Good Time To Buy Valero, HollyFrontier

 |  Includes: ALJ, DK, HFC, VLO
by: Takeover Analyst

When it comes to oil & gas companies, two of my top picks include HollyFrontier (NYSE:HFC) and Valero (NYSE:VLO). While the fundamentals have remained the same, these companies are valued at a significant discount to historical levels. Based on my review of the fundamentals and multiples analysis, I expect both to yield high double-digit returns over the next few years.

From a multiples perspective, both firms are cheap. HollyFrontier trades at a respective 6.5x and 7.8x past and forward earnings, with a dividend yield of 1.2%. Valero, on the other hand, trades at a respective 6.7x and 5.9x past and forward earnings, with a dividend yield of 2.5%. To put this into perspective, consider that HollyFrontier is valued at only 29% of its historical 5-year PE multiple.

Two other oil & gas firms that I anticipate will generate high returns are Delek US (NYSE:DK) and Alon USA (NYSE:ALJ). While the former trades at just 8.7x past earnings, the latter has gained more than 33% over the last six months. As Wall Street starts to pick up on the potential of these stocks, I strongly recommend an early investment. HollyFrontier and Valero provide will help buoy up sector-wide appreciation.

At its fourth-quarter earnings call, Valero's management provided the following guidance:

"For modeling our first quarter operations, you should expect the refinery throughput volumes to fall within the following ranges: the Gulf Coast at 1.38 million to 1.42 million barrels per day; the Mid-Continent at 390,000 to 400,000 barrels per day; the West Coast at 220,000 to 230,000 barrels per day; and the North Atlantic at 450,000 to 460,000 barrels per day. The lower throughput volumes in our Gulf Coast and West Coast regions are due to substantial turnaround activities planned for this quarter, particularly at our St. Charles and Wilmington refinery. A listing of our planned turnaround activities was posted this morning to our website under the News Room.

Refining cash operating expenses in the first quarter are expected to be around $4.50 per barrel, which is higher than last quarter due mainly to lower throughput volumes and some higher maintenance cost related to the turnaround activity".

Credit Suisse values Valero's US natural gas cost advantage at around C$1.8B pa versus Neste (OTC:NTOIF). This strength is likely to be leveraged for greater buyback activity. With hydrocracker projects kicking-in in the second half of 2012, capex will become more efficient and decline by around $1B from the preceding year. I model net debt declining by around $2B over the next three years to $4.7B. And, with regards to the narrowing WTI-Brent spread, Valero is well positioned to gain share, as its access to the export markets will prevent margin erosion.

Consensus estimates for Valero's EPS forecast that it will grow by 3.8% to $3.54 in 2012, grow by 18.2% in 2013, and then decline by 17.1% in 2014. Assuming a multiple of 10.5x and a conservative 2013 EPS of $4.06, the rough intrinsic value of the stock is $42.63, implying a staggering 74.8% upside. It may take some time to get there, but the fundamentals are strong and overly discounted.

HollyFrontier similarly has significant upside. The company is still paying dividend through risk mitigation and financial improvement. Past investments in crude have also protected the firm in view of the narrowing WTI-Brent spread. I expect margins to actually hold steady as a result of low-cost feedstock and successful past investments.

Consensus estimates for HollyFrontier's EPS forecast that it will fall to $4.39 in 2012, and then by 29% more in the next year. Assuming a multiple of 10.5x and a conservative 2013 EPS of $4.31, the rough intrinsic value of the stock is $45.26, implying 33.5% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and prospectively commissioned. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence. Always discuss investments with a licensed professional before making any financial decision. Statements made within this report may include “forward-looking statements” as stipulated under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.