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Much of the world is experiencing famine. Food riots are occurring in Egypt, Bangladesh, Haiti, and South America, to name a few. The use of corn to produce ethanol has been blamed in part for food scarcity and rising prices. Government leaders in South America, India, and the U.N. have called corn as a biofuel "a crime against humanity". Rising food shortages will pressure the United States to stop subsidizing ethanol as an energy source. Ultimately, I expect the Pope to weigh in and speak out against using food for fuel.

At that point, the hue and cry will be so great that the United States will be forced to reverse its energy policy and allow the refiners to stop blending ethanol into gasoline, and thereby increase demand for their refined products.

Of all the refiners, I see Holly Corporation (HOC) best poised to deliver the best earnings over the next two years. Holly and the oil refiners have had a dismal year to date as their profit margins have been hurt by higher oil prices.

The reason that should change (especially for HOC) are:

  1. Many refiners in the United States are giving up under the onslaught of federal regulation and high oil cost. They've cut back on projects to expand their refineries. Valero is considering selling a number of its refineries (speculation is that Petrobras may buy their Aruba refinery). They have cut production to 80% capacity (levels not seen since Katrina). This comes on top of the fact that no new refinery has been built since 1970. I think we are ripe for a squeeze in which there is a shortage of refined products (think HURRICANES -- something we're due for). Holly is out of the hurricane zone; moreover, one of its competitors, Alon (NYSE:ALJ), was forced to shut down a large nearby refinery.
  2. A large amount of gasoline is imported to the United States, about 10%. Last year, we imported 1.6 million bpd; now we bring in 0.9 million bpd. Some of the decrease is due to weaker demand in the U.S.; however, a lot is due to the increasing price of refined products abroad. The world is getting more competitive. Other areas of the world have increased their demand not only for oil but gasoline as well. Our dollar is getting weaker; their currency is becoming stronger. Shipping costs are increasing. I predict the United States will have difficulty supplying its gasoline needs due to global demand (weak dollar, high shipping costs) all of which will help HOC and the refiners.
  3. Emergency methods of getting fuel to customers will aid the refiners. A gas tax holiday will spur gasoline use. Allowing the strategic oil reserves to sell oil on the open market will lower oil costs and increase refinery margins and volumes.
  4. Some refineries have worked hard to be able to process lower grades of oil (sour, heavy). These more difficult and less desirable grades are cheaper to buy. Holly has been increasing its capacity to process these and will have greater margins. Holly also sells its sulfur credits on the open market and will (as it did last quarter) surprise the analysts to the upside.
  5. Holly is cheap cheap. Market cap is $2.1 billion with no debt and $250 million in cash. They own 45% of Holly Energy Partners (NYSE:HEP), a worth of $280 million. They own an asphalt company as well. That leaves a remaining value of about $1.5 billion for the 2 refineries they own, which I think undervalues this company. It trades at a PE of 7 with a PEG of 0.23. Holly, until the last half of the year, had been a darling of the market with high growth in its profits and earnings. I think it's about to return to their "glory" days.

Disclosure: Author is long HOC and short PEIX, VSE, AVR

Source: 5 Reasons to Buy Holly Corporation