In this article, I will give a brief snapshot of the refining industry and the direction I believe it is heading. Following this, I will begin explaining which companies are the best in the industry and the companies that will outperform their peers and the market in the next 12 months.
I am bullish for the overall refining industry for the next 12 months. Despite the supply crisis hitting the oil market these days, there has been an increase in domestic crude production, which has added to the excess supply. In general, this supply has an effect on crude oil purchases for refiners and improves their cost. Now, there have been a multitude of opinions of where oil prices could go over the next 12 months. I believe it is safe to say the price per barrel will range from $40 to $48 for much of 2016, with a slight uptick in 2017 to the $50-52 range. This is pending on how long it takes China to regain its footing. If the country shows signs of a strong recovery, expect prices to begin to float upwards as hedges are being placed on the expectation of the revival of the Chinese oil-consuming machine.
The upstream defaults are far from over, but the heavy investment over the last several years in the Canadian Sands and the build out of infrastructure across the country has increased the supply of heavy crude to the Gulf Coast. Many Gulf Coast refineries have been adapted to handle this heavy crude. For the last several years, these North American crudes have become cheaper compared to imported oil from South America and the Middle East. If the spread between West Texas and Brent Crude widens, it will be very beneficial for refiners who refine domestic crude.
In my opinion, the best in the refining industry right now are those who have safeguarded their balance sheets and have positioned themselves to continue to reward shareholders despite the turbulence in the market. This requires at least maintaining their dividends, if not growing them, returning capital to shareholders through share repurchases (especially when values are depressed), and still being opportunistic in the market.
Valero Energy Corp.
At the top of the best category sits Valero Energy Corp. (NYSE:VLO). Valero is one of the best-positioned, if not the best-positioned, refiner in the Gulf coast. The company is in a prime position to benefit from the supply glut. It is situated to strategically benefit from both the shale plays and the Canadian oil sands. I mentioned that one of the criteria I focused on was the strength of a company's balance sheet. Valero has plenty of cash on hand to survive a prolonged turbulent market, and will have even more once it complete the sale of its McKee Terminal Services to Valero Energy Partners (NYSE:VLP) for $240 million. The company has strong free cash flow and will be able to continue to return capital back to investors through stock repurchases and dividends. Speaking of dividends, Valero just recently increased its dividend by 20%, which yields 3.68%.
Compared to the oil & gas industry, VLO is trading at a significant discount based on a trailing P/E, forward P/E, and PEG ratio. Its forward PEG trades at a 51% discount and the forward P/E trades at a 58% discount to the S&P 500. The 17 analysts offering 12-month price forecasts for Valero Energy have a median target of $73.00, with a high estimate of $100.00 and a low estimate of $65.00. The median estimate represents an +11.83% increase from the last price of $65.28, according to CNN Money. I personally give VLO a price target of $74.38, which is 8.5x my forecasted earnings of $8.75 a share.
Another member of the best category is PBF Energy (NYSE: PBF). It has performed very well this past year compared to its peers. During the last earnings call, Thomas O'Malley, chairman of PBF, was asked how the company would perform in a recession. He made it clear that he did not foresee a recession coming. However, O'Malley believes he has a team in place that is "buttoning the operation up." Thomas Nimbley, CEO of PBF, gave some color on CapEx. "Our main priority is to keep the balance sheet strong. And we are taking defensive steps," he said. The company gave guidance in the range of $475-500 million, $400 million of which is dedicated to turnaround, maintenance, and Tier 3 health safety and environmental, which leaves around $100 million of discretionary. Further discussing balance sheet management, Erik Young, CFO, expressed emphasis to keep net debt cap below 40%. The rating agencies are on board with this plan. Overall liquidity is around $1.4 billion. After the completion of the Torrance acquisition, the company will use $550-600 million worth of liquidity to purchase the assets as well hydrocarbon inventory. Hence, PBF was in the market raising funds in the 4th quarter, in order to make sure it had enough liquidity to weather any future storm.
The company announced it will pay a quarterly dividend of $0.30 a share, which equates to a 3.67% yield. At the end of the last quarter, PBF has $149 million available for the repurchase program, which expires in the 4th quarter of 2016. At the end of quarter, there were 102,767,291 outstanding shares. Therefore, the company could retire roughly 4.5% of outstanding shares.
PBF is trading at a significant discount to its historical averages. The stock is trading at a 4% discount to its 5-year forward PEG average of 1.2. At PBF's current price, it is trading at a 66% discount to its 5-year average and a 6% discount to its 5-year forward P/E. If trading at its historic 5-year average for trailing P/E, the stock would be trading at $94.52.
The 12 analysts offering 12-month price forecasts for PBF Energy have a median target of $40.50, with a high estimate of $48.00 and a low estimate of $27.00. The median estimate represents a +23.82% increase from the last price of 32.71, according to CNN Money. I concur near the median estimate of $41 per share.
Marathon Petroleum Corporation
A company that barely slips into the best category is Marathon Petroleum Corp. (NYSE: MPC). The only thing holding MPC back from being the best of the best is its exposure to price fluctuations through its support and general partner ownership of MPLX LP (NYSE: MPLX). The company's refining business is very solid, and it positioned to be flexible and capture opportunities wherever they may exist. MPC's Gulf Coast refineries have access to the export market and several options to sell their finished products. The refinery in Galveston Bay is in a prime spot to support Latin American and South American demand. A lot of potential is here if Brazil can manage to get their act together and grow their economy. Their refineries in the mid-west charge premium prices on products due to demand outpacing the refining capacity. MPC also recognized the lacking capacity in the mid-west and upgraded its Detroit refinery to be able to process 80,00 b/d of heavy sour crude oils, and increase refining capacity by 15,000 b/d.
The toss-up about MPC and why I do not give it as high marks as VLO is the performance of MPLX. If MPLX can perform, I believe MPC is the clearly the best investment in this industry. The marriage between MPLX and MarkWest was misunderstood by many. If you really listen to the executive team, they stress the idea that MarkWest had - the key word is had - numerous profitable opportunities, but lacked the funds to do so, and MPLX could fund these projects with support from MPC. Obviously, MPC is a major winner if MPLX performs, as it controls the General Partner Units. The issue now becomes if the once-profitable projects MarkWest had are still profitable, with natural gas prices being suppressed. Regardless, I think MPC's refining and retail business can carry the weight until MPLX is hitting on all cylinders. MPC offers and attractive yield and has stated it will continue to be opportunistic with stock repurchases.
The valuation on MPC is, as I expressed above, very dependent on MPLX's future performance. MPC's forward PEG of 3.9 is at the very high end of its historical 5-year range. The trailing P/E is at a 28% discount to its historical 5-year average, and its forward P/E is only at a 4.1% discount. My 12-month price range is $45.45-50.50 per share. This represents a 22-36% upside. It is based off of EPS of $5.05 and a P/E ratio 9-10, which is well within the historical range. The 17 analysts offering 12-month price forecasts for Marathon Petroleum have a median target of $55.00, with a high estimate of $65.00 and a low estimate of $38.00. The median estimate represents a +50.03% increase from the last price of 36.66, according to CNN Money.
Overall, I think the refining industry remains oversold in general. I think there are some great companies at tremendous discounted values that have protected their balance sheets to weather the volatility storm. I also think there are some refineries that are in serious trouble and will struggle to be profitable in the near future. My analysis has uncovered VLO, PBF, and MPC as the refiners which offer the best return-to-risk ratio and would add great value to any portfolio in 2016.
Disclosure: I am/we are long MPC, MPLX.
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.