5 Reasons to Buy Holly Corporation

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 (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 (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

Comments

[Jake2]

Point #3, Emergency Methods, is speculative, and, of course, highly political, especially McCain's gasoline tax "holiday."

2008 Apr 28 11:14 AM

[wheels14]

I have several points of contention with this article. People were starving to death in Africa and Bangladesh when corn was $2/bushel. Ethanol is not causing the food shortages. Fuel prices are. If farmers in Iowa gave corn away for free, the poor in India would not be able to afford the cost of shipping it to India using $4.20/gallon diesel fuel.

South America does not produce ethanol from corn, and South America especialy Argentina, is an exporter of corn and other grains. If by "South America" you are refering to the cost of food in Mexico, I would point out that Mexico is the second largest supplier of oil to the United States, and their oil company is state owned. Mexico can affort to feed it's people from the profits of $118/barrel oil.

2008 Apr 28 03:40 PM

[Urbane Gorilla!]

Mexico's oil fields are expected to underperform and go into deficit mode by 2010. As Pemex supplies 60% of the cost of Mexico's welfare state, this bodes ill for the US oil supply (particularly the West Coast refiners) and the friendly government of Mexico. Also, expect an uptrend in illegal entries from south of the border if Mexico has to curtail it's support of the populace.

Thx jegan

2008 Apr 28 04:55 PM

[doubtful]

Good articel by Rosenman. How and when the political ramifications will play out with ethanol is an unknown. It'll probably take more food riots and chaos.
To wheels 14 I'd say: Go and tell a starving mob that you burn tons of corn in your SUV to go sight seeing - you'll get lynched/exterminated.

2008 Apr 29 12:51 AM