Since I first argued how there was strong upside for Valero (VLO) and HollyFrontier (HFC) here, the stocks have soared by 20.5% and 34.6%, respectively, while the Dow Jones is up by only 6.7% during the same time period. This outperformance roughly hit my price targets and has ultimately closed much of the value gap. Given macro headwinds, major EPS revisions, and the specter of increased EPA regulations, I no longer recommend opening a long position.
From a multiples perspective, both companies appear incredibly cheap. Valero trades at a respective 6.3x and 6.9x past and forward earnings while HollyFrontier trades at a respective 5.6x and 7.1x past and forward earnings. These figures are at the low-end of peers, but by no means outliers. The Street currently rates shares of both firms a "buy", but continues to prefer HollyFrontier.
At the third quarter earnings call, Valero's management provided a slightly reserved outlook:
"For modeling our fourth quarter operations, you should expect the refinery throughput volumes to fall within the following ranges: the Gulf coast should be somewhere between 1.52 million to 1.56 million barrels per day; Mid-Continent at 430,000 to 440,000 barrels per day; the West Coast at 270,000 to 280,000 barrels per day; and the North Atlantic at 440,000 to 460,000 barrels per day in the fourth quarter.
Refining cash operating expenses are expected to be around $3.85 per barrel in the fourth quarter. Regarding our ethanol operations, we expect total throughput volumes of 3.4 million gallons per day, and operating expenses should average approximately $0.36 per gallon, including $0.04 per gallon in non-cash costs such as depreciation and amortization".
While large refiners are best positioned to weather macro uncertainty, the recent information about fourth quarter progress gives on pause. Valero needs to harness its export markets in order to curtail the deterioration of margins. It has more than a dozen cost-effective refiners than are flexible in the sense that can easily crate a variety of value outputs. Towards improving its operational strength, Valero is modernizing several projects and adding two more. I am particularly optimistic about how the hydrocrackers will drive the bottom-line by 2013. Furthermore, the company has solid pipeline connections to compensate for for certain geographic weaknesses. Even still, recent struggles in the fourth quarter have highlighted how size and networks are no solution for macro challenges.
Consensus estimates for Valero's EPS forecast that it will grow by 116% to $3.50 in 2011 and then by 0.3% and 16.2% more in the following two years. Of the 18 revisions to EPS, 14 have gone down for a staggering net change of -24.8%. Assuming a multiple of 7.5x and a conservative 2012 EPS of $3.45, the rough intrinsic value of the stock is $25.88, implying only 5% upside.
HollyFrontier similarly has little ups at this point. The market has now satisfactorily accounted for the substantial opportunities to expand margins and strong financial profile. HollyFrontier may even hit $1.3B worth of net cash by 2012. Third quarter EPS of $2.48 meaningfully beat consensus and set records in earnings, which soared by 922% y-o-y. Refinery gross margins were up 170% y-o-y at $21.10/barrel with particularly strong results in the Rockies. Management is further seeking to increase scale in its low-cost production system.
Consensus estimates for HollyFrontier's EPS forecast that it will spike by 569.1% to $6.49 in 2011 and then decline by 37.6% and 15.1% more in the following two years. Assuming a multiple of 7x and a once-conservative 2012 EPS of $4.22, the company is roughly trading at intrinsic value. With EPS revisions now reducing the conservative 2012 EPS figure to more like $4.01, the stock even has some downward pressure.