In the last few years, U.S. refining companies have benefited from a high Brent-WTI crude spread, high refining margins due to cheap North American crude oil as feedstock and strong demand for refined products. As a result, their profit has soared and their shares have surged. However, the large Brent-WTI crude spread has vanished because of the U.S. Congress decision on December 18, 2015, to repeal the 40-year ban on exporting U.S. crude oil and shares of refiners have significantly retreated since then, as a consequence. As such, only two refiners stocks among the six leading refining companies that are included in Russell 1000 index have recorded a positive return (including dividend) in the last 52 weeks. Nevertheless, refining companies have shown a significant rebound in the last four weeks, as shown in the table below.
Western Refining (NYSE:WNR) which owns and operates two refineries in the Southwest with a total crude oil throughput capacity of approximately 151,000 barrels per day, has had the worst 52-weeks return among the six leading refining companies. However, Western Refining has the highest dividend yield and the best price to free cash flow ratio among the companies in the group.
On February 25, Western Refining reported its fourth quarter and full year 2015 financial results which missed EPS expectations by $0.13 (18.8%). Revenue for the period was $2.07 billion, lower than Wall Street's expectations of $2.14 billion. The company showed earnings per share surprise in its three previous quarters, as shown in the table below.
In the report, Jeff Stevens, Western's President and Chief Executive Officer, said:
Western had a successful 2015 despite a volatile crude oil pricing environment and challenging fourth quarter. We had good, reliable operations at both the El Paso and Gallup refineries as we increased refinery throughput to record levels. Additionally, our retail operations achieved record levels in fuel volumes, merchandise sales, and profitability. On a standalone basis, Western invested $127 million in discretionary capital during the year primarily to expand our logistics capabilities in the Permian and San Juan Basins. We now have a fully integrated crude oil pipeline logistics system able to move crude oil south to either our El Paso refinery or eastward to Midland and the Gulf Coast. Additionally, we continued to balance capital investment with returning cash to shareholders, and in 2015, we returned approximately $234 million in cash to shareholders through dividends and share repurchases.
On December 21, 2015, Western Refining and Northern Tier Energy LP (NYSE:NTI) jointly announced that they have entered into a merger agreement whereby Western will acquire all of NTI's outstanding common units not already owned by Western. Under the terms of the merger agreement, NTI unitholders will receive $15.00 in cash and 0.2986 of a share of WNR common stock for each NTI common unit held. WNR intends to fund the cash portion of the merger consideration with a combination of cash-on-hand and debt financing. Assuming completion of the proposed transaction, NTI will become a wholly-owned subsidiary of WNR and NTI common units will cease to be publicly traded.
In my view, Western is not paying an excessive amount for NTI. The merger of Western and NTI will result in the combined entity owning three of the most profitable independent refineries on a gross margin per barrel basis, with direct pipeline access to advantaged crude oil combined with an integrated retail and wholesale distribution network. According to Western, with a simplified corporate structure and diverse geographic base, the firm will have greater access to capital and be positioned to grow the company profitably.
Since the beginning of the year, WNR's stock is down 17.7% while the S&P 500 Index has increased 0.4% and the Nasdaq Composite Index has lost 4.0%. However, since the beginning of 2012, WNR's stock has gained an impressive 234%. In this period, the S&P 500 Index has increased 63.1% and the Nasdaq Composite Index has risen 84.6%. Considering its compelling valuation, the recent drop in its price creates an excellent opportunity to buy the stock at an attractive price. According to TipRanks, the average target price of the top analysts is $40, up 36.4% from its March 21 close price, which appears reasonable, in my opinion.
WNR Daily Chart
WNR Weekly Chart
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Considering its compelling valuation metrics WNR's stock, in my opinion, is extremely undervalued. Western's trailing P/E is very low at 6.87 and its forward P/E is also very low at 11.31. The price-to-free-cash-flow ratio is very low at 6.50, the second lowest among all Russell 1000 energy stocks and the price to sales is also very low at 0.27. The Enterprise Value/EBITDA ratio is extremely low at 4.32, the second lowest among all Russell 1000 energy stocks. According to James P. O'Shaughnessy, the Enterprise Value/EBITDA ratio is the best-performing single value factor. In his impressive book "What Works on Wall Street," Mr. O'Shaughnessy demonstrates that 46 years backtesting, from 1963 to 2009, have shown that companies with the lowest EV/EBITDA ratio have given the best return.
The 10 Russell 1000 Energy stocks with the lowest price to free cash flow ratio
The 10 Russell 1000 Energy stocks with the lowest EV/EBITDA ratio
Moreover, WNR's Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median, as shown in the table below:
In 2015, the company returned approximately $234 million in cash to shareholders through dividends and share repurchases. The annual dividend yield is high at 5.18% and the payout ratio is only 31.9%.
According to Portfolio123's "All-Stars: Greenblatt" ranking system, WNR's stock is ranked first among all 64 Russell 1000 energy stocks.
The "All-Stars: Greenblatt" ranking system is taking into account just two factors; Return on Capital and Earnings Yield (E/P) in equal proportions. Back-testing has proved that this ranking system is one of the best free available ranking method. I recommend investors to read Joel Greenblatt's book "The Little Book That Beats the Market", where he thoroughly explains his system.
In my view, Western will benefit from the acquisition of NTI. The merger will result in the combined entity owning three of the most profitable independent refineries on a gross margin per barrel basis, with direct pipeline access to advantaged crude oil combined with an integrated retail and wholesale distribution network. Considering its compelling valuation metrics WNR's stock, in my opinion, is extremely undervalued, its EV/EBITDA ratio is the second lowest among all Russell 1000 energy stocks. Moreover, the company is generating strong free cash flows and returns value to its shareholders by stock buyback and high-yielding dividend. The average target price of the top analysts is $40, up 36.4% from its March 21 close price, which appears reasonable, in my opinion.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.