Refining Stocks: A Cheap Way To Play The Oil Sector

Includes: HFC, TSO, VLO, WNR
by: Hawkinvest

The price of oil has surged about 9% in just the first few weeks into 2012. The strength of oil, coupled with a market rally, has boosted many energy stocks. However, there is at least one segment of the oil sector that remains cheap when compared to valuations in general, and that would be refining stocks.

Overall, industry conditions have been challenging, with many refiners recently reporting the impact of low profit margins. A recent article summarizes the industry conditions and the hedges that many U.S. refiners have had to make to reduce margin risk, it states:

"However, those US refiners that rely on expensive seaborne crude have struggled, forcing companies such as Sunoco, ConocoPhillips and Hess to shut down money-losing facilities on the East Coast and in the Caribbean. Those US refiners who have fared well against that turbulent backdrop ramped up their hedging activities last year and continue to be active hedgers, says Guillaume Malle, head of Americas commodity sales at Credit Suisse. "Last year, a large number of US refiners became active hedgers because of the disruptions that we saw in the market, particularly those who were fortunate enough to rely on WTI or related crudes for their feedstock," Malle says.

It can be rewarding to buy stocks when a company or an industry is challenged, because it often provides an opportunity to buy at very reasonable, if not downright cheap valuations. All businesses face challenges and can see short-term issues that will impact financial results, just as the refiners have seen.

However, refiners are able to use hedges to manage the challenges, and refining margins have historically risen just before the start of the Summer driving season. This could lead to improved financial results for these companies in the next couple of quarters. The refining stocks listed below appear very undervalued when you consider the book values, and the average price to earnings ratio for other energy stocks:

Valero Energy Corp.

Valero Energy Corp. (NYSE:VLO) operates refineries that produce gasoline, diesel, jet fuel, asphalt, petrochemicals, and lubricants. The company also operates fueling stations and convenience stores, which offers some diversification in revenue sources. Valero did see weaker margins in the fourth quarter, but the company is already seeing signs of improvement as stated by CEO Bill Klesse, in the company's earnings release:

"So far in 2012, product margins have improved versus the fourth quarter of 2011," Klesse continued. "The macro view for refining in 2012 looks promising given the combination of positive economic trends in the U.S., expectations of global demand growth, and continuing capacity rationalization in the industry, particularly in Europe, the U.S. East Coast, and the Caribbean."

Valero's shares are trading at just about 6 times forward earnings. Plus the stock is trading below book value, which is $29.81 per share. Investors are paid to wait for a higher stock price, with an above-average dividend yield of 2.4%.

Some key points for VLO:

  • Current share price: $25.51
  • The 52-week range: $16.40 to $31.32
  • Earnings estimates for 2012: $3.51 per share
  • Earnings estimates for 2013: $4.15 per share
  • Annual dividend: 60 cents per share, which yields 2.4%

Tesoro Corporation

Tesoro Corporation (NYSE:TSO) operates seven refineries, with a combined capacity of approximately 665,000 barrels per day. This company also operates fueling stations under the Tesoro, Shell and USA Gasoline brands. Tesoro was impacted by weak refining margins and it posted a loss in the fourth quarter of $124 million, or 89 cents per share.

However, for the full year 2011, Tesoro reported net income of $546 million, or $3.81 per diluted share. This compares favorably to a net loss of $29 million, or 21 cents per diluted share for 2010. Tesoro's shares have a book value of $26.64 and a forward price to earnings ratio of about 7. Barclays Capital recently gave Tesoro's shares an overweight rating with a $37 price target. Buying on dips is likely to be a solid strategy for long-term gains.

Some key points for TSO:

  • Current share price: $28.59
  • The 52-week range: $17.43 to $29.61
  • Earnings estimates for 2012: $3.63 per share
  • Earnings estimates for 2013: $3.55 per share
  • Annual dividend: none

HollyFrontier Corporation

HollyFrontier Corporation (NYSE:HFC) refines crude oil and markets petroleum products. It has five refineries with a total refining capacity of about 443,000 barrels per day. It manufactures and markets lubricants and asphalt products, and also own a 75% interest in an energy pipeline. This stock has a book value of $24.30 per share and it trades for just about 8 times forward earnings.

However, HFC shares were trading around $22 per share in December, and have rallied sharply ever since. The stock is still undervalued relative to the rest of the market, but it is overbought now. Because of the recent rebound, it is not as attractive as the other stocks we mention. The stock is worth watching and considering on major pullbacks.

Some key points for HFC:

  • Current share price: $35.28
  • The 52 week range: $21.13 to $38.90
  • Earnings estimates for 2012: $6.46 per share
  • Earnings estimates for 2013: $4.34 per share
  • Annual dividend: 40 cents per share which yields 1.2%

Western Refining

Western Refining (NYSE:WNR) owns and operates two refineries with a total refining capacity of about 151,000 barrels per day. The company also has a wholesale division which supplies fuels, lubricants, and automotive chemicals. Western is expected to report earnings on February 28, 2012. Since many refining stocks have reported weaker than expected results in the fourth quarter, it might make sense to watch this stock and consider it on a pullback.

Western is trading for about 7 times earnings, so it is still undervalued compared to the rest of the market and even to other refining stocks. However, the stock was trading for about $12 per share in December, so it only makes sense to consider buying on dips.

Some key points for WNR:

  • Current share price: $19.10
  • The 52-week range: $11.17 to $21.75
  • Earnings estimates for 2012: $2.96 per share
  • Earnings estimates for 2013: $2.86 per share
  • Annual dividend: 16 cents per share which yields .9%

Data is sourced from Yahoo Finance.

Disclosure: I am long VLO.

Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.