60

--

Gross Profit Margin (ttm)

8.97%

5.54%

$13.07%

12.28%

Operating Profit Margin (ttm)

2.35%

2.43%

5.03%

2.49%

Net Profit Margin (ttm)

1.23%

0.33%

2.82%

1.04%

This data is complex to parse. The net profit margins of these companies are all still terrible. However, all the companies are still in the recovery stage. One might reasonably expect the Net Profit Margins of these companies to improve. Still one should not ignore the fact that HFC has the highest Net Profit Margin currently. HFC also has by far the highest Return on Equity. In the value vein, the Price/Book ratio of both VLO and TSO is approximately 1. These are vastly better than the other two companies’ P/B’s of 2.65 and 5.09. Still growth rate is often the biggest determinant of stock price appreciation. WNR has a stupendous 50.00% 5 year EPS Growth Estimate per annum. It is very hard to beat that. However, it is also hard to believe that crack spreads will remain at or near current levels for the next 5 years. Therefore it is hard to take any 5 year estimate as gospel in the refining business. Plus WNR has had the biggest run up this year. It has by far the most short interest at 37.53%. It has the lowest Net Profit Margin (0.33%). It is perhaps in the most precarious financial condition. This all makes me view this stock as speculative. I recognize it may produce great gains, but I would prefer to stay away from it at this time.

TSO and VLO are great value plays with good 5 year EPS Growth Estimates per annum. Both look like solid investments. I should add that VLO’s growth prospects could well be understated. HFC has similar fundamentals in many ways, but its Price/Book of 5.09 is worrisome. Off hand I am guessing that that is at least partially an artifact of the recently completed merger (of Holly and Frontier) that may have caused many assets to be valued at the depressed prices of today. Those prices will likely rise in the future to bring HFC’s Price/Book down. I would look at this as a good opportunity with HFC’s greater growth prospects.

Let’s take a look at the technicals through the 5 year charts.

The 5 year chart of VLO:


(Click to enlarge)

The 5 year chart of WNR:


(Click to enlarge)

The 5 year chart of HFC:


(Click to enlarge)

I am not sure how meaningful the HFC chart is after its recent merger. However, I have included it so readers can get an idea of the steepness of its recent rise.

The 5 year chart of TSO:


(Click to enlarge)

The Slow Stochastic sub charts all indicate that the respective stocks are overbought. I do not think I would want to buy any of the stocks at their current technical positions. I would prefer to wait until they are oversold. However, it is unclear when or if that might happen. If you wanted to do something now, you could sell out of the money August puts on these stocks at a level at which you feel the stock is a good bargain. In that way, you could make some money from the option premiums while you are waiting to get in. Worst case you would end up buying the stock(s) for a price that you consider reasonable. This would be much preferable to simply buying in now for a higher price.

A point to keep in mind is that the overall market is overbought currently. One could wait a bit to sell out of the money put options on these stocks. You could collect a higher premium for selling an out of the money put option that was nearer to being in the money. You could watch the overall market go down. When you thought it was turning up, you could sell out of the money put options at a price at which you were willing to buy the stock(s).

Currently the S&P500 futures are down considerably. The Asian markets were down on Monday, and the European markets have started out to the downside on jitters about Spain and Italy. The bond vigilantes seem to be starting to target these two. This is indeed worrisome for the overall market. It may dictate that investors should be very wary of potentially large down moves in the near future. The current 10 year bond yields for the PIIGS are up today (Monday July 11, 2011): Greece +1.038% to 17.04%, Portugal +2.064% to 13.20%, Ireland +0.046% to 12.92%, Spain +3.065% to 5.849%, and Italy +3.450% to 5.45% (Bloomberg). Both Spanish and Italian 10 year bond yields seem to be breaking higher out of a consolidation phase. This is a very bad sign after the lowering of Portuguese debt to junk status last week. If these two countries simultaneously need bailouts soon, this could push the EU into a true credit crisis that will bring on a depression (or at least a severe recession).

The EU is having an emergency meeting today. On the table is a selective Greek default to make Greece’s debt more sustainable. No one is sure what to do about Spain and Italy yet. We could be on the brink of the kind of Black Swan event not seen since the Lehman Brothers bankruptcy. Perhaps this one will be worse. It may be wise to trim some positions at least temporarily.

Good Luck Trading.

Source: Oil Refiners Stand to Benefit From Record Crack Spreads