Slowing global economic conditions and the grinding-to-a-halt U.S. economy have driven crude prices down 15% YTD and affirmed the state of severely depressed natural gas prices (down 26.5% YTD and down 83.5% from the 2008 top), resulting in a broad-based decline in valuation across the energy sector. The sector is down 5.0% to 20.0%-plus, depending on the underlying business.
I have continued to read the calls to buy the "bottom" of oil, natural gas, and the sector broadly on Seeking Alpha and in other financial media outlets. I am not much for guessing the bottom, and I think most calls that attempt to call bottoms are merely guesses. That is especially true in energy, considering the complete uncertainty around the macroeconomic picture (applied specifically to oil, I wouldn't be surprised if oil were at $60.00/BBL or $120.00/BBL in 12 months, creating a binary outcome based on exogenous factors for exploration and production and oilfield services at the moment, which I specifically try to avoid as an investor). But I always look for value, and believe refiner HollyFrontier Corp. (HFC) represents a compelling long-term opportunity at the moment.
I like HFC for the following reasons:
- The company is awash in cash, with $1.9 billion on the balance sheet as of March 31, 2012. HFC has recourse debt of $687.8 million (the remaining $624.2 million in debt is consolidated up from 40%-plus-owned, publicly traded MLP Holly Energy Partners, L.P. (HEP), which is non-recourse to the assets of the HFC business). As HFC can support the full debt load with underlying EBITDA (LTM $2.1 billion), the $9.00 per share of cash on the balance sheet is fully available for shareholders.
- What has HFC been doing with the cash? Returning it to shareholders. The company has already declared four special dividends of $0.50 per share, raised the annual dividend to $0.60 per share, and authorized in January a $350.0 million share repurchase program. At $2.60 per share of dividends, the TTM dividend yield of over 8.0% makes HFC an attractive yield play (for at least the medium term, based on the company's financial flexibility).
- HFC owns 11.1 million common units of HEP (worth about $600 million) and the GP of HEP (worth between $250.0 million and $500.0 million), adding unlocked value (outside of the refining business) to the consolidated HFC enterprise and a dividend stream of cash flow to the parent company, HFC.
- HFC is undervalued. The company has $1.9 billion of debt, $0.7 billion of debt, and an equity market cap of $6.6 billion. Let's value the HEP interest at $875.0 million. The enterprise value of the business is $5.4 billion, before the HEP value. Strip out HEP, and HFC is being valued at $4.5 billion. The business did $2.1 billion of LTM EBITDA, but as a refiner should be valued against a midcycle number of $1.5 billion (which is conservative relative to the forward prospects for the business). At 3.0 times, an investment in HFC seems quite compelling.
- The current prospects for refiners broadly appear reasonable. Crude prices have moderated (which is good for product demand and can support margins), and motor gasoline and distillate stocks are operating below the five-year levels (with consistent demand and little erosion despite the economic backdrop). In the case of HFC specifically, the company's refiners are positioned near key share development regions in the U.S., creating the potential for above-average margin potential (lower cost of input relative to peers thanks to the strategic position) on a go-forward basis (assuming product demand holds).
- Management has done an excellent job operating the business (e.g., the merger, the value of HEP, and the reinvestment in facilities) and understands how to balance the interests of shareholders of stakeholders.
With the strong cash position that has been returned to shareholders, the reasonable forward prospects, and a compelling valuation, HFC appears to be a safe haven in the otherwise binary world of trying to guess bottoms in energy (for now).